SECURITIES
      AND EXCHANGE COMMISSION


WASHINGTON,
      DC 20549





FORM
      10-Q





(Mark
                One)x
            QUARTERLY
                REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
                OF 1934For
                the quarterly period ended September 30, 2006ORo
            TRANSITION
                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 22ndStreet, 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 sections 13 or 15(d) of the Securities Exchange Act of 1934
      during the preceding 12 months (or for such shorter period that the
      Registrant was required to file such reports), and (2) has been subject to
      such filing requirements for the past 90 days.




Yes
              X
              
              No


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





Large Accelerated filer
            X
            Accelerated filer
            
            
            Non-accelerated filer





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




Yes
            
            
            No
            X




On
      October 25, 2006, there were outstanding 20,945,963 shares of the Registrant's
      $0.01 par value common stock.













RC2
      CORPORATION





FORM
      10-Q





SEPTEMBER
      30, 2006





INDEX ****





PART
      I -
      FINANCIAL INFORMATION






PageItem
                1.
            Condensed
                Consolidated Balance Sheets as of September 30,
                2006
                  and December 31, 2005
            3Condensed
                  Consolidated Statements of Earnings for the
                  Three
                Months
                  and Nine Months Ended September 30, 2006 and
                  2005
            4Condensed
                  Consolidated Statements of Cash Flows for
                  the
                Nine
                  Months Ended September 30, 2006 and
                  2005
            5Notes
                to Condensed Consolidated Financial
                Statements
            6Item
                2.
            Management's
                Discussion and Analysis of Financial Condition
                and
                  Results of Operations
            17Item
                3.
            Quantitative
                and Qualitative Disclosures about Market
                Risk
            26Item
                4.
            Controls
                and Procedures
            26







PART
      II -
      OTHER INFORMATION







Item
                1.
            Legal
                Proceedings
            27Item
                1A.
            Risk
                Factors
            27Item
                2.
            Unregistered
                Sales of Equity Securities and Use of
                Proceeds
            27Item
                3.
            Defaults
                Upon Senior Securities
            27Item
                4.
            Submission
                of Matters to a Vote of Security
                Holders
            27Item
                5.
            Other
                Information
            27Item
                6.
            Exhibits
            27Signatures
            28


2




PART
      I.  FINANCIAL
      INFORMATION







**Item
      1. Financial Statements**





**RC2Corporation
      and Subsidiaries**


**Condensed
      Consolidated Balance Sheets**


**(Unaudited
      and in thousands)**





**September
                30,**
              **2006**
            
            **December
                31,**
              **2005****Assets**Cash
                and cash equivalents
            
            $
            20,405
            
            $
            25,262Accounts
                receivable, net
            
            
            122,614
            
            
            113,066Inventory
            
            
            96,355
            
            
            71,260Other
                current assets
            
            
            17,643
            
            
            17,597Total
                current assets
            
            
            257,017
            
            
            227,185Property
                and equipment, net
            
            
            47,426
            
            
            47,039Goodwill
            
            
            254,133
            
            
            253,571Intangible
                assets, net
            
            
            99,357
            
            
            99,611Other
                non-current assets
            
            
            3,376
            
            
            2,330Total
                assets
            
            $
            661,309
            
            $
            629,736**Liabilities
                and stockholders’ equity**Accounts
                payable and accrued expenses
            
            $
            95,382
            
            $
            87,322Line
                of credit
            
            
            ---
            
            
            3,979Current
                maturities of bank term loans
            
            
            21,250
            
            
            21,250Other
                current liabilities
            
            
            798
            
            
            1,348Total
                current liabilities
            
            
            117,430
            
            
            113,899Lines
                of credit
            
            
            10,000
            
            
            13,980Bank
                term loans, less current maturities
            
            
            27,500
            
            
            43,438Other
                non-current liabilities
            
            
            60,439
            
            
            59,468Total
                liabilities
            
            
            215,369
            
            
            230,785Stockholders’
                equity
            
            
            445,940
            
            
            398,951Total
                liabilities and stockholders' equity
            
            $
            661,309
            
            $
            629,736





See
      accompanying notes to condensed consolidated financial statements.





3


**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,****2006**
            
            **2005**
            
            **2006**
            
            **2005**Net
                sales
            
            $
            160,454
            
            $
            142,567
            
            $
            376,670
            
            $
            347,867Cost
                of sales
            
            
            84,690
            
            
            72,833
            
            
            198,838
            
            
            176,267Gross
                profit
            
            
            75,764
            
            
            69,734
            
            
            177,832
            
            
            171,600Selling,
                general and administrative expenses
            
            
            43,725
            
            
            39,943
            
            
            117,237
            
            
            111,917Amortization
                of intangible assets
            
            
            315
            
            
            845
            
            
            945
            
            
            1,095Gain
                on sale of W. Britain product line
            
            
            ---
            
            
            (1,953
            )
            
            ---
            
            
            (1,953
            )Operating
                income
            
            
            31,724
            
            
            30,899
            
            
            59,650
            
            
            60,541Interest
                expense, net
            
            
            944
            
            
            1,522
            
            
            2,815
            
            
            4,557Other
                expense (income)
            
