Litigation; Commitments And Contingencies

6 Months Ended

Jun. 30, 2011

Litigation; Commitments And Contingencies [Abstract]

LITIGATION; COMMITMENTS AND CONTINGENCIES

NOTE 10 — LITIGATION; COMMITMENTS AND CONTINGENCIES

(a) LaJobi Customs, LaJobi Earnout and Asia Staffing Matters

In late December 2010, the Company’s LaJobi subsidiary was selected by U.S. Customs and Border Protection (“U.S. Customs”) for a “Focused Assessment” of its import practices and procedures, which Focused Assessment commenced on January 19, 2011. In preparing for the Focused Assessment, the Company found certain potential issues with respect to LaJobi’s import practices. As a result, the Board of Directors initiated an investigation, supervised by a Special Committee of three non-management members of the Board. The Board’s investigation found instances at LaJobi in which incorrect anti-dumping duties were applied on certain wooden furniture imported from vendors in the PRC, resulting in a violation of anti-dumping laws. On the basis of the investigation, the Board concluded that there was misconduct involved on the part of certain LaJobi employees in connection with the incorrect payment of duties, including misidentifying the manufacturer, shipper and description of products. As a result, effective March 14, 2011, LaJobi’s President, Lawrence Bivona, and LaJobi’s Managing Director of operations were both terminated from employment. Promptly upon becoming aware of the issues and related misconduct described above, the Company voluntarily disclosed its findings to the SEC on an informal basis and is cooperating with the Staff of the SEC. See “SEC Informal Investigation” below.

The Company expects to complete a voluntary prior disclosure to U.S. Customs identifying certain underpayments of anti-dumping duty, and remit payment of duty not paid, with interest thereon. Accordingly, the Company has recorded charges of approximately: (i) $6,860,000 (which includes approximately $340,000 of interest) for the quarter and year ended December 31, 2010; (ii) $382,000 (which includes approximately $55,000 of interest) for the quarter ended March 31, 2011; and (iii) $55,000 in related interest for the quarter ended June 30, 2011, in each case for duties (or related interest) the Company anticipates will be owed to U.S. Customs by LaJobi in respect of the matters discussed above. All of the foregoing charges were recorded in cost of sales (other than the interest portions, which were recorded in interest expense), and adversely affected gross margins and net (loss)/income for the affected periods. As the Focused Assessment is still pending, it is possible that the actual amount of duty owed for the period covered thereby will be higher upon completion thereof, and in any event, additional interest will continue to accrue on the amounts the Company currently anticipates the Company will owe until payment is made. In addition, the Company may be assessed by U.S. Customs a penalty of up to 100% of such duty owed, as well as possibly being subject to additional fines, penalties or other measures from U.S. Customs or other governmental authorities. The Company has discontinued the practices that resulted in the charge for anticipated anti-dumping duty, and the Company believes that its ability to procure the affected categories of wooden bedroom furniture will not be materially adversely affected in future periods. The Company is committed to working closely with U.S. Customs to address issues relating to incorrect duties. The Company has also initiated certain enhancements to its processes and procedures in areas where underpayments were found, and is reviewing these and possibly other remedial measures. In addition, there can be no assurance that the Company’s licensors, vendors and/or retail partners will not take adverse action under applicable agreements with the Company (or otherwise) as a result of the matters described above; however, to date, the Company is unaware of any such adverse actions.

As a result of the accrual recorded in the fourth quarter and year ended December 31, 2010 for anticipated duty (and interest thereon) owed by LaJobi to U.S. Customs and the facts and circumstances discovered in the Company’s preparation for the Focused Assessment and in its related investigation into LaJobi’s import practices described above (including misconduct on the part of certain employees at LaJobi), the Company concluded that no LaJobi Earnout Consideration (and therefore no finder’s fee) was payable. Accordingly, the Company did not record any amounts related thereto in the Company’s financial statements for the fourth quarter and year ended December 31, 2010. The Company previously disclosed a potential earnout payment of approximately $12 to $15 million in the aggregate relating to its acquisitions of LaJobi and CoCaLo, substantially all of which was estimated to relate to LaJobi.

