SECURITIES AND EXCHANGE COMMISSION


WASHINGTON, D.C. 20549





FORM 10-Q





X

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the quarterly period ended September 30, 2010TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the transition period from _______ to ________





Commission file number:
0-22635





RC2 Corporation(Exact name of Registrant as specified in its charter)Delaware

36-4088307(State or other jurisdiction of incorporation or organization)

(IRS Employer Identification No.)1111 West 22nd Street, Suite 320, Oak Brook, Illinois  60523(Address of principal executive offices)Registrant’s telephone number, including area code:  630-573-7200





Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.





Yes
X

No





Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files).





Yes


No








Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Exchange Act Rule 12b-2.





Large accelerated filer
[     ]
Accelerated filer
[ X ]Non-accelerated filer
[     ]
Smaller reporting company
[     ](Do not check if a smaller reporting company)





Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).





Yes


No
X





On October 21, 2010, there were outstanding 21,646,409 shares of the Registrant’s $0.01 par value common stock.








2


RC2 CORPORATION





FORM 10-Q





SEPTEMBER 30, 2010





INDEX








PART I – FINANCIAL INFORMATION
PageItem 1.
Condensed Consolidated Balance Sheets as of September 30, 2010 and December 31, 2009
4Condensed Consolidated Statements of Earnings for the

Three and Nine Months Ended September 30, 2010 and 2009
5Condensed Consolidated Statements of Cash Flows for the

Nine Months Ended September 30, 2010 and 2009
6Notes to Condensed Consolidated Financial Statements
7Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
20Item 3.
Quantitative and Qualitative Disclosures about Market Risk
32Item 4.
Controls and Procedures
33PART II – OTHER INFORMATIONItem 1.
Legal Proceedings
34Item 1A.
Risk Factors
34Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
34Item 3.
Defaults Upon Senior Securities
34Item 4.
[Reserved]
34Item 5.
Other Information
34Item 6.
Exhibits
34Signatures
36


3


PART I – FINANCIAL INFORMATION





Item 1.  Financial Statements





RC2 Corporation and Subsidiaries


Condensed Consolidated Balance Sheets


(Unaudited and in thousands)





September 30,

2010


December 31,

2009AssetsCash and cash equivalents

$
49,223


$
88,049Accounts receivable, net


103,634



88,905Inventory


93,375



65,888Other current assets


12,421



18,171Total current assets


258,653



261,013Property and equipment, net


29,445



28,073Goodwill


18,719



---Intangibles, net


104,653



80,309Other non-current assets


6,956



6,390Total assets

$
418,426


$
375,785Liabilities and equityAccounts payable and accrued expenses

$
79,367


$
69,951Current maturities of bank term loan


7,500



---Other current liabilities


2,443



2,629Total current liabilities


89,310



72,580Bank term loan


33,750



41,250Other non-current liabilities


20,418



17,222Total liabilities


143,478



131,052Total equity


274,948



244,733Total liabilities and equity

$
418,426


$
375,785





See accompanying notes to condensed consolidated financial statements.


4


RC2 Corporation and Subsidiaries


Condensed Consolidated Statements of Earnings


(Unaudited and in thousands, except per share data)





For the three months ended

September 30,


For the nine months ended

September 30,2010


2009


2010


2009Net sales

$
128,974


$
126,507


$
303,178


$
299,814Cost of sales


75,577



67,785



174,389



169,687Gross profit


53,397



58,722



128,789



130,127Selling, general andadministrative expenses


34,747



36,757



97,695



96,594Amortization


435



153



963



514Operating income


18,215



21,812



30,131



33,019Interest expense


559



819



1,657



2,968Interest income


(193
)


(153
)


(665
)


(344
)Other (income) expense, net


(867
)


(311
)


(479
)


614Income before incometaxes


18,716



21,457



29,618



29,781Income tax expense


6,259



7,864



9,956



11,071Net income


12,457



13,593



19,662



18,710Less: net incomeattributable to non-controlling interest


44



---



44



---Net income attributable to common stockholders

$
12,413


$
13,593


$
19,618


$
18,710Earnings per share attributable to common stockholders:Basic

$
0.57


$
0.68


$
0.91


$
1.03Diluted

$
0.56


$
0.66


$
0.89


$
1.01Weighted average shares outstanding:Basic


21,636



20,078



21,535



18,215Diluted


22,118



20,602



22,049



18,517





See accompanying notes to condensed consolidated financial statements.





5


RC2 Corporation and Subsidiaries


Condensed Consolidated Statements of Cash Flows


(Unaudited and in thousands)





For the nine months ended

September 30,2010


2009Cash flows from operating activitiesNet income

$
19,662


$
18,710Depreciation and amortization


8,105



9,162Amortization of deferred financing costs


483



706Stock-based compensation


3,642



3,812Excess tax benefit on stock option exercises


(819
)


(16
)Loss on disposition of assets


23



129Changes in operating assets and liabilities, net of effects of acquisition


(26,951
)


8,299Net cash provided by operating activities


4,145



40,802Cash flows from investing activitiesPurchase of property and equipment


(8,295
)


(6,023
)Proceeds from disposition of property and equipment


26



33Acquisitions


(44,631
)


270Changes in other assets


3,726



(4,933
)Net cash used in investing activities


(49,174
)


(10,653
)Cash flows from financing activitiesSale of non-controlling interest


3,959



---Net cash proceeds from public stock offering


---



57,090Stock option repurchase and cancellation


(76
)


---Issuance of stock upon option exercises


820



45Excess tax benefit on stock option exercises


819



16Issuance of stock under ESPP


142



116Payments on bank term loan


---



(15,000
)Net payments on line of credit


---



(20,120
)Financing fees paid


---



(157
)Net cash provided by financing activities


5,664



21,990Effect of exchange rate changes on cash


539



2,544Net (decrease) increase in cash


(38,826
)


54,683Cash and cash equivalents, beginning of year


88,049



32,095Cash and cash equivalents, end of period

$
49,223


$
86,778Supplemental information:Interest paid

$
981


$
2,365Income taxes paid


3,351



4,595Income tax refunds received

$
1,098


$
2,145


See accompanying notes to condensed consolidated financial statements.


6


RC2 Corporation and Subsidiaries


Notes to Unaudited Condensed Consolidated Financial Statements





Note 1 – Basis of Presentation





The unaudited condensed consolidated financial statements include the accounts of RC2 Corporation and its subsidiaries (the Company or RC2).  All intercompany transactions and balances have been eliminated.





The accompanying unaudited condensed consolidated financial statements have been prepared by management, and in the opinion of management, contain all adjustments, consisting of normal recurring adjustments, necessary to present fairly the financial position of the Company as of September 30, 2010, the results of operations for the three-month and nine-month periods ended September 30, 2010 and 2009, and cash flows for the nine-month periods ended September 30, 2010 and 2009.





Certain information and note disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles have been omitted.  It is suggested that these condensed consolidated financial statements be read in conjunction with the consolidated financial statements and related notes included in the Company’s Form 10-K for the year ended December 31, 2009.  The condensed consolidated balance sheet information as of December 31, 2009, appearing herein, is derived from the consolidated balance sheet in the Form 10-K.





Due to the seasonality of the Company's business, the results of operations for interim periods are not necessarily indicative of the operating results for a full year.





Note 2 – Business Combinations





At the close of business on August 4, 2010, the Company acquired substantially all of the assets of White Pines, LLC (the JJ Cole Business), a Logan, Utah-based, privately-held, developer and marketer of mother, infant and toddler stylized travel, storage, comfort and convenience products marketed under the JJ Cole® Collections brand.  The acquired brands and products and the new additions to the Company’s management team will allow the Company to rapidly expand its presence in stylized and fashion-driven mother, infant and toddler products.  Closing consideration consisted of $44.6 million of cash, excluding transaction expenses, of which $4.0 million was provided by the sale of non-controlling interest, resulting in a net cash outlay by the Company of $40.7 million.





Concurrent with the acquisition of the JJ Cole Business, JJCC, Inc. (JJCC), a subsidiary of RC2 Corporation, was formed to acquire the assets of the JJ Cole Business.  RC2 Corporation holds an approximate 91.1% interest in JJCC.  The fair value of the non-controlling interest of $4.0 million in JJCC is provisional pending receipt of the final valuation.