            
            273
            
            
            4
            
            
            153
            
            
            (347
            )Income
                before income taxes
            
            
            30,507
            
            
            29,373
            
            
            56,682
            
            
            56,331Income
                tax expense
            
            
            11,134
            
            
            11,113
            
            
            20,684
            
            
            20,480Net
                income
            
            $
            19,373
            
            $
            18,260
            
            $
            35,998
            
            $
            35,851Net
                income per share:Basic
            
            $
            0.93
            
            $
            0.88
            
            $
            1.73
            
            $
            1.74Diluted
            
            $
            0.91
            
            $
            0.85
            
            $
            1.69
            
            $
            1.67Weighted
                average shares outstanding:Basic
            
            
            20,917
            
            
            20,656
            
            
            20,844
            
            
            20,582Diluted
            
            
            21,365
            
            
            21,594
            
            
            21,337
            
            
            21,525





See
      accompanying notes to condensed consolidated financial statements.





4


**RC2
      Corporation and Subsidiaries**


**Condensed
      Consolidated Statements of Cash
      Flows**


**(Unaudited
      and in thousands)**





**For
                the nine months ended**
              **September
                30,****2006**
            
            **2005****Cash
                flows from operating activities**Net
                income
            
            $
            35,998
            
            $
            35,851Depreciation
                and amortization
            
            
            11,706
            
            
            11,429Stock-based
                compensation
            
            
            3,165
            
            
            ---Excess
                tax benefit on stock option exercises
            
            
            (1,411
            )
            
            ---Amortization
                of deferred financing costs
            
            
            376
            
            
            362Gain
                on disposition of assets
            
            
            (6
            )
            
            (2,031
            )Changes
                in operating assets and liabilities
            
            
            (22,416
            )
            
            (25,253
            )Net
                cash provided by operating activities
            
            
            27,412
            
            
            20,358**Cash
                flows from investing activities**Purchase
                of property and equipment
            
            
            (10,919
            )
            
            (9,948
            )Adjustments
                to the purchase price of TFY
            
            
            ---
            
            
            39Proceeds
                from disposition of property and equipment
            
            
            18
            
            
            608Proceeds
                from sale of W. Britain product line
            
            
            ---
            
            
            2,850Investment
                in Meteor The Monster Truck Company, LLC
            
            
            (1,214
            )
            
            (529
            )Increase
                in other non-current assets
            
            
            (45
            )
            
            (84
            )Net
                cash used in investing activities
            
            
            (12,160
            )
            
            (7,064
            )**Cash
                flows from financing activities**Net
                payments on lines of credit
            
            
            (8,270
            )
            
            (3,000
            )Payments
                on bank term loans
            
            
            (15,938
            )
            
            (11,250
            )Issuance
                of common stock upon option exercises
            
            
            2,244
            
            
            1,349Excess
                tax benefit on stock option exercises
            
            
            1,411
            
            
            ---Issuance
                of common stock for ESPP
            
            
            156
            
            
            139Financing
                fees paid
            
            
            (182
            )
            
            ---Net
                cash used in financing activities
            
            
            (20,579
            )
            
            (12,762
            )Effect
                of exchange rate changes on cash
            
            
            470
            
            
            (578
            )Net
                decrease in cash and cash equivalents
            
            
            (4,857
            )
            
            (46
            )Cash
                and cash equivalents, beginning of year
            
            
            25,262
            
            
            20,123Cash
                and cash equivalents, end of period
            
            $
            20,405
            
            $
            20,077Supplemental
                information:Cash
                flows during the period for:Interest
            
            $
            2,931
            
            $
            4,356Income
                taxes
            
            $
            18,317
            
            $
            12,775Income
                tax refunds received
            
            $
            530
            
            $
            4,751





See
      accompanying notes to condensed consolidated financial
      statements.


5


**RC2
      Corporation and Subsidiaries**


**Notes
      to Condensed Consolidated Financial
      Statements**





**Note
      1 - Basis of Presentation**





The
      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, 2006, the
      results of its operations for the three-month and nine-month periods ended
      September 30, 2006 and 2005, and its cash flows for the nine-month periods
      ended
      September 30, 2006 and 2005.





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, 2005. The condensed consolidated balance sheet information as of December
      31, 2005 appearing herein is derived from the consolidated balance sheet in
      the
      Form 10-K.





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





**Note
      2 - Stock-Based Payment Arrangements**





On
      January 1, 2006, the Company adopted SFAS No. 123R, “Share-Based Payment.” This
      Statement is a revision of SFAS No. 123, “Accounting for Stock-Based
      Compensation” and supersedes APB Opinion No. 25, “Accounting for Stock Issued to
      Employees.” This Statement establishes standards for the accounting for
      transactions in which an entity exchanges its equity instruments for goods
      or
      services and also addresses transactions in which an entity incurs liabilities
      in exchange for goods and services that are based on the fair value of the
      entity’s equity instruments or that may be settled by the issuance of those
      instruments. The Company adopted this Statement on a modified prospective basis,
      and therefore, no compensation expense related to stock-based payment
      arrangements was recognized in the financial statements prior to
      adoption.