On July 25, 2011, the Company received a letter from counsel to Lawrence Bivona demanding payment of the LaJobi Earnout Consideration to Mr. Bivona in the amount of $15 million. In addition, on July 25, 2011, the Company received a letter from counsel to Mr. Bivona alleging that Mr. Bivona’s termination by LaJobi “for cause”, effective March 14, 2011, violated his employment agreement and demanding payment to Mr. Bivona of amounts purportedly due under such employment agreement. The Company does not intend to pay the LaJobi Earnout Consideration to Mr. Bivona and believes that Mr. Bivona was properly terminated “for cause” pursuant to his employment agreement, and the Company has so advised counsel for Mr. Bivona. The Company intends to vigorously defend any related action that Mr. Bivona may bring. There can be no assurance that the Company will prevail in any such dispute, although the Company believes that, in any event, it would have additional claims that it could assert against the LaJobi seller and Mr. Bivona. The Company anticipates that cash flow from operations and anticipated availability under the Company’s credit facility will be sufficient to fund any duty, interest and potential penalties thereon, and any potential LaJobi Earnout Consideration and related finder’s fee, and such funding will be permitted under the terms of the New Credit Agreement and related documentation, but there can be no assurance that this will be the case.

Prior to the Company’s acquisition of LaJobi, Lawrence Bivona, the former President of LaJobi, Inc., along with various family members, established L&J Industries in Asia to provide quality control, compliance and certain other services to LaJobi for goods being shipped by LaJobi from Asian ports. Pursuant to the terms of a transition services agreement entered into in connection with the acquisition of LaJobi, commencing in April 2008, the Company utilized the full time services of approximately 28 individuals who were compensated by L&J Industries for such services. Beginning February, 2010, the Company paid for the services of some, and later all or substantially all, of the individuals who had previously been paid by L&J Industries (based in Hong Kong, China, Vietnam and Thailand), either directly to the individuals or through an individual based in Hong Kong. Companies retaining the services of individuals in these jurisdictions are subject to a variety of foreign laws. The Company has completed an internal investigation of its Asia payment and staffing practices and believes that its payments into Thailand may have violated a criminal law in that country that requires certain disclosures in connection with wire transfers into that country, and that its employment practices likely violated a criminal law in Hong Kong, in the category of a petty violation, that requires registration by foreign companies doing business in that country. In addition, the Company may have violated certain foreign regulatory, administrative and civil laws in connection with its payment and employment practices in Asia. However, the Company currently does not believe that such matters (individually or in the aggregate) will have a material adverse effect on the Company, and has not accrued any amounts to date in connection therewith. See “SEC Informal Investigation” below.

LaJobi has since discontinued the above-described manner of paying individuals providing such services in the PRC, Hong Kong and Thailand, and has taken corrective action by establishing interim arrangements (i.e., retaining the services of such individuals through a third-party outsource agency) which it believes are currently in compliance with applicable requirements in such jurisdictions, and is in the process of establishing subsidiaries in the PRC and Thailand through which the Company intends to directly employ the quality control individuals in these jurisdictions in the future. Although we believe that once these subsidiaries are fully established, the Company will be in compliance with applicable laws of the relevant Asian countries, no assurance can be given that applicable governmental authorities will concur with such a view and will not impose taxes or penalties or other measures with respect to staffing practices prior thereto.

(b) Customs Compliance Investigation

Following the discovery of the matters described above with respect to LaJobi, our Board authorized a review, supervised by the Special Committee and conducted by outside counsel, of customs compliance practices at the Company’s non-LaJobi operating subsidiaries, consisting of Kids Line, CoCaLo and Sassy (the “Customs Review”). Although such review is ongoing, based on work to date involving a sampling of customs filings, the Special Committee has identified instances in which these subsidiaries filed incorrect entries and invoices with U.S. Customs as a result of, in the case of Kids Line, incorrect descriptions, classifications and valuations of certain products imported by Kids Line and, in the case of CoCaLo, incorrect classifications of certain products imported by CoCaLo. As a result of these findings to date, the Company currently estimates that it will incur aggregate costs of approximately $2.4 million (pretax) relating to customs duty for the years ended 2006 through 2010 and the six months ended June 30, 2011. The impact on prior periods was deemed to be immaterial to the previously reported financial statements and therefore such amounts were accrued in the period they were identified (the quarter ended June 30, 2011). Of the amount accrued, the Company recorded $2.2 million in cost of sales and $0.2 million in interest expense for the three months ended June 30, 2011. As the Customs Review is still pending, it is possible that the actual amount of duty owed will be higher upon its completion and, in any event, additional interest will continue to accrue until payment is made. In addition, the Company may be assessed by U.S. Customs a penalty of up to 100% of any such duty owed, as well as possibly being subject to additional fines, penalties or other measures from U.S. Customs or other governmental authorities. Promptly after becoming aware of the foregoing, the Company submitted voluntary prior disclosures to U.S. Customs identifying such issues. Following the completion of the Customs Review, the Company intends to remit to U.S. Customs the amount of duties owed and any interest and penalties thereon. Our Board has also recently authorized an investigation, supervised by the Special Committee and conducted by a second outside counsel, to more fully review the customs practices at these operating subsidiaries, including whether there was any misconduct by personnel (the “Customs Investigation”). The Company has also voluntarily disclosed to the SEC the existence of the Customs Review and the Customs Investigation. Because the Customs Review and the Customs Investigation are ongoing, there can be no assurance as to how the resulting consequences, if any, may impact our internal controls, business, reputation, results of operations or financial condition.