7


Transaction expenses of $0.3 million are included in selling, general and administrative expenses in the accompanying condensed consolidated statements of earnings for the three months and nine months ended September 30, 2010.  The operating results of the JJ Cole Business have been included in the accompanying condensed consolidated statements of earnings since the acquisition date.  The excess of the aggregate purchase price over fair market value of net assets acquired of $18.5 million has been recorded as goodwill in the accompanying condensed consolidated balance sheet at September 30, 2010, and is expected to be fully deductible for income tax purposes.  The goodwill arising from the acquisition consists of the expected synergies with the Company’s mother, infant and toddler category.  All but $0.3 million of the goodwill has been recorded in the North America segment.





The following table summarizes the amounts of the assets acquired and liabilities assumed at the acquisition date:





(in thousands)Total purchase price

$
44,631Less:Current assets


1,710Property and equipment


175Intangible assets


25,065Liabilities


(807
)Total identifiable net assets


26,143Goodwill

$
18,488





The fair value of the identifiable intangible assets is provisional pending completion of the final valuations for those assets.  To the extent such assets are amortizable, the related amortization expense may vary from the approximate $0.2 million recorded on the accompanying condensed consolidated financial statements for the three months and nine months ended September 30, 2010.  The Company’s unaudited pro forma consolidated results of operations are not presented due to the immateriality of the JJ Cole Business results of operations.


Note 3 – Business Segments





The Company is a leading designer, producer and marketer of a broad range of innovative, high-quality products for mothers, infants and toddlers, as well as toys and collectible products sold to preschoolers, youths and adults.





The Company’s reportable segments under the requirements of Business Segments Topic of the FASB Accounting Standards Codification are North America and International.  The North America segment includes the United States, Canada and Mexico.  The International segment includes non-North America markets.





8


Segment performance is measured at the operating income level.  Segment assets are comprised of all assets, net of applicable reserves and allowances.  Certain assets and resources are jointly used between the North America and International segments.  Intercompany allocations of such uses are not made.





Results are not necessarily those that would be achieved if each segment were an unaffiliated business enterprise.  Information by segment and a reconciliation to reported amounts for the three months and nine months ended September 30, 2010 and 2009, are as follows:





Three Months Ended

September 30,(in thousands)

2010


2009Net sales:North America

$
96,615


$
99,471International


32,572



27,437Sales and transfers between segments


(213
)


(401
)Combined total

$
128,974


$
126,507Operating income:North America

$
10,726


$
16,268International


7,503



5,515Sales and transfers between segments


(14
)


29Combined total

$
18,215


$
21,812
  Nine Months Ended

June 30,(in thousands)

2010


2009Net sales:North America

$
222,638


$
232,195International


81,063



68,343Sales and transfers between segments


(523
)


(724
)Combined total

$
303,178


$
299,814Operating income:North America

$
14,833


$
22,743International


15,304



10,295Sales and transfers between segments


(6
)


(19
)Combined total

$
30,131


$
33,019
  (in thousands)

September 30,

2010


December 31,

2009Total Assets:North America

$
284,870


$
258,815International


133,556



116,970Combined total

$
418,426


$
375,785





9


Under the entity-wide disclosure requirements of the Business Segments Topic of the FASB Accounting Standards Codification, the Company reports net sales by product category and by distribution channel.  The Company groups its products into two product categories: mother, infant and toddler products, and preschool, youth and adult products.  The following table presents consolidated net sales by product category and by distribution channel for the three months and nine months ended September 30, 2010 and 2009:





Three Months Ended

September 30,(in thousands)

2010


2009Mother, infant and toddler products

$
50,688


$
44,718Preschool, youth and adult products


78,286



81,789Net sales

$
128,974


$
126,507Chain retailers

$
91,986


$
93,117Specialty retailers, wholesalers, OEM dealers and other


36,988



33,390Net sales

$
128,974


$
126,507





Nine Months Ended

September 30,(in thousands)

2010


2009Mother, infant and toddler products

$
144,854


$
137,688Preschool, youth and adult products


158,324



162,126Net sales

$
303,178


$
299,814Chain retailers

$
221,906


$
224,681Specialty retailers, wholesalers, OEM dealers and other


81,272



75,133Net sales

$
303,178


$
299,814





Note 4 – Goodwill and Intangible Assets





The carrying value of goodwill by reporting unit as of September 30, 2010, is shown below:





(in thousands)

North America


International


TotalBalance at December 31, 2009

$
---


$
---


$
---JJ Cole Business fair value allocation


18,188



300



18,488Other adjustments


225



6



231Balance at September 30, 2010

$
18,413


$
306


$
18,719








10


The components of intangible assets, net are as follows:





(in thousands)

September 30,

2010


December 31,

2009Gross amounts of amortizable intangible assets:Licenses and trademarks

$
20,132


$
1,998Customer relationships


15,425



8,582Other


3,101



2,98838,658



13,568Accumulated amortization of amortizable

intangible assets:Licenses and trademarks


1,252



897Customer relationships


1,465



1,172Other


2,987



2,9195,704



4,988Intangible assets not subject to amortization:Licenses and trademarks


71,699



71,729Total intangible assets, net

$
104,653


$
80,309





Other amortizable intangible assets consist primarily of patents and non-compete agreements.  The fair value of the identifiable intangible assets of the JJ Cole Business acquired during the third quarter of 2010 is provisional pending completion of the final valuations for those assets.  To the extent such assets are amortizable, the related amortization expense may vary from the approximate $0.2 million recorded on the accompanying condensed consolidated financial statements for the three months and nine months ended September 30, 2010.  Amortization expense related to amortizable intangible assets for 2010 is estimated to be approximately $1.2 million.





Note 5 – Income Taxes





The uncertain tax positions were $2.3 million and $2.8 million as of September 30, 2010 and December 31, 2009, respectively.  At September 30, 2010 and December 31, 2009, approximately $2.1 million and $2.2 million, respectively, of the total gross unrecognized tax benefits represent the amount that, if recognized, would affect the effective income tax rate in future periods.  The Company and its subsidiaries are subject to U.S. federal income tax, as well as income tax of multiple state and foreign jurisdictions.  The Company has substantially concluded all U.S. federal income tax matters for years through 2008.  Substantially all material state and local and foreign income tax matters have been concluded for years through 2005.  In the next twelve months, the Company expects to reduce the unrecognized tax position reserves by approximately $1.0 million, primarily due to the settlement of international rulings and the closing of various statutes.  The Company’s continuing practice is to recognize interest and/or penalties related to income tax matters in income tax expense.  During the nine months ended September 30, 2010, the Company recorded an increase to interest of $0.1 million and reversed $0.1 million for potential penalties, related to these unrecognized tax benefits.


11


In total, as of September 30, 2010 and December 31, 2009, the Company has recorded a liability for interest of $2.3 million and $2.2 million, respectively, and a liability for potential penalties of $0.3 million and $0.4 million, respectively.





Note 6 – Debt





The Company’s credit facility is comprised of a term loan and provides for borrowings up to $70.0 million under a revolving line of credit.  The total borrowing capacity available under the credit facility is subject to a formula based on the Company’s leverage ratio, as defined in the credit agreement.  The term loan and the revolving line of credit both have a scheduled maturity date of November 1, 2011.  Under this credit facility, the term loan and the revolving line of credit bear interest, at the Company’s option, at a base rate or at LIBOR, plus applicable margins, which are based on the Company’s leverage ratio.  Applicable margins vary between 2.25% and 3.25% on LIBOR borrowings and 1.25% and 2.25% on base rate borrowings.  At September 30, 2010, the applicable margins in effect were 2.25% for LIBOR borrowings and 1.25% for base rate borrowings.  Principal payments on the term loan are $3.8 million per calendar quarter, with the remaining principal of $33.8 million due on November 1, 2011.  During the fourth quarter of 2009, the Company prepaid $18.8 million on its term loan, with the next quarterly principal payment of $3.8 million due on June 30, 2011.  The Company is also required to pay a commitment fee which varies from 0.45% and 0.50% per annum on the average daily unused portion of the revolving line of credit.  At September 30, 2010, the commitment fee in effect was 0.45% per annum.