6


At
      September 30, 2006, the Company has four stock incentive plans, three of which
      are dormant, and an employee stock purchase plan (ESPP), which are described
      below. Amounts recognized in the financial statements with respect to these
      stock-based payment arrangements for the three months and nine months ended
      September 30, 2006 are as follows:





**For
                the three**
              **months
                ended**
            
            **For
                the nine**
              **months
                ended**(in
                thousands)
            
            **September
                30, 2006**
            
            **September
                30, 2006**Total
                expense recognized for stock-based payment plans
            
            $
            1,042
            
            $
            3,165Amount
                of related income tax benefit recognized in net income
            
            $
            386
            
            $
            1,174





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,
      2006.





Prior
      to
      January 1, 2006, the Company accounted for stock-based compensation arrangements
      with employees in accordance with the provisions of APB Opinion No. 25 and
      complied with the disclosure provisions of SFAS No. 123. If compensation costs
      for stock options issued, including options for shares issued under the ESPP,
      had been determined based on the fair value at their grant date consistent
      with
      SFAS No. 123, the Company’s net income and net income per share would have been
      reduced to the following pro forma amounts:





(in
                thousands, except per share data)
            
            **For
                the three**
              **months
                ended September 30, 2005**
              **(Unaudited)**
            
            **For
                the nine**
              **months
                ended September 30, 2005**
              **(Unaudited)**Net
                income as reported
            
            $
            18,260
            
            $
            35,851Deduct:
                total stock-based employee compensation
              expense
                determined under fair value based method
              for
                all awards, net of related income tax benefit
            
            
            (541
            )
            
            (1,527
            )Pro
                forma net income
            
            $
            17,719
            
            $
            34,324Basic
                net income per share:As
                reported
            
            $
            0.88
            
            $
            1.74Pro
                forma
            
            $
            0.86
            
            $
            1.67Diluted
                net income per share:As
                reported
            
            $
            0.85
            
            $
            1.67Pro
                forma
            
            $
            0.82
            
            $
            1.59





7


**Employee
      Stock Purchase Plan**





The
      Company has an ESPP to provide its employees with an opportunity to
      purchase common stock of the Company through accumulated payroll deductions.
      The
      plan allows eligible employees to purchase shares of the Company’s common stock
      through quarterly offering periods, commencing on each January 1, April 1,
      July
      1 and October 1. The option price for each share of common stock purchased
      equals 90% of the last quoted sales price of a share of the Company’s common
      stock as reported by the NASDAQ National Market on the first day of the
      quarterly offering period or the last day of the quarterly offering period,
      whichever is lower. The Company has reserved 500,000 shares of common stock
      held
      in treasury for issuance under the plan. The plan will terminate on July 1,
      2007, unless sooner terminated by the Board of Directors.





The
      fair
      value of each option for shares issued under the ESPP during the nine months
      ended September 30, 2006 and 2005 is estimated on the date of grant based on
      the
      Black-Scholes option pricing model with the following assumptions: weighted
      average risk-free rates of return of 4.6% and 2.8%, respectively, weighted
      average volatility factors of 24.9% and 31.4%, respectively, and expected life
      of three months. The weighted average fair value of those purchase rights
      granted during the nine months ended September 30, 2006 and 2005 was $5.02
      and
      $5.01, respectively.





The
      Company calculates the volatility factor for those options issued under the
      ESPP
      based on the volatility of the Company’s common stock during the most recent
      three-month period. The expected term of share options granted represents the
      period of time that share options granted are expected to be outstanding. The
      risk-free rate for the period within the contractual term of the share option
      is
      based on the U.S. Treasury yield curve in effect at the time of
      grant.





**Stock
      Incentive Plans**





The
      Company maintains an employee stock option plan for its key employees. The
      Company had reserved 415,041 shares of common stock for issuance under the
      plan.
      These options vested in equal installments over a five-year period. The options
      will expire on the earlier of the tenth anniversary of the date of grant or
      30
      days after the date of termination of the employee’s employment with the
      Company. This plan is dormant, and no future issuances are authorized from
      this
      plan.





The
      Company maintains a stock incentive plan, under which options could be granted
      to purchase up to 2,300,000 shares of common stock to executives or key
      employees of the Company. Some of the options that were granted vested
      immediately, and the rest vest over a five-year period. These options expire
      on
      the tenth anniversary of the date of grant or 90 days after the date of
      termination of the employee’s employment with the Company. Under this plan,
      cancelled options revert back into the plan. This plan became dormant in 2005
      upon the approval of the 2005 Stock Incentive Plan, as discussed below. No
      future issuances are authorized from this plan.


8


The
      Company also maintains an omnibus stock plan, under which the Company had
      400,000 shares of its common stock reserved for issuance. This plan is dormant,
      and no future issuances are authorized from this plan.





During
      2005, a stock incentive plan was approved by the Company’s stockholders. Under
      this plan, restricted stock awards or options to purchase stock may be granted
      for up to 1,200,000 shares of common stock to executives or key employees of
      the
      Company. Options granted may vest immediately or over a five-year period. These
      options expire on the tenth anniversary of the date of grant or 90 days after
      the date of termination of the employee’s employment with the Company. Under
      this plan, cancelled options revert back into the plan and are available for
      future issuances.