(c) LaJobi-Related Litigations

Putative Class Action. On March 22, 2011, a complaint was filed in the United States District Court, District of New Jersey, encaptioned Shah Rahman v. Kid Brands, et al. (the “Putative Class Action”). The Putative Class Action is brought by one plaintiff on behalf of a putative class of all those who purchased or otherwise acquired the common stock of the Company between March 26, 2010 and March 15, 2011. In addition to KID, Bruce G. Crain, KID’s President, Chief Executive Officer and a member of KID’s board of directors, Guy A. Paglinco, KID’s Vice President and Chief Financial Officer, Raphael Benaroya, Mario Ciampi, Frederick J. Horowitz, Salvatore Salibello and Michael Zimmerman, each members of KID’s board of directors, as well as Lauren Krueger and John Schaefer, each a former member of KID’s board of directors, were named as defendants.

The Putative Class Action alleges one claim for relief pursuant to Section 10(b) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and Rule 10b-5 promulgated thereunder, and a second claim pursuant to the Exchange Act, claiming generally that the Company and/or the other defendants issued materially false and misleading statements during the relevant time period regarding compliance with customs laws, the Company’s financial reports and internal controls. The Putative Class Action does not state the size of the putative class. The Putative Class Action seeks compensatory damages but does not quantify the amount of damages sought. The Putative Class Action also seeks unspecified extraordinary and injunctive relief, the costs and disbursements of the lawsuit, including attorneys’ and experts’ fees and costs, and such equitable relief as the court deems just and proper. By order dated July 26, 2011, Shah Rahman was appointed lead plaintiff pursuant to Section 21D(a)(3)(B) of the Exchange Act. Based on that order the lead plaintiff is required to file a consolidated complaint by September 26, 2011. Defendants will have until November 10, 2011 to respond to the complaint.

The Company intends to defend the Putative Class Action vigorously, and has notified its insurance carriers of the existence of the action; however, no amounts have been accrued in connection therewith, although legal costs are being expensed as incurred.

Putative Shareholder Derivative Action. On May 20, 2011, a putative stockholder derivative complaint was filed by the City of Roseville Employees’ Retirement System in the United States District Court of the District of New Jersey (the “Putative Derivative Action”), against Bruce Crain, KID’s CEO, Guy Paglinco, KID’s CFO, Marc Goldfarb, KID’s Senior Vice President and General Counsel, each member of KID’s current Board of Directors, and John Schaefer, a former member of KID’s Board of Directors (collectively, the “Defendants”). In addition, KID has been named as a nominal defendant.

The Putative Derivative Action alleges, among other things, that the Defendants breached their fiduciary duties to the Company by allegedly failing to implement an internal controls system for compliance with US Customs laws for imported goods and applicable local foreign laws, and issuing false and misleading public statements about the Company’s related party transactions with the former owners of its LaJobi subsidiary and about its internal controls, all in violation of state law. In addition, the Putative Derivative Action alleges that such failures also constitute gross mismanagement, abuse of control and commission of corporate waste and resulted in unjust enrichment. The Putative Derivative Action seeks monetary damages against the individual Defendants in an unspecified amount together with interest, in addition to exemplary damages, the costs and disbursements of the lawsuit, including attorneys’ and experts’ fees and costs, and such equitable relief as the court deems just and proper.

The Company has notified its insurance carriers of the Putative Derivative Action. While the Company will incur costs in connection with the defense of this lawsuit (which costs are being expensed as incurred), the lawsuit does not seek monetary damages against the Company, and no amounts have been accrued in connection therewith. On July 25, 2011, the Company filed a motion to dismiss the complaint in this action. The motion is scheduled to be submitted to the court on September 19, 2011.

(d) SEC Informal Investigation

As noted above, the Company voluntarily disclosed to the SEC the findings of its internal investigation of LaJobi’s customs and Asia staffing practices. On June 20, 2011, the Company received a letter from the SEC indicating that the Staff was conducting an informal investigation and requesting that the Company provide certain documents on a voluntary basis. More recently, the Company voluntarily disclosed to the SEC the existence of the Customs Review and the Customs Investigation. The Company believes that it has fully cooperated, and will continue to fully cooperate, with the SEC. The Company is currently unable to predict the duration, resources required or outcome of the investigation or the impact such investigation may have on the Company’s financial condition or results of operations.