Under the terms of this credit facility, the Company is required to comply with certain financial and non-financial covenants.  Among other restrictions, the Company is restricted in its ability to pay dividends, buy back its stock, incur additional debt and make acquisitions above certain amounts.  The credit facility also includes a clean down provision that limits the maximum amount of borrowings under the revolving line of credit for a period of 60 consecutive days during the first four calendar months.  The Company has met its clean down provision for the year 2010. The remaining clean down provision limit consists of $25.0 million for a period of 60 consecutive days during the first four calendar months of 2011.   The credit facility is secured by the Company’s domestic assets along with a portion of the Company’s equity interests in its foreign subsidiaries.  On September 30, 2010, the Company had $41.3 million outstanding on its bank term loan and no borrowings under its revolving line of credit.  At September 30, 2010, the Company had $69.6 million available on its revolving line of credit and was in compliance with all covenants.





Note 7 – Commitments and Contingencies





The Company leases office and warehouse/distribution space under various non-cancelable operating lease arrangements, which expire through November 30, 2019.





12


The Company markets a significant portion of its products under licenses from other parties.  These licenses are limited in scope and duration and authorize the sale of specific licensed products generally on a nonexclusive basis.  The Company has license agreements with, among others, various entertainment, publishing and media companies, automotive and truck manufacturers, and agricultural and construction vehicle and equipment manufacturers.  The Company is a party to more than 250 license agreements with terms generally of two to three years.  Many of the license agreements include minimum guaranteed royalty payments that the Company must pay whether or not it meets specified sales targets.  The Company believes it either achieved its minimum guarantees or has accrued for the costs related to these guarantees for the nine months ended September 30, 2010 and 2009.





Note 8 – Legal Proceedings





The Company has certain contingent liabilities resulting from litigation and claims incident to the ordinary course of business.  Management believes that the probable resolution of such contingencies will not materially affect the Company’s financial position or results of operations.





Note 9 – Common Stock





Authorized and outstanding shares and the par value of the Company’s voting common stock are as follows:





(in thousands, except par value)
Authorized

Shares

Par

Value
Shares

Outstanding

at

September

30, 2010
Shares

Outstanding

at

December

31, 2009Voting common stock
28,000

$0.01
21,643
21,384





The Company held 2.9 million shares of its common stock in treasury at both September 30, 2010 and December 31, 2009.  During the nine months ended September 30, 2010 and 2009, the Company sold a total of 9,580 shares and 20,737 shares, respectively, out of treasury to Company employees under the Employee Stock Purchase Plan (ESPP) for $0.1 million in each period.





13


Note 10 – Stock-Based Payment Arrangements





At September 30, 2010, the Company has three stock incentive plans, two of which are dormant, and an ESPP. Amounts recognized in the condensed consolidated financial statements with respect to these stock-based payment arrangements for the three months and nine months ended September 30, 2010 and 2009, are as follows:





Three Months Ended

September 30,(in thousands)

2010


2009Total expense recognized for stock-basedpayment plans

$
1,486


$
1,466Amount of related income tax benefit recognized indetermining net income

$
564


$
516





Nine Months Ended

September 30,(in thousands)

2010


2009Total expense recognized for stock-basedpayment plans

$
3,642


$
3,812Amount of related income tax benefit recognized indetermining net income

$
1,370


$
1,314





Stock-based compensation expense is included in cost of sales and selling, general and administrative expenses in the accompanying condensed consolidated statements of earnings for the three months and nine months ended September 30, 2010 and 2009.





14


Restricted stock awards, restricted stock units (RSUs), options to purchase stock or stock-settled and cash-settled stock appreciation rights (SARs) may be granted under the current stock incentive plan.  A summary of stock option and stock-settled SAR activity for the Company’s stock incentive plans for the nine months ended September 30, 2010, is as follows:





Number

of Shares


Weighted

Average

Exercise

Price


Weighted

Average

Remaining Contractual

Life


Aggregate

Intrinsic

Value

(000)Outstanding, beginning of year


2,534,005


$
14.76Changes during the period:Granted


360,000



17.04Exercised


237,782



4.88Forfeited


12,400



8.04Expired


400



20.23Outstanding, end of period


2,643,423


$
15.99



7.0


$
19,044Exercisable and vested as ofSeptember 30, 2010


1,262,434


$
19.87






$
6,608Expected to vest


1,374,829



12.46







12,363Total vested and expected to vest


2,637,263


$
16.01



7.0


$
18,971





A summary of cash-settled SAR activity for the Company’s stock incentive plans for the nine months ended September 30, 2010, is as follows:





Number

of Shares


Weighted

Average

Exercise

Price


Weighted

Average

Remaining

Contractual

Life


Aggregate

Intrinsic

Value

(000)Outstanding, beginning of year


---


$
---Changes during the period:Granted


207,000



16.03Forfeited


8,500



14.90Outstanding, end of period


198,500


$
16.09



9.2


$
966Exercisable and vested as ofSeptember 30, 2010


---


$
---






$
---Expected to vest


195,093



16.10







945Total vested and expected to vest


195,093


$
16.10



9.5


$
945





15


The total fair value of options and SARs vested during the nine months ended September 30, 2010, was $2.9 million.  As of September 30, 2010, there was $8.9 million of total unrecognized compensation cost related to nonvested stock-based compensation arrangements granted under the Company’s stock incentive plans for stock options and SARs.  That cost is expected to be recognized over a weighted average period of 2.3 years.





A summary of restricted stock awards for the Company’s stock incentive plans for the nine months ended September 30, 2010, is as follows:





Number

of Shares


Weighted

Average

Fair Value

Weighted

Average

Remaining

Contractual

LifeUnvested restricted stock awards, beginning of year


91,236


$
14.44Changes during the period:Granted


32,800



18.29Vested


49,866



16.19Unvested restricted stock awards, end of period


74,170


$
14.97

2.1





As of September 30, 2010, there was $0.9 million of total unrecognized compensation cost related to nonvested stock-based compensation arrangements granted under the Company’s stock incentive plans for restricted stock awards.  That cost is expected to be recognized over a weighted average period of 2.1 years.





During the nine months ended September 30, 2010, performance-based RSUs were granted to employees, which entitle the holder to receive one share of common stock for each performance-based RSU which is earned.    The performance goals require compounded annual growth in the Company’s EBITDA (as defined in the grant agreements) over a three-year period ending December 31, 2012.  If the minimum threshold is not achieved, none of the performance-based RSUs will be earned.  If the minimum threshold amount of cumulative three-year EBITDA for this period is achieved, then 37.5% of the performance-based RSUs are earned.  If cumulative three-year EBITDA exceeds the minimum threshold, additional performance-based RSUs will be earned above 37.5% on a pro-rata basis up to the maximum number of performance-based RSUs granted, which is 140,000 performance-based RSUs.   Stock-based compensation expense has been recognized during the nine months ended September 30, 2010, based upon an estimate of 52,500 performance-based RSUs expected to be earned at the end of the three-year measurement period.  The weighted average fair value at the date of grant for these performance-based RSUs is $18.29.  As of September 30, 2010, there was $0.8 million of total unrecognized compensation cost related to nonvested stock-based compensation arrangements granted under the Company’s stock incentive plans for performance-based RSUs.  That cost is expected to be recognized over a weighted average period of 2.3 years.





16


Note 11 – Employee Benefit Plans





The Company maintains a funded, noncontributory defined benefit pension plan (the Plan) that covers a select group of the Company’s workforce covered by a collective bargaining agreement who were hired prior to January 1, 2002.  The Plan provides defined benefits based on the employees’ years of service.