The
      fair
      value of stock options granted under the stock incentive plans during the nine
      months ended September 30, 2006 and 2005 is estimated on the date of grant
      based
      on the Black-Scholes option pricing model that assumes, among other things,
      no
      dividend yield, weighted average risk-free rates of return of 4.6% and 4.2%,
      respectively, weighted average volatility factors of 54.5% and 54.6%,
      respectively, and expected life of seven years.





The
      Company calculates the expected volatility factor for those options issued
      under
      the stock incentive plan to correspond with the average volatility factor of
      those companies included in a peer group study conducted by a third-party on
      behalf of the Company. The historical stock price movements of the Company’s
      common stock are not considered to be a good indicator of expected future
      volatility because the Company’s business has changed significantly as a result
      of acquisitions completed. However, the Company continues to monitor its actual
      volatility to assess whether the peer group volatility remains appropriate
      and
      updates the peer group study at least annually.





The
      Company uses historical data to estimate share option exercise and employee
      departure behavior used in the Black-Scholes option pricing model. The expected
      term of share options granted represents the period of time that share options
      granted are expected to be outstanding based upon historical experience. The
      risk-free rate for the period within the contractual term of the share option
      is
      based on the U.S. Treasury yield curve in effect at the time of
      grant.





A
      summary
      of stock option activity for the Company’s stock incentive plans for the nine
      months ended September 30, 2006 is as follows:





**Number
                of Shares**
            
            **Weighted
                Average Exercise Price**
            
            **Weighted
                Average Remaining Contractual Life**
            
            **Aggregate
                Intrinsic Value (000)**Outstanding
                at beginning of the year
            
            
            1,562,842
            
            $
            16.14Changes
                during the period:Granted
            
            
            256,221
            
            $
            35.73Exercised
            
            
            209,150
            
            $
            10.73Cancelled/Expired
            
            
            34,790
            
            $
            27.77Outstanding
                at end of period
            
            
            1,575,123
            
            $
            19.79
            
            
            6.5
            
            $
            22,262Exercisable
                at end of period
            
            
            786,292
            
            $
            12.24
            
            
            5.0
            
            $
            16,776





9


The
      weighted average fair value of options granted under the Company’s stock
      incentive plans for the nine months ended September 30, 2006 and 2005 was $21.49
      and $18.69 per share, respectively. The total intrinsic value of options
      exercised during the nine months ended September 30, 2006 and 2005 was $5.5
      million and $6.2 million, respectively.





As
      of
      September 30, 2006, there was $11.2 million of total unrecognized compensation
      cost related to nonvested stock-based compensation arrangements granted under
      the Company’s stock incentive plans. That cost is expected to be recognized over
      a weighted average period of 3.5 years. The total fair value of options vested
      during the nine months ended September 30, 2006 was $2.8 million.





**Note
      3 - Business Segments**




The
      Company is a leading designer, producer and marketer of innovative, high-quality
      toys, collectibles, hobby and infant care products targeted to consumers of
      all
      ages.





The
      Company’s reportable segments under SFAS No. 131, “Disclosure About Segments of
      an Enterprise and Related Information,” are North America and International. The
      North America segment includes the United States, Canada and Mexico. The
      International segment includes non-North America markets.





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 was an
      unaffiliated business enterprise. Information by segment and a reconciliation
      to
      reported amounts for the three months and nine months ended September 30, 2006
      and 2005 are as follows:





**Three
                Months Ended September 30,**(in
                thousands)
            
            **2006**
            
            **2005****Net
                sales:**North
                America
            
            $
            136,175
            
            $
            121,661International
            
            
            24,554
            
            
            21,378Sales
                and transfers between segments
            
            
            (275
            )
            
            (472
            )Combined
                total
            
            $
            160,454
            
            $
            142,567**Operating
                income:**North
                America
            
            $
            26,499
            
            $
            24,079International
            
            
            5,225
            
            
            6,820Combined
                total
            
            $
            31,724
            
            $
            30,899





10





**Nine
                Months Ended September 30,**(in
                thousands)
            
            **2006**
            
            **2005****Net
                sales:**North
                America
            
            $
            316,723
            
            $
            299,704International
            
            
            60,520
            
            
            49,264Sales
                and transfers between segments
            
            
            (573
            )
            
            (1,101
            )Combined
                total
            
            $
            376,670
            
            $
            347,867**Operating
                income:**North
                America
            
            $
            47,356
            
            $
            48,534International
            
            
            12,294
            
            
            12,007Combined
                total
            
            $
            59,650
            
            $
            60,541





(in
                thousands)
            
            **September
                30,**
              **2006**
            
            **December
                31,**
              **2005****Total
                assets:**North
                America
            
            $
            565,920
            
            $
            558,452International
            
            
            95,389
            
            
            71,284Combined
                total
            
            $
            661,309
            
            $
            629,736





Under
      the
      enterprise-wide disclosure requirements of SFAS No. 131, the Company reports
      net
      sales by product category and by distribution channel. The Company groups its
      products into three product categories: children’s toys, infant products and
      collectible products. The presentation is consistent with how the Company views
      its business. The following tables present consolidated net sales by product
      category and by distribution channel for the three months and nine months ended
      September 30, 2006 and 2005:





**Three
                Months Ended September 30,**(in
                thousands)
            
            **2006**
            
            **2005**Children’s
                toys
            
            $
            85,466
            
            $
            66,543Infant
                products
            
            
            44,878
            
            
            41,162Collectible
                products
            
            
            30,110
            
            
            34,862Net
                sales
            
            $
            160,454
            
            $
            142,567Chain
                retailers
            
            $
            108,555
            
            $
            88,901Specialty
                and hobby wholesalers
              and
                retailers
            
            
            33,951
            
            
            34,252OEM
                dealers
            
            
            12,755
            
            
            13,268Corporate
                promotional
            
            
            4,716
            
            
            5,643Direct
                to consumers
            
            
            477
            
            
            503Net
                sales
            
            $
            160,454
            
            $
            142,567





11




**Nine
                Months Ended September 30,**(in
                thousands)
            
            **2006**
            
            **2005**Children’s
                toys
            
            $
            175,939
            
            $
            140,121Infant
                products
            
            
            131,118
            
            
            117,545Collectible
                products
            
            
            69,613
            
            
            90,201Net
                sales
            
            $
            376,670
            
            $
            347,867Chain
                retailers
            
            $
            249,631
            
            $
            214,212Specialty
                and hobby wholesalers
              and
                retailers
            
            
            92,294
            
            
            92,290OEM
                dealers
            
            
            23,390
            
            
            27,084Corporate
                promotional
            
            
            10,213
            
            
            12,575Direct
                to consumers
            
            
            1,142
            
            
            1,706Net
                sales
            
            $
            376,670
            
            $
            347,867





**Note
      4 - Goodwill and Intangible Assets**





The
      change in carrying value of goodwill by reportable segment for the nine months
      ended September 30, 2006 is shown below:





(in
                thousands)
            
            **North
                America**
            
            **International**
            
            **Total**Balance
                at January 1, 2006
            
            $
            240,130
            
            $
            13,441
            
            $
            253,571Other
                adjustments
            
            
            (561
            )
            
            1,123
            
            
            562Balance
                at September 30, 2006
            
            $
            239,569
            
            $
            14,564
            
            $
            254,133





Adjustments
      made during the nine months ended September 30, 2006 primarily relate to
      currency exchange rate changes, release of certain purchase accounting
      liabilities and other adjustments.





12


The
      components of intangible assets, net are as follows:





(in
                thousands)
            
            **September
                30, 2006**
            
            **December
                31, 2005****Gross
                amount of amortizable intangible assets:**Customer
                relationships
            
            $
            8,704
            
            $
            8,704Other
            
            
            3,262
            
            
            2,962$
            11,966
            
            $
            11,666**Accumulated
                amortization of amortizable intangible assets:**Customer
                relationships
            
            $
            433
            
            $
            275Other
            
            
            1,991
            
            
            1,204$
            2,424
            
            $
            1,479**Intangible
                assets not subject to amortization:**Licenses
                and trademarks
            
            $
            89,663
            
            $
            89,272Other
            
            
            152
            
            
            152$
            89,815
            
            $
            89,424**Total
                intangible assets, net**
            
            $
            99,357
            
            $
            99,611





Other
      amortizable intangible assets consist primarily of patents, non-compete
      agreements, licenses and trademarks. Amortization expense of amortizable
      intangible assets for the year 2006 is estimated to be approximately $1.1
      million.





**Note
      5 - Comprehensive Income**





The
      Company reports comprehensive income in accordance with SFAS No. 130, "Reporting
      Comprehensive Income." SFAS No. 130 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, 2006 and 2005 is calculated as follows:





(in
                thousands)
            
            **2006**
            
            **2005**Net
                income
            
            $
            35,998
            
            $
            35,851Other
                  comprehensive income (loss) - foreign currency
                translation
                  adjustments
            
            
            3,577
            
            
            (3,742
            )Comprehensive
                income
            
            $
            39,575
            
            $
            32,109





13


**Note
      6 - Common Stock**





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





**Authorized**
            **Par**
            **Shares
                Outstanding at**
            **Shares
                Outstanding at****Shares**
            **Value**
            **September
                30, 2006**
            **December
                31, 2005**Voting
                Common Stock
            28,000,000
            $0.01
            20,931,886
            20,717,954





At
      December 31, 2005, the Company held 1,830,830 shares of its common stock in
      treasury. During the first nine months of 2006 and 2005, the Company sold a
      total of 4,782 shares and 4,729 shares, respectively, out of treasury to Company
      employees under the ESPP for $0.2 million and $0.1 million, respectively.