(e) TRC Landlord Litigation

In connection with the sale of KID’s former gift business in December 2008 (the “Gift Sale”), KID and Russ Berrie U.S. Gift, Inc. (“U.S. Gift”), KID’s subsidiary at the time (and currently a subsidiary of TRC), sent a notice of termination with respect to the lease (the “TRC Lease”), originally entered into by KID (and subsequently assigned to U.S. Gift) of a facility in South Brunswick, New Jersey. Although the TRC Lease became the obligation of TRC (through its ownership of U.S. Gift), KID remains potentially obligated for rental and other specified payments due thereunder (to the extent they are owed but have not been paid by U.S. Gift). On April 27, 2011, KID received a letter on behalf of the landlord under the TRC Lease (the “TRC Landlord”) demanding payment by KID of specified rent and other additional charges allegedly owed by U.S. Gift in an aggregate amount of approximately $5.9 million (including, among other things, approximately $3.8 million in rent and other charges for periods subsequent to the effective date of the termination of the TRC Lease (December 23, 2010), for which KID does not believe it is responsible, and approximately $1.0 million in specified repairs (“Repair Charges”)).

On July 18, 2011, the TRC Landlord filed a complaint in the Superior Court of New Jersey Law Division: Middlesex County, alleging that KID, having agreed via an assignment agreement to remain liable for the obligations of the tenant under the TRC Lease, has breached the TRC Lease and such assignment by failing to pay rent and other charges due and owing pursuant to the TRC Lease, in an aggregate amount of approximately $12 million as of June 11, 2011. The complaint also demands payment of costs in an unspecified amount, including late charges, pre-judgment interest and the TRC Landlord’s attorneys fees in connection with the action. The complaint provides no itemization of the amounts claimed to be due and owing under the TRC Lease; however, KID believes that such amounts likely reflect amounts specified in the demand letter, plus similar amounts accrued from the date of such letter through June 11, 2011 (although there can be no assurance that this is the case). KID believes that any liability it may have under the TRC Lease expired upon the date of its termination. To the extent that: (i) the rental and related amounts due and owing by U.S Gift under the TRC Lease for periods on or prior to the termination date thereof (“Pre-Termination Amounts”) are in fact due and owing, and no further amounts in respect of the TRC Lease are paid by the estate of TRC or U.S. Gift; (ii) no accommodation with respect to Pre-Termination Amounts is secured from the TRC Landlord; (iii) KID’s potential defenses to payment of Pre-Termination Amounts are not accorded any weight; (iv) KID is not required to pay any rental or related amounts other than Pre-Termination Amounts, and (v) no amounts paid in respect thereof by KID are reimbursed by TRC’s bankrupt estate, we currently estimate that KID’s potential liability for rental and related amounts under the TRC Lease is approximately $1.1 million and, accordingly, we have accrued such amount for the three and six month period ended June 30, 2011. With respect to the alleged Repair Charges, KID is currently unable to assess its potential liability therefor, if any, under the Lease. As a result, the aggregate amount of any payments that may potentially be required to be made by KID with respect to the TRC Lease cannot be ascertained at this time.

In addition to the proceedings described above, in the ordinary course of its business, the Company is from time to time party to various copyright, patent and trademark infringement, unfair competition, breach of contract, customs, employment and other legal actions incidental to the Company’s business, as plaintiff or defendant. In the opinion of management, the amount of ultimate liability with respect any such actions that are currently pending will not, individually or in the aggregate, materially adversely affect the Company’s consolidated results of operations, financial condition or cash flows. KID may also remain obligated with respect to certain contracts and other obligations of its former gift business that were not novated in connection with their transfer. No payments have been made by KID in connection with the contracts described in the preceding sentence as of June 30, 2011, nor is KID aware of any remaining potential obligations (other than the TRC Lease described above), but there can be no assurance that payments will not be required of KID in the future with respect thereto.

The Company has approximately $38.7 million in outstanding purchase commitments at June 30, 2011, consisting primarily of purchase orders for inventory.

The Company enters into various license and distribution agreements relating to trademarks, copyrights, designs, and products which enable the Company to market items compatible with its product line. Most of these agreements are for two- to five-year terms with extensions if agreed to by both parties. Several of these agreements require pre-payments of certain minimum guaranteed royalty amounts. The amount of minimum guaranteed royalty payments with respect to all license agreements pursuant to their original terms aggregates approximately $21.0 million, of which approximately $11.9 million remained unpaid at June 30, 2011. Royalty expense for the three and six months ended June 30, 2011, was $2.0 million, and $3.8 million, respectively. Royalty expense for the three and six months ended June 30, 2010 was $1.8 million, and $3.7 million, respectively.

As of June 30, 2011, the Company had obligations under certain letters of credit that require the Company to make payments to parties aggregating $0.1 million upon the occurrence of specified events.