The components of net periodic benefit cost for the three months and nine months ended September 30, 2010 and 2009, are as follows:





Three Months Ended

September 30,(in thousands)

2010


2009Service cost

$
42


$
31Interest cost


221



223Expected return on plan assets


(259
)


(242
)Amortization of prior service costs


5



4Amortization of net loss


126



57Net periodic benefit cost

$
135


$
73





Nine Months Ended

September 30,(in thousands)

2010


2009Service cost

$
126


$
94Interest cost


664



668Expected return on plan assets


(777
)


(728
)Amortization of prior service costs


14



14Amortization of net loss


379



173Net periodic benefit cost

$
406


$
221





The Company did not make any contributions to the Plan during the nine months ended September 30, 2010, and currently does not expect to make any additional contributions during the remainder of 2010.





Note 12 – Reclassifications





Certain prior year amounts have been reclassified to conform to the current year presentation.





Note 13 – Use of Estimates





The preparation of the financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes.  Actual results could differ from those estimates.





17


Note 14 – Comprehensive Income





The Company reports comprehensive income in accordance with the requirements of the Comprehensive Income Topic of the FASB Accounting Standards Codification, which requires companies to report all changes in equity during a period, except those resulting from investment by owners and distributions to owners, in a financial statement for the period in which they are recognized.  Comprehensive income for the nine months ended September 30, 2010 and 2009, is calculated as follows:





Nine Months Ended

September 30,(in thousands)

2010


2009Net income

$
19,662


$
18,710Other comprehensive income – foreign currencytranslation adjustments


1,517



7,903Comprehensive income


21,179



26,613Less: Comprehensive income attributable tonon-controlling interest


44



---Comprehensive income attributable tocommon stockholders

$
21,135


$
26,613





Note 15 – Earnings Per Share Attributable to Common Stockholders





The Company computes earnings per share attributable to common stockholders in accordance with the requirements under the Earnings Per Share Topic of the FASB Accounting Standards Codification.  Under the provisions of this Topic, basic earnings per share attributable to common stockholders is computed by dividing net income attributable to common stockholders for the period by the weighted average number of common shares outstanding during the period.  Diluted earnings per share attributable to common stockholders is computed by dividing net income attributable to common stockholders for the period by the weighted average number of common and common equivalent shares outstanding during the period.


18


The following table discloses the components of earnings per share attributable to common stockholders for the three months and nine months ended September 30, 2010 and 2009:








Three Months Ended

September 30,(in thousands, except per share data)

2010


2009Net income attributable to common stockholders

$
12,413


$
13,593Weighted average common and commonequivalent shares outstanding:Weighted average common shares outstanding


21,636



20,078Add effect of diluted securities – assumedexercise of stock options and stock-settled SARs


482



524Weighted average common and commonequivalent shares outstanding


22,118



20,602Earnings per share attributable to common stockholders:Basic

$
0.57


$
0.68Diluted

$
0.56


$
0.66





Nine Months Ended

September 30,(in thousands, except per share data)

2010


2009Net income attributable to common stockholders

$
19,618


$
18,710Weighted average common and commonequivalent shares outstanding:Weighted average common shares outstanding


21,535



18,215Add effect of diluted securities – assumedexercise of stock options and stock-settled SARs


514



302Weighted average common and commonequivalent shares outstanding


22,049



18,517Earnings per share attributable to common stockholders:Basic

$
0.91


$
1.03Diluted

$
0.89


$
1.01





Options and stock-settled SARs to purchase 1,307,383 shares and 1,264,609 shares of common stock were outstanding during the three months ended September 30, 2010 and 2009, respectively, but were not included in the computation of diluted earnings per share attributable to common stockholders because the options and stock-settled SARs were anti-dilutive.  Options and stock-settled SARs to purchase 1,307,383 shares and 1,369,356 shares of common stock were outstanding during the nine months ended September 30, 2010 and 2009, respectively, but were not included in the computation of diluted earnings per share attributable to common stockholders because the options and stock-settled SARs were anti-dilutive.


19


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





The following is a discussion and analysis of the Company’s results of operations, financial condition, liquidity and capital resources.  The discussion and analysis should be read in conjunction with the Company’s unaudited condensed consolidated financial statements and notes thereto included elsewhere herein.





RESULTS OF OPERATIONS





Operating Highlights





Net sales for the three months ended September 30, 2010, increased 2.0% compared to net sales for the three months ended September 30, 2009.  Gross profit margin decreased to 41.4% for the three months ended September 30, 2010, from 46.4% for the three months ended September 30, 2009.  Higher input costs, including ocean transportation costs, along with China labor and currency inflation, continue to put pressure on the Company’s margins.  Selling, general and administrative expenses, as a percentage of net sales, decreased to 26.9% for the three months ended September 30, 2010, from 29.1% for the three months ended September 30, 2009.  Operating income was $18.2 million for the three months ended September 30, 2010, compared to $21.8 million for the three months ended September 30, 2009.  As a percentage of net sales, operating income was 14.1% for the three months ended September 30, 2010, compared to 17.2% for the three months ended September 30, 2009.





Net sales for the nine months ended September 30, 2010, increased 1.1% compared to net sales for the nine months ended September 30, 2009.  Gross profit margin decreased to 42.5% for the nine months ended September 30, 2010, from 43.4% for the nine months ended September 30, 2009.  Selling, general and administrative expenses, as a percentage of net sales, remained unchanged at 32.2% for the nine months ended September 30, 2010 and 2009.  Operating income was $30.1 million for the nine months ended September 30, 2010, compared to $33.0 million for the nine months ended September 30, 2009.  As a percentage of net sales, operating income was 9.9% for the nine months ended September 30, 2010, compared to 11.0% for the nine months ended September 30, 2009.





On September 29, 2010, the U.S. Consumer Product Safety Commission and the U.S. Food and Drug Administration issued a blanket warning related to all infant sleep positioners.  The Company has had no reported injuries from its line of Airflow® infant sleep positioners, but has stopped production of these products and is cooperating with retailers who request product returns.  Accordingly, the results of operations for the three months and nine months ended September 30, 2010, include amounts relating to estimated retailer product returns, write-down of existing inventory and other related costs totaling $2.0 million.  Annualized 2010 net sales of Airflow infant sleep positioners represent less than 1% of consolidated net sales.





20


At the close of business on August 4, 2010, the Company acquired substantially all of the assets of White Pines, LLC (the JJ Cole Business), a Logan, Utah-based, privately-held, developer and marketer of mother, infant and toddler stylized travel, storage, comfort and convenience products marketed under the JJ Cole® Collections brand.  The acquired brands and products and the new additions to the Company’s management team will allow the Company to rapidly expand its presence in stylized and fashion-driven mother, infant and toddler products.  Closing consideration consisted of $44.6 million of cash, excluding transaction expenses, of which $4.0 million was provided by non-controlling interest, resulting in a net cash outlay by the Company of $40.7 million.  Concurrent with the acquisition of the JJ Cole Business, JJCC, Inc. (JJCC), a subsidiary of RC2 Corporation, was formed to acquire the assets of the JJ Cole Business.  RC2 Corporation holds an approximate 91.1% interest in JJCC.  Transaction expenses of $0.3 million are included in selling, general and administrative expenses in the accompanying condensed consolidated statements of earnings for the three months and nine months ended September 30, 2010.  The operating results of the JJ Cole Business have been included in the accompanying condensed consolidated statements of earnings since the acquisition date.





Three Months Ended September 30, 2010, Compared to Three Months Ended September 30, 2009





Net sales.  Net sales for the three months ended September 30, 2010, increased $2.5 million, or 2.0%, to $129.0 million from $126.5 million for the three months ended September 30, 2009.  Net sales in the Company's North America segment decreased 2.9% and net sales in the Company's international segment increased 18.7%, which includes a 2.1% negative impact in changes from currency exchange rates.  Infant sleep positioner estimated retailer product returns negatively impacted net sales by 0.6%.  Foreign currency exchange rate fluctuations had no significant impact on consolidated net sales for the three months ended September 30, 2010.