**Note
      7 - Debt**





Upon
      the
      closing of the acquisition of The First Years Inc. (TFY) on September 15, 2004,
      the Company entered into a new credit facility, which has subsequently been
      amended, to replace its previous credit facility. The credit facility is
      comprised of an $85.0 million term loan and a $100.0 million revolving line
      of
      credit, both of which mature on September 14, 2008. The credit facility also
      provides an additional $75.0 million of capacity under the revolving line of
      credit. This additional capacity is currently uncommitted by the lenders and
      must be approved by the lenders upon the Company’s request for borrowing.
      Principal payments ranging from $3.8 million to $6.9 million are scheduled
      quarterly beginning December 31, 2004 and continue thereafter with a final
      balloon payment upon maturity. A portion of the term loan has an interest rate
      of 3.45% plus applicable margin through the first three years of the facility.
      The remaining term loan and revolving line of credit bear interest, at the
      Company’s option, at a base rate or at a LIBOR rate plus applicable margin. The
      applicable margin is based on the Company’s ratio of consolidated debt to
      consolidated EBITDA (earnings before interest, taxes, depreciation, amortization
      and non-cash expense related to equity awards) and varies between 0.75% and
      1.625%. The Company is also required to pay a commitment fee of 0.20% to 0.35%
      per annum on the average daily unused portion of the revolving line of credit.
      At September 30, 2006, the margin in effect was 0.75% for LIBOR loans, and
      the
      commitment fee in effect was 0.20% 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, incur additional debt and make acquisitions above
      certain amounts. The key financial covenants include minimum EBITDA and interest
      coverage and leverage ratios. The credit facility is secured by working capital
      assets and certain intangible assets. On September 30, 2006, the Company had
      $58.8 million outstanding on this credit facility and was in compliance with
      all
      covenants.





During
      2005, the Company’s United Kingdom subsidiary entered into a line of credit with
      a bank for $8.0 million that was to expire on September 14, 2008. The line
      of
      credit bore interest at 1.15% over the LIBOR rate, and the total amount was
      secured by a guarantee of the Company. During the first half of 2006, all
      borrowings under the line of credit were repaid and the Company cancelled the
      availability thereunder.





14


**Note
      8 - Net Income Per Share**





The
      Company computes net income per share in accordance with SFAS No. 128, "Earnings
      Per Share." Under the provisions of SFAS No. 128, basic net income per share
      is
      computed by dividing net income for the period by the weighted average number
      of
      common shares outstanding during the period. Diluted net income per share is
      computed by dividing the net income for the period by the weighted average
      number of common and common equivalent shares outstanding during the period.
      Options to purchase 548,875 shares of common stock at prices between $29.94
      and
      $37.19 per share were outstanding during the three months ended September 30,
      2006, but were not included in the computation of diluted earnings per share
      because either the options’ exercise price was greater than the average market
      price of common shares or the options’ total assumed proceeds under the treasury
      stock method were anti-dilutive. Options to purchase 503,067 shares of common
      stock at prices between $31.27 and $37.19 per share were outstanding during
      the
      nine months ended September 30, 2006, but were not included in the computation
      of diluted earnings per share because either the options’ exercise price was
      greater than the average market price of common shares or the options’ total
      assumed proceeds under the treasury stock method were anti-dilutive. Options
      to
      purchase 2,927 shares of common stock at $36.54 per share were outstanding
      during the nine months ended September 30, 2005, but were not included in the
      computation of diluted earnings per share because the options’ exercise price
      was greater than the average market price of common shares.





**Note
      9 - 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.





**Note
      10 - 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.





**Note
      11 - Reclassifications**





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





**Note
      12 - Related Party Transactions**





The
      Company purchased some of its finished goods during the nine months ended
      September 30, 2006 and 2005 from two companies in which a relative of a Company
      stockholder/director has ownership interests.





15


**Note
      13 - Commitments and Contingencies**





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





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 entertainment publishing and media companies; automotive
      and truck manufacturers; agricultural, construction and outdoor sports vehicle
      and equipment manufacturers; major race sanctioning bodies; and race team
      owners, sponsors and drivers. The Company has more than 700 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, 2006 and 2005.





Effective
      January 1, 2006, the Company entered into a five-year supply agreement with
      one
      of its third-party, dedicated suppliers (the Supplier). Under this agreement,
      the Supplier agrees to manufacture the Company’s products exclusively, and the
      Company agrees to purchase a minimum of $20.4 million of product from the
      Supplier each year. The annual minimum purchase guarantee is subject to annual
      decreases based upon the Company’s overall annual purchases from all of its
      suppliers.





In
      conjunction with the acquisition of TFY during the third quarter of 2004, the
      Company acquired purchase commitments with certain vendors relating to product
      and product components which are kept on hand to shorten lead times. In the
      event the Company chooses to discontinue the product, the Company would be
      required to reimburse the applicable vendor for the cost of the products and
      product components on hand. At September 30, 2006, the total commitment to
      these
      vendors was approximately $0.5 million.





**Note
      14 - 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 retirement 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, 2006 and 2005 are as follows:





**Three
                Months Ended September 30,**(in
                thousands)
            
            **2006**
            
            **2005**Service
                cost
            
            $
            27
            
            $
            27Interest
                cost
            
            
            197
            
            
            192Expected
                return on plan assets
            
            
            (245
            )
            
            (244
            )Amortization
                of prior service costs
            
            
            5
            
            
            5Amortization
                of net loss
            
            
            110
            
            
            93Net
                periodic benefit cost
            
            $
            94
            
            $
            73





16





**Nine
                Months Ended September 30,**(in
                thousands)
            
            **2006**
            
            **2005**Service
                cost
            
            $
            79
            
            $
            81Interest
                cost
            
            
            591
            
            
            576Expected
                return on plan assets
            
            
            (735
            )
            
            (734
            )Amortization
                of prior service costs
            
            
            15
            
            
            15Amortization
                of net loss
            
            
            330
            
            
            279Net
                periodic benefit cost
            
            $
            280
            
            $
            217





The
      Company did not make any contributions to the pension benefit plan during the
      nine months ended September 30, 2006 and does not expect to make any
      contributions during the fiscal 2006 year.