Net sales in the Company's mother, infant and toddler products category increased 13.4% due to increases in The First Years® feeding and gear product lines, Lamaze infant development toys and the acquisition of the JJ Cole Business.  Organic net sales (net sales of products other than products of the JJ Cole Business) in the Company's mother, infant and toddler products category grew by over 6%.  Net sales in the Company's preschool, youth and adult products category decreased 4.3% due to declines in the discontinued Take Along Thomas & Friends die-cast product line.  Excluding the net impact from discontinued product lines of $16.2 million in the three months ended September 30, 2010 and 2009, net sales in the Company's preschool, youth and adult products category increased 19.4%, due to increases from the Chuggington, Dinosaur Train and Thomas & Friends Early EngineersTM product lines. Information in this paragraph regarding net sales in the Company's preschool, youth and adult products category excluding discontinued product lines constitutes non-GAAP financial information.  See the discussion of “Non-GAAP Financial Information” below.





21


A reconciliation to the nearest GAAP financial measure follows:





Net Sales(in thousands)
2010

2009

Difference


% ChangePreschool, youth and adult products actual

$
78,286


$
81,789


$
(3,503
)


(4.3
%)Deduct: discontinued product lines


362



16,525



(16,163
)


(97.8
%)As adjusted

$
77,924


$
65,264


$
12,660



19.4
%





Gross profit.  Gross profit decreased $5.3 million, or 9.0%, to $53.4 million for the three months ended September 30, 2010, from $58.7 million for the three months ended September 30, 2009.  As a percentage of net sales, gross profit margin decreased to 41.4% for the three months ended September 30, 2010, from 46.4% for the three months ended September 30, 2009.  Infant sleep positioners estimated retailer product returns and inventory charges reduced gross margin by 1.2 percentage points.  The remaining gross margin decrease was primarily due to unfavorable product cost and sales mix, as well as increased promotional allowances and transportation costs.  The Company's quarterly gross margins can be affected by the mix of product that is shipped during each quarter.  The Company's mother, infant and toddler products category has higher sales of non-licensed products that carry lower selling prices and gross margins that vary significantly and cause quarterly fluctuations, based on the timing of these individual shipments throughout the year.  There were no major changes in the components of cost of sales.





Selling, general and administrative expenses.  Selling, general and administrative expenses decreased $2.1 million, or 5.7%, to $34.7 million for the three months ended September 30, 2010, from $36.8 million for the three months ended September 30, 2009.  Selling, general and administrative expenses, as a percentage of net sales, decreased to 26.9% for the three months ended September 30, 2010, from 29.1% for the three months ended September 30, 2009.  The decrease in selling, general and administrative expenses is primarily due to lower royalty and other variable costs.  Because of the Company's 50% interest in Chuggington’s intellectual property rights, the Company is benefitting from effectively lower net royalty expense related to Chuggington product sales as compared with its other licensed preschool products.





Operating income.  Operating income was $18.2 million for the three months ended September 30, 2010, compared to $21.8 million for the three months ended September 30, 2009.  As a percentage of net sales, operating income was 14.1% for the three months ended September 30, 2010, compared to 17.2% for the three months ended September 30, 2009.  Operating income for the three months ended September 30, 2010, includes $2.0 million of estimated retailer product returns, inventory charges and costs related to infant sleep positioners, as well as $0.3 million of acquisition-related costs.





Interest expense.  Interest expense of $0.6 million and $0.8 million for the three months ended September 30, 2010 and 2009, respectively, relates primarily to borrowings under the Company's credit facility.  The decrease in interest expense is due to lower average debt outstanding.





22


Interest income and Other (income) expense, net.  Interest income remained consistent at $0.2 million for the three months ended September 30, 2010 and 2009.  Other income, net, increased to $0.9 million for the three months ended September 30, 2010, from $0.3 million for the three months ended September 30, 2009, primarily as a result of net favorable currency transactions.





Income tax expense.  Income tax expense for the three months ended September 30, 2010 and 2009, includes provisions for federal, state and foreign income taxes at an effective rate of 33.4% and 36.7%, respectively, including discrete items.  Discrete items include significant, infrequent, unusual or non-recurring items.  The effective tax rate for the three months ended September 30, 2009, was unfavorably impacted principally by non-deductible discrete tax items.





Adjusted EBITDA.  Adjusted EBITDA decreased $0.9 million to $26.0 million for the three months ended September 30, 2010, from $26.9 million for the three months ended September 30, 2009.  Information in this paragraph regarding Adjusted EBITDA constitutes non-GAAP financial information.  See the discussion of “Non-GAAP Financial Information” and “Adjusted EBITDA” below.  A calculation of Adjusted EBITDA follows:





Three Months Ended

September 30,(in thousands)

2010


2009Income before income taxes

$
18,716


$
21,457Depreciation


2,423



2,932Amortization


435



153Stock-based compensation expense


1,486



1,466(Gain) loss on sale of fixed assets


(4
)


51Interest expense


559



819Infant sleep positioners product charges


2,045



---Acquisition-related costs


305



---Adjusted EBITDA

$
25,965


$
26,878





Nine Months Ended September 30, 2010, Compared to Nine Months Ended September 30, 2009





Net sales.  Net sales for the nine months ended September 30, 2010, increased $3.4 million, or 1.1%, to $303.2 million from $299.8 million for the nine months ended September 30, 2009.  Net sales in the Company's North America segment decreased 4.1% and net sales in the Company's international segment increased 18.6%, which includes a 5.4% positive impact in changes from currency exchange rates.  Overall, favorable fluctuations in foreign currency exchange rates increased the Company's net sales by approximately 1.5% for the nine months ended September 30, 2010, as compared to the nine months ended September 30, 2009.





23


Net sales in the Company's mother, infant and toddler products category increased 5.2%, primarily driven by higher sales in The First Years gear and feeding product lines, Lamaze infant development toys and the acquisition of the JJ Cole Business, partially offset by a decrease in the Company's infant and toddler care product lines.  Net sales in the Company's preschool, youth and adult products category decreased 2.3%, driven by increases in the Company's new product lines such as Chuggington, Dinosaur Trainand Thomas & Friends Early Engineers, which were more than offset by declines from the Company's sell-off product line Take Along Thomas & Friendsdiecast.  Excluding the net impact from discontinued product lines of $25.0 million in the nine months ended September 30, 2010 and 2009, net sales in the Company's preschool, youth and adult products category increased 17.0%. Information in this paragraph regarding net sales in the Company's preschool, youth and adult products category excluding discontinued product lines constitutes non-GAAP financial information.  See the discussion of “Non-GAAP Financial Information” below.





A reconciliation to the nearest GAAP financial measure follows:





Net Sales(in thousands)
2010

2009

Difference


% ChangePreschool, youth and adult products actual

$
158,324


$
162,126


$
(3,802
)


(2.3
%)Deduct: discontinued product lines


12,600



37,610



(25,010
)


(66.5
%)As adjusted

$
145,724


$
124,516


$
21,208



17.0
%





Gross profit.  Gross profit decreased $1.3 million, or 1.0%, to $128.8 million for the nine months ended September 30, 2010, from $130.1 million for the nine months ended September 30, 2009.  As a percentage of net sales, gross profit margin decreased to 42.5% for the nine months ended September 30, 2010, from 43.4% for the nine months ended September 30, 2009.  Infant sleep positioners estimated retailer product returns and inventory charges decreased gross margin by 0.5 percentage points.  The remaining gross margin decrease was primarily due to unfavorable product cost and sales mix, as well as increased promotional allowances and transportation costs.  There were no major changes in the components of cost of sales.





Selling, general and administrative expenses.  Selling, general and administrative expenses increased $1.1 million, or 1.1%, to $97.7 million for the nine months ended September 30, 2010, from $96.6 million for the nine months ended September 30, 2009.  Selling, general and administrative expenses, as a percentage of net sales, remained unchanged at 32.2% for the nine months ended September 30, 2010 and 2009.  The increase in selling, general and administrative expenses is primarily due to increased marketing and legal expenses, partially offset by lower royalty costs.





24


Operating income.  Operating income was $30.1 million for the nine months ended September 30, 2010, compared to $33.0 million for the nine months ended September 30, 2009.  As a percentage of net sales, operating income was 9.9% for the nine months ended September 30, 2010, compared to 11.0% for the nine months ended September 30, 2009.  Operating income for the nine months ended September 30, 2010, includes $2.0 million of estimated retailer product returns, inventory charges and costs related to infant sleep positioners, as well as $0.3 million of acquisition-related costs.





Interest expense.  Interest expense of $1.7 million and $3.0 million for the nine months ended September 30, 2010 and 2009, respectively, relates primarily to borrowings under the Company's credit facility.  The decrease in interest expense is primarily due to lower average debt outstanding.





Interest income and Other (income) expense, net.  Interest income increased to $0.7 million for the nine months ended September 30, 2010, from $0.3 million for the nine months ended September 30, 2009.  Other income, net of $0.5 million for the nine months ended September 30, 2010, increased compared to other expense, net of $0.6 million for the nine months ended September 30, 2009, primarily as a result of net favorable currency transactions.





Income tax expense.  Income tax expense for the nine months ended September 30, 2010 and 2009, includes provisions for federal, state and foreign income taxes at an effective rate of 33.6% and 37.2%, respectively, including discrete items.  The decline was due to the nine month 2009 effective rate unfavorably impacted by non-deductible discrete tax items and lower 2010 estimated full year tax rate recognition.  Discrete items include significant, infrequent, unusual or non-recurring items.





Adjusted EBITDA.  Adjusted EBITDA decreased $0.5 million to $45.4 million for the nine months ended September 30, 2010, from $45.9 million for the nine months ended September 30, 2009.  Information in this paragraph regarding Adjusted EBITDA constitutes non-GAAP financial information.  See the discussion of “Non-GAAP Financial Information” and “Adjusted EBITDA” below.  A calculation of Adjusted EBITDA follows:





Nine Months Ended

September 30,(in thousands)

2010


2009Income before income taxes

$
29,618


$
29,781Depreciation


7,142



8,648Amortization


963



514Stock-based compensation expense


3,642



3,812Loss on sale of fixed assets


23



129Interest expense


1,657



2,968Infant sleep positioners product charges


2,045



---Acquisition-related costs


305



---Adjusted EBITDA

$
45,395


$
45,852





25


NON-GAAP FINANCIAL INFORMATION





This section includes non-GAAP financial information consisting of net sales in the Company's preschool, youth and adults products category excluding discontinued product lines and Adjusted EBITDA (as described in more detail in the next section).  Internally, the Company uses this non-GAAP financial information for the following purposes: financial and operational decision making, evaluating period-to-period results and making comparisons of its results with those of its competitors.  Management believes that the presentation of this non-GAAP financial measure provides useful information to investors because this information may allow investors to better evaluate ongoing business performance and certain components of the Company’s results.  This information should be considered in addition to the results presented in accordance with GAAP, and should not be considered a substitute for the GAAP results.





ADJUSTED EBITDA





Adjusted EBITDA is defined as earnings before interest expense, taxes, depreciation, amortization and non-controlling interest as further adjusted to eliminate the impact of the other items set forth in “The Calculation of Adjusted EBITDA” above that the Company does not believe are indicative of its core operating performance.  Adjusted EBITDA is not adjusted for all non-cash expenses or for working capital, capital expenditures or other investment requirements and, accordingly, is not necessarily indicative of amounts that may be available for discretionary uses.  Because of these limitations, Adjusted EBITDA should not be considered in isolation or as a substitute for net income or cash provided by operating activities, each prepared in accordance with GAAP, when measuring RC2’s profitability or liquidity as more fully discussed in the Company’s accompanying condensed consolidated financial statements.





LIQUIDITY AND CAPITAL RESOURCES





The Company’s operations provided net cash of $4.1 million and $40.8 million for the nine months ended September 30, 2010 and 2009, respectively.  During the nine months ended September 30, 2010, cash flows from operations were unfavorably impacted by increases in accounts receivable and inventory of $14.8 million and $24.8 million, respectively.  The inventory increase is attributable to several factors.  Inventory increases due to new preschool product categories, including Chuggington, Dinosaur Train and Thomas and Friends Early Engineers, as well as inventory investment required to support global mother, infant and toddler products growth were attributable for approximately half of the increase.  Additionally, the impact of increased cycle times and working with the Company's factories to level load capacity was attributable for the other half of the inventory increase.  The increase in accounts receivable is primarily due to increased sales this year as compared to the prior year.





26


Net cash used in investing activities was $49.2 million and $10.7 million for the nine months ended September 30, 2010 and 2009, respectively.  The increase in net cash used in investing activities was primarily due to the acquisition of the JJ Cole Business during the third quarter of 2010.  Capital expenditures for the nine months ended September 30, 2010, were $8.3 million, of which $6.4 million were for molds and tooling to support new product development.





Net cash provided by financing activities was $5.7 million and $22.0 million for the nine months ended September 30, 2010 and 2009, respectively.  The decrease in net cash related to financing activities is primarily due to net cash proceeds from the secondary offering during the third quarter 2009, somewhat offset by net payments on the term loan and the line of credit during the nine months ended September 30, 2009.





Working capital decreased $19.1 million to $169.3 million at September 30, 2010, from $188.4 million at December 31, 2009.  The decrease in working capital resulted from a portion of the Company’s outstanding debt classified as current at September 30, 2010, which was long term at December 31, 2009, as well as an increase in accounts payable, due to the increased inventory levels at September 30, 2010, as compared to December 31, 2009.  Cash and cash equivalents decreased $38.8 million during the nine months ended September 30, 2010, to $49.2 million as of September 30, 2010, from $88.0 million as of December 31, 2009, due to the acquisition of the JJ Cole Business.  This decrease in cash was nearly offset by the increase in inventory and accounts receivable at September 30, 2010, compared to December 31, 2009.





The Company’s credit facility is comprised of a term loan and provides for borrowings up to $70.0 million under a revolving line of credit.  The total borrowing capacity available under the credit facility is subject to a formula based on the Company’s leverage ratio, as defined in the credit agreement.  The term loan and the revolving line of credit both have a scheduled maturity date of November 1, 2011.  Under this credit facility, the term loan and the revolving line of credit bear interest, at the Company’s option, at a base rate or at LIBOR, plus applicable margins, which are based on the Company’s leverage ratio.  Applicable margins vary between 2.25% and 3.25% on LIBOR borrowings and 1.25% and 2.25% on base rate borrowings.  At September 30, 2010, the applicable margins in effect were 2.25% for LIBOR borrowings and 1.25% for base rate borrowings.  Principal payments on the term loan are $3.8 million per calendar quarter, with the remaining principal of $33.8 million due on November 1, 2011. During the fourth quarter of 2009, the Company prepaid $18.8 million on its term loan, with the next quarterly principal payment of $3.8 million due on June 30, 2011.  The Company is also required to pay a commitment fee which varies from 0.45% and 0.50% per annum on the average daily unused portion of the revolving line of credit.  At September 30, 2010, the commitment fee in effect was 0.45% per annum.





27


Under the terms of this credit facility, the Company is required to comply with certain financial and non-financial covenants.  Among other restrictions, the Company is restricted in its ability to pay dividends, buy back its stock, incur additional debt and make acquisitions above certain amounts.  The credit facility also includes a clean down provision that limits the maximum amount of borrowings under the revolving line of credit for a period of 60 consecutive days during the first four calendar months.  The Company has met its clean down provision for the year 2010.  The remaining clean down provision limit consists of $25.0 million for a period of 60 consecutive days during the first four calendar months of 2011.  The credit facility is secured by the Company’s domestic assets along with a portion of the Company’s equity interests in its foreign subsidiaries.  On September 30, 2010, the Company had $41.3 million outstanding on its bank term loan and no borrowings under its revolving line of credit.  At September 30, 2010, the Company had $69.6 million available on its revolving line of credit and was in compliance with all covenants.





In 2010, the Company has met its working capital needs through cash on hand and funds generated from operations.  The Company’s working capital requirements fluctuate during the year based on the seasonality related to sales.  Due to seasonal increases in demand for the Company’s products, working capital financing requirements are usually highest during the third and fourth quarters.  The Company expects that capital expenditures during 2010, principally for molds and tooling, will be approximately $11.0 million.