**Note
      15 - Meteor The Monster Truck Company, LLC**





In
      July
      2005, the Company invested in Meteor The Monster Truck Company, LLC (Meteor).
      The Company initially contributed $0.8 million to Meteor, and after recovery
      of
      its capital contributions and preferred returns, the Company was to share in
      7.5% of the profits and losses of Meteor. In April 2006, an event occurred
      under
      the Company’s agreement with Meteor which triggered the Company’s obligation to
      make an additional investment in Meteor. During the second quarter of 2006,
      the
      Company contributed an additional $1.2 million which adjusted the Company’s
      share in the profits and losses of Meteor to 17.5%.





The
      Company accounts for the investment in Meteor using the equity method of
      accounting. This determination was made based on the Company’s ability to
      exercise significant influence over the operating and financial policies of
      Meteor as a result of its representation on the board of directors. The
      investment in Meteor of $1.9 million and $0.7 million is included in other
      non-current assets on the accompanying condensed consolidated balance sheets
      at
      September 30, 2006 and December 31, 2005, respectively.





**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 financial condition,
      results of operations, 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.





17


RESULTS
      OF OPERATIONS





**Operating
      Highlights**





Net
      sales
      for the quarter ended September 30, 2006 increased 12.6% primarily due to
      our ** *Thomas
      & Friends,* John
      Deere and *Bob
      the Builder* toy
      product lines, The First Years’ Take & Toss® toddler self-feeding system and
      SoothieTM  bottle
      system, and Learning Curve’s Lamaze infant toys. Gross margin decreased to 47.2%
      for the third quarter of 2006 from 48.9% for the third quarter of 2005 primarily
      due to a less favorable product and distribution mix and higher product costs,
      especially in die-cast products, than that experienced in the third quarter
      of
      2005. Selling, general and administrative expenses as a percentage of net sales
      decreased to 27.2% for the third quarter of 2006 from 28.0% for the third
      quarter of 2005. Operating income increased to $31.7 million for the third
      quarter of 2006 compared to $30.9 million for the third quarter of 2005.
      Operating income for the third quarter of 2006 includes $1.0 million in
      compensation expense for stock options. As a percentage of net sales, operating
      income decreased to 19.8% for the third quarter of 2006 from 21.7% for the
      third
      quarter of 2005.





Net
      sales
      for the nine months ended September 30, 2006 increased 8.3% primarily due to
      our ** *Thomas
      & Friends,*  *Bob
      the Builder* and John
      Deere toy product lines, our John Deere and *Thomas
      & Friends* ride-on’s, as well as The First Years’ Take & Toss® toddler self-feeding
      system, our infant feeding product lines, our Lamaze infant play and certain
      other infant care and safety product lines. Gross margin decreased to 47.2%
      for
      the nine months ended September 30, 2006 from 49.3% for the nine months ended
      September 30, 2005 primarily due to a less favorable product and distribution
      mix and higher product costs, especially in die-cast products. Selling, general
      and administrative expenses as a percentage of net sales decreased to 31.1%
      for
      the nine months ended September 30, 2006 from 32.2% for the nine months ended
      September 30, 2005. Operating income decreased to $59.7 million for the nine
      months ended September 30, 2006 compared to $60.5 million for the nine months
      ended September 30, 2005 due to the inclusion of $3.2 million of compensation
      expense for stock options and $1.0 million of legal and settlement expenses
      for
      litigation involving The First Years (TFY) which preceded its acquisition by
      RC2. As a percentage of net sales, operating income decreased to 15.8% for
      the
      nine months ended September 30, 2006 from 17.4% for the nine months ended
      September 30, 2005.





Operating
      income for the three months and nine months ended September 30, 2005 was
      positively impacted by $2.0 million, or $0.06 per share, from a gain on the
      sale
      of the W. Britain product line and negatively impacted by $0.6 million, or
      $0.03
      per share, related to catch-up amortization expense from the completion of
      the
      valuation of assets acquired in the TFY transaction.




On
      January 1, 2006, the Company adopted SFAS No. 123R, “Share-Based Payment,” using
      the modified prospective method. This Statement is a revision of SFAS No. 123,
      “Accounting for Stock-Based Compensation” and supersedes APB Opinion No. 25,
“Accounting for Stock Issued to Employees.” For periods ended prior to January
      1, 2006, pursuant to APB Opinion No. 25, no stock-based employee compensation
      expense was recognized by the Company and, under the modified prospective method
      pursuant to SFAS No. 123R, results for prior periods have not been restated.
      Operating income for the three months and nine months ended September 30, 2006
      includes $1.0 million and $3.2 million, respectively, in compensation expense
      for stock options as a result of the Company’s adoption of SFAS No. 123R which
      negatively impacted diluted earnings per share by $0.03 and $0.09, respectively.
      Results for the three months and nine months ended September 30, 2005 do not
      include compensation expense for stock options.