Although the Company anticipates its working capital needs in 2010 will be higher than 2009, there are no scheduled debt repayments in 2010.  Therefore, the Company believes that its cash on hand, cash flows from operations and available borrowings will be sufficient to meet its working capital and capital expenditure requirements and provide the Company with adequate liquidity to meet anticipated operating needs for 2010.  Any significant future acquisitions, including up-front licensing payments for new products, may require additional debt or equity financing.  The Company’s existing credit facility matures November 1, 2011, and the Company currently anticipates that it will refinance its credit facility during 2011 to fund future working capital needs.  There can be no assurance that financing, if needed, would be available on terms acceptable to the Company, if at all.





CRITICAL ACCOUNTING POLICIES AND ESTIMATES





The Company makes certain estimates and assumptions that affect the reported amounts of assets and liabilities and the reported amounts of revenues and expenses.  The accounting policies described below are those the Company considers critical in preparing its consolidated financial statements.  These policies include significant estimates made by management using information available at the time the estimates are made.  However, as described below, these estimates could change materially if different information or assumptions were used.





28


Allowance for doubtful accounts.The allowance for doubtful accounts represents adjustments to customer trade accounts receivable for amounts deemed uncollectible.  The allowance for doubtful accounts reduces gross trade receivables to their estimated net realizable value.  The Company’s allowance is based on management’s assessment of the business environment, customers’ financial condition, historical trends, customer payment practices, receivable aging and customer disputes.  The Company maintains credit insurance for some of its major domestic customers, and the amount of this insurance covers a limited amount of the total amount of its accounts receivable.  The Company will continue to proactively review its credit risks and adjust its customer terms to reflect the current environment.





Inventory.  Inventory, which consists primarily of finished goods, has been written down for excess quantities and obsolescence, and is stated at the lower of cost or market.  Cost reasonably approximates the first-in, first-out method and includes all costs necessary to bring inventory to its existing condition and location.  Market represents the lower of replacement cost or estimated net realizable value.  Inventory write-downs are recorded for damaged, obsolete, excess and slow-moving inventory.  The Company’s management uses estimates to record these write-downs based on its review of inventory by product category, length of time on hand, sales projections and order bookings.  Changes in public and consumer preferences and demand for product or changes in customer buying patterns and inventory management, as well as discontinuance of products or product lines, could impact the inventory valuation.





Impairment of long-lived assets, goodwill and other intangible assets.  Long-lived assets have been reviewed for impairment based on the requirements under the Intangibles-Goodwill and Other Topic of the FASB Accounting Standards Codification.  This Topic requires that an impairment loss be recognized whenever the carrying value of an asset exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of that asset, excluding future interest costs the entity would recognize as an expense when incurred.  Goodwill and other intangible assets have been reviewed for impairment based on the requirements under the Intangibles-Goodwill and Other Topic of the FASB Accounting Standards Codification.  Under this Topic, goodwill and other intangible assets that have indefinite useful lives are not amortized, but rather tested at least annually for impairment.  The next scheduled annual test for impairment on its indefinite lived intangibles will be as of October 1, 2010, and will be completed in the fourth quarter of 2010.  The Company’s management reviews for indicators that might suggest an impairment loss could exist.  An interim test for impairment is performed if a triggering event occurs suggesting possible impairment.  Testing for impairment requires estimates of expected cash flows to be generated from the use of the assets.  Various uncertainties, including changes in consumer preferences, ability to maintain related licenses, deterioration in the political environment, adverse conditions in the capital markets or changes in general economic conditions, could impact the expected cash flows to be generated by an asset or group of assets.  Intangible assets that have finite useful lives are amortized over their useful lives.





29


Income taxes.  The Company records current and deferred income tax assets and liabilities.  Management considers all available evidence in evaluating the realizability of the deferred tax assets and records valuation allowances against its deferred tax assets as needed.  Management believes it is more likely than not that the Company will generate sufficient taxable income in the appropriate carry-forward periods to realize the benefit of its deferred tax assets, except for those deferred tax assets for which an allowance has been provided.





Management considers certain tax exposures and all available evidence when evaluating and estimating tax positions and tax benefits, which may require periodic adjustments and which may not accurately anticipate actual outcomes.  If the available evidence were to change in the future, an adjustment to the tax-related balances may be required.  Estimates for such tax contingencies are classified in other current liabilities and other non-current liabilities in the accompanying condensed consolidated balance sheets.





Accrued allowances.  The Company ordinarily accepts returns only for defective merchandise.  In certain instances, where retailers are unable to resell the quantity of products that they have purchased from the Company, the Company may, in accordance with industry practice, assist retailers in selling excess inventory by offering credits and other price concessions, which are typically evaluated and issued annually.  Other allowances can also be issued primarily for defective merchandise, volume programs and co-op advertising.  All allowances are accrued throughout the year, as sales are recorded.  The allowances are based on the terms of the various programs in effect; however, management also takes into consideration historical trends and specific customer and product information when making its estimates.  For the volume programs, the Company generally sets a volume target for the year with each participating customer and issues the discount if the target is achieved.  The allowance for the volume program is accrued throughout the year, and if it becomes clear to management that the target for the participating customer will not be reached, the Company will change the estimate for that customer as required.





Accrued royalties.  Royalties are accrued based on the provisions in licensing agreements for amounts due on net sales during the period, as well as management estimates for additional royalty exposures.  Royalties vary by product category and are generally paid on a quarterly basis.  Multiple royalties may be paid to various licensors on a single product.  Royalty expense is included in selling, general and administrative expenses in the accompanying condensed consolidated statements of earnings.





Stock-based compensation.  The fair value of stock options and SARs granted under the stock incentive plan is estimated on the date of grant, and in the case of cash-settled SARs, remeasured at each reporting date, based on the Black-Scholes option-pricing model.  The Company calculates the expected volatility factor using Company-specific volatility as the Company believes that its actual volatility is a good indicator of expected future results.  The Company uses historical data to estimate stock option exercise and employee departure behavior in the Black-Scholes option-pricing model.  The expected term of stock options and SARs granted represents the period of time that stock options and SARs granted are expected to be outstanding.  The risk-free rate for the period within the contractual term of the stock option or SAR is based on the U.S. Treasury yield curve in effect at the time of grant.


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The fair value of restricted stock awards granted under the stock incentive plan is calculated either using the market price on the grant date or the market price on the last day of the reported period.  The fair value of performance-based restricted stock units (RSUs) granted under the stock incentive plan is calculated using the market price on the grant date.  The Company records stock-based compensation expense for performance-based RSUs based on its estimate of the amount of the performance-based RSUs to be earned upon completion of the performance period.





FORWARD LOOKING STATEMENTS





Certain statements contained in this report are considered "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995.These statements may be identified by the use of forward-looking words or phrases such as "anticipate,'' "estimate,'' "believe,'' "confidence,'' "could,'' "expect,'' "intend,'' "may,'' "planned,'' "potential,'' "should,'' "will,'' "would'' or the negative of those terms or other words of similar meaning. Such forward-looking statements are inherently subject to known and unknown risks and uncertainties. The Company's actual results and future developments could differ materially from the results or developments expressed in, or implied by, these forward-looking statements.  Factors that may cause actual results to differ materially from those contemplated by such forward-looking statements include, but are not limited to, the following:  the Company is dependent upon continuing licensing arrangements with owners of popular and classic licensed properties such as Chuggington, Dinosaur Train, certain Disney properties, John Deere, Bob the Builderand Thomas & Friends Wooden Railway, which license currently expires on December 31, 2012, vehicle manufacturers, agricultural equipment manufacturers and other licensors;  the effect on the Company’s business of the termination of the license of the Take Along Thomas & Friends die-cast product line at the end of 2009; risks related to product recalls or product liability claims, compliance with product safety standards and the effect of recalls on the Company’s relationship with licensors, including the effect on renewal and retention of licenses; the Company's business depends on its ability to conceive, design and market new products that appeal to consumers and on continuing market acceptance of its product offerings; uncertainty and potential adverse changes in the general economic conditions in the Company's markets, including fluctuating oil prices, declining consumer confidence, unemployment, fluctuations in stock markets, contraction of credit availability, bankruptcy or liquidity problems with its customers or other factors affecting economic conditions generally; currency exchange rate fluctuations, including in the Chinese renminbi, the Hong Kong dollar, the British pound sterling, the Australian dollar, the Euro or the Canadian dollar, could increase the Company’s expenses or reduce the U.S. dollar value of the Company’s assets denominated in foreign currencies, including funds the Company needs to transfer to the U.S.; increases in the cost of raw materials, labor and other costs to manufacture the Company’s products could increase the Company’s cost of sales and reduce the Company’s gross margins; the Company’s ability to comply with covenants in its credit facility; competition in the markets for the Company's products may increase significantly;  the Company is dependent upon the continuing willingness of leading retailers to purchase and provide shelf space for the Company's products; the Company may not be able to collect outstanding accounts receivable from its major retail customers; the Company relies upon a limited number of independently owned factories located in China to manufacture a significant portion of its products; the Company may not be able to manufacture, source and ship new and continuing products on a timely basis; the Company is dependent upon timely shipping of product and unloading of product through West Coast ports as well as timely rail/truck delivery to the Company’s warehouse and/or customers’ warehouses; customers and consumers may not accept the Company’s products at prices sufficient for the Company to profitably recover development, manufacturing, marketing, royalty and other costs; the inventory policies of retailers, together with increased reliance by retailers on quick response inventory management techniques, may increase the risk of underproduction of popular items, overproduction of less popular items and failure to achieve tight shipping schedules; the risk of future write-downs of goodwill and intangible assets; and the Company may experience unanticipated negative results of litigation.  Such uncertainties and other risks that may affect the Company’s performance are discussed further in Part I, Item 1A, “Risk Factors,” in the Company's Form 10-K for the year ended December 31, 2009.  The Company undertakes no obligation to make any revisions to the forward-looking statements contained in this report or to update them to reflect events or circumstances occurring after the date of this report.


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Item 3.  Quantitative and Qualitative Disclosures about Market Risk





The Company’s exposure to market risk is limited to interest rate risk associated with the Company’s credit facility and foreign currency exchange rate risk associated with the Company’s foreign operations.





Based on the Company’s interest rate exposure on variable rate borrowings at September 30, 2010, a one percentage point increase in average interest rates on the Company’s borrowings would increase future interest expense by less than $0.1 million per month and a five percentage point increase would increase future interest expense by approximately $0.2 million per month.  The Company determined these amounts based on $41.3 million of variable rate borrowings at September 30, 2010, multiplied by 1.0% and 5.0%, respectively, and divided by twelve.  The Company is currently not using any interest rate collars, hedges or other derivative financial instruments to manage or reduce interest rate risk.  As a result, any increase in interest rates on the Company’s variable rate borrowings would increase interest expense and reduce net income.





The Company’s net sales are primarily denominated in U.S. dollars, with 23.5% of net sales for the nine months ended September 30, 2010, denominated in British pounds sterling, Australian dollars, Euros and Canadian dollars.  The Company’s purchases of finished goods from Chinese manufacturers are primarily denominated in Hong Kong dollars.  Expenses for these manufacturers are primarily denominated in Chinese renminbi.  Any material increase in the value of the Chinese renminbi relative to the U.S. dollar would increase the Company's suppliers’ expenses, and therefore, the cost of its products, which could adversely affect its profitability. The Hong Kong dollar is currently pegged to the U.S. dollar.  If the Hong Kong dollar ceased to be pegged to the U.S. dollar, a material increase in the value of the Hong Kong dollar relative to the U.S. dollar would increase the Company's expenses, and therefore, could adversely affect its profitability.  A 10.0% change in the exchange rate of the U.S. dollar with respect to the Hong Kong dollar for the nine months ended September 30, 2010, would have changed the total dollar amount of the Company's gross profit by 12.6%.  The Company is also subject to exchange rate risk relating to transfers of funds or other transactions denominated in British pounds sterling, Australian dollars, Canadian dollars or Euros from its foreign subsidiaries to the United States, such as for purchases of inventory by certain of its foreign subsidiaries, effectively in U.S. dollars.  A 10.0% change in the exchange rate of the U.S. dollar with respect to the British pound sterling, the Australian dollar and the Canadian dollar for the nine months ended September 30, 2010, would have changed the total dollar amount of the Company's gross profit by 1.6%, 0.8% and 1.0%, respectively.  A 10.0% change in the exchange rate of the U.S. dollar with respect to the translation of financial reporting denominated in the British pound sterling, the Australian dollar or the Euro for the nine months ended September 30, 2010, individually would not have had a significant impact on the Company’s net income.  The Company is not currently using and has not historically used hedges or other derivative financial instruments to manage or reduce exchange rate risk.


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Item 4.  Controls and Procedures





The Company maintains disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that the information required to be disclosed by the Company in reports that it files or submits under the Securities Exchange Act of 1934 is accumulated and communicated to its management, including its Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.  The Company carried out an evaluation as of September 30, 2010, 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.  Based on such evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of September 30, 2010, at reaching a level of reasonable assurance.  In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.  The Company has designed its disclosure controls and procedures to reach a level of reasonable assurance of achieving the desired control objectives.





There was no change in the Company’s internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, as amended) during the Company’s most recently completed fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.





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PART II.  OTHER INFORMATION





Item 1.  Legal Proceedings





The Company has certain contingent liabilities resulting from litigation and claims incident to the ordinary course of business.  Management believes that the probable resolution of such contingencies will not materially affect the financial position or the results of the Company’s operations.





Item 1A.  Risk Factors





There have been no material changes from the risk factors previously disclosed in Part I, Item 1A, “Risk Factors,” of the Company's Form 10-K for the year ended December 31, 2009.  Please refer to that section for disclosures regarding the risks and uncertainties relating to the Company's business.





Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds





(a)     Not applicable.





(b)     Not applicable.





(c)     Not applicable.





Item 3.  Defaults Upon Senior Securities





Not applicable.





Item 4.  [Reserved]





Item 5.  Other Information





Not applicable.





Item 6.  Exhibits






3.1

Amended and Restated Certificate of Incorporation of the Company (incorporated byreference to Exhibit 3.1 of the Company’s Quarterly Report on Form 10-Q for the quarterended March 31, 2002 (File No. 0-22635) filed by the Company with the Securities andExchange Commission on May 14, 2002).3.2

First Amendment to the Amended and Restated Certificate of Incorporation of theCompany (incorporated by reference to Exhibit 3.2 of the Company’s Quarterly Reporton Form 10-Q for the quarter ended March 31, 2002 (File No. 0-22635) filed by theCompany with the Securities and Exchange Commission on May 14, 2002).






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3.3

Certificate of Ownership and Merger changing the Company’s name to RacingChampions Ertl Corporation (incorporated by reference to Exhibit 3.3 of the Company’sQuarterly Report on Form 10-Q for the quarter ended March 31, 2002 (File No. 0-22635)filed by the Company with the Securities and Exchange Commission on May 14, 2002).3.4

Certificate of Ownership and Merger changing the Company’s name to RC2 Corporation(incorporated by reference to Exhibit 3.4 of the Company’s Quarterly Report on Form10-Q for the quarter ended March 31, 2003 (File No. 0-22635) filed by the Company with the Securities and Exchange Commission on May 14, 2003).3.5

Amended and Restated By-Laws of the Company (incorporated by reference to Exhibit3.1 of the Company’s Current Report on Form 8-K (File No. 0-22635) filed by the Company with the Securities and Exchange Commission on July 30, 2009).31.1

Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.31.2

Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-OxleyAct of 2002.32.1*

Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 (Section 906 of the Sarbanes-Oxley Act of 2002).


___________________





*This certification is not “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, or incorporated by reference into any filing under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended.





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SIGNATURES





Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on behalf by the undersigned thereunto duly authorized.





Dated this 28th day of October, 2010. 
 
 RC2 CORPORATION
 
 By /s/ Curtis W. Stoelting
 Curtis W. Stoelting, Chief Executive Officer
 
 By /s/ Peter A. Nicholson
 Peter A. Nicholson, Chief Financial Officer
 and Secretary
 
 
 36