18


As
      of
      September 30, 2006, there was $11.2 million of total unrecognized compensation
      cost related to nonvested stock-based compensation arrangements granted under
      the Company’s stock incentive plans. The cost is expected to be recognized over
      a weighted average period of 3.5 years. The total fair value of options vested
      during the nine months ended September 30, 2006 was $2.8 million.




On
        August 24, 2006, we announced that we have signed two
        new license agreements with HIT Entertainment with respect to certain *Thomas
& Friends* product lines.  Based on the new agreements, we expect
        our total pre-tax licensing cost, net of expected price increases and margin
        improvements, for these *Thomas & Friends* licenses will increase by
        approximately $4.0 million in 2007 when compared to 2006.


**Three
      Months Ended September 30, 2006 Compared to Three Months Ended September 30,
      2005**





*Net
      sales.* Net
      sales
      for the third quarter of 2006 increased $17.9 million, or 12.6%, to $160.5
      million from $142.6 million for the third quarter of 2005. Net sales increases
      occurred in our children’s toys and infant products categories, but these
      increases were partially offset by a decrease in our collectible products
      category.





Net
      sales
      in our children’s toys category increased 28.4% primarily driven by *Thomas
      & Friends,*  *Bob
      the Builder* and John
      Deere toy product lines. Net sales in our infant products category increased
      9.0% primarily driven by The First Years’ Take & Toss® toddler self-feeding
      system and SoothieTM  bottle
      system and Learning Curve’s Lamaze infant toys. Net sales in our collectible
      products category decreased 13.6% primarily due to continued softness in the
      collectibles market.





*Gross
      profit.* Gross
      profit increased $6.1 million, or 8.8%, to $75.8 million for the third quarter
      of 2006 from $69.7 million for the third quarter of 2005. However, as a
      percentage of net sales, gross profit margin decreased to 47.2% in the third
      quarter of 2006 compared to 48.9% in the third quarter of 2005 primarily due
      to
      a less favorable product and distribution mix and higher product costs,
      especially in die-cast products, than that experienced in the third quarter
      of
      2005. Our quarterly gross margins can be affected by the mix of product that
      is
      shipped during each quarter. Our infant products category has higher sales
      of
      non-licensed products that carry lower selling prices and gross margins than
      our
      children’s toys and collectible products categories. Additionally, individual
      product lines within a category carry 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 increased $3.8 million, or 9.5%, to $43.7
      million for the third quarter of 2006 from $39.9 million for the third quarter
      of 2005. As a percentage of net sales, selling, general and administrative
      expenses decreased to 27.2% for the third quarter of 2006 from 28.0% for the
      third quarter of 2005. Selling, general and administrative expenses for the
      third quarter of 2006 include $0.9 million of compensation expense for stock
      options. Results for the third quarter of 2005 do not include compensation
      expense for stock options.





*Operating
      income.* Operating
      income increased to $31.7 million for the third quarter of 2006 from $30.9
      million for the third quarter of 2005. However, as a percentage of net sales,
      operating income decreased to 19.8% in the third quarter of 2006 from 21.7%
      in
      the prior year third quarter. Operating income for the third quarter 2005 was
      positively impacted by $2.0 million in gain from the sale of the W. Britain
      product line and negatively impacted by $0.6 million in catch-up amortization
      related to the completion of the valuation of assets acquired with the TFY
      transaction.


19


*Net
      interest expense* .
      Net
      interest expense of $0.9 million for the third quarter of 2006 and $1.5 million
      for the third quarter of 2005 relates primarily to bank term loans and lines
      of
      credit. The decrease in net interest expense was primarily due to the decrease
      in average outstanding debt balances offset slightly by higher interest rates.





*Income
      tax.* Income
      tax expense for the third quarter of 2006 and 2005 includes provisions for
      federal, state and foreign income taxes at an effective rate of 36.9% and 37.1%,
      respectively. However, the tax rate for the third quarter of 2006 and 2005
      is
      36.5% and 37.8%, respectively, which include discrete items.





**Nine
      Months Ended September 30, 2006 Compared to Nine Months Ended September 30,
      2005**





*Net
      sales.* Net
      sales
      for the nine months ended September 30, 2006 increased $28.8 million, or 8.3%,
      to $376.7 million from $347.9 million for the nine months ended September 30,
      2005. Net sales increases occurred in our children’s toys and infant products
      categories, but these increases were partially offset by a decrease in our
      collectible products category.





Net
      sales
      in our children’s toys category increased 25.6% primarily driven by *Thomas & Friends,* John
      Deere and *Bob
      the Builder* toy
      vehicle product lines as well as John Deere and *Thomas
      & Friends* ride-on
      product lines. Net sales in our infant products category increased 11.5%
      primarily driven by The First Years’ Take & Toss® toddler self-feeding
      system, our infant feeding product lines, Learning Curve’s Lamaze infant toys
      and certain care and safety product lines. Net sales in our collectible products
      category decreased 22.8% primarily due to continued softness in the collectibles
      market.





*Gross
      profit.* Gross
      profit increased $6.2 million, or 3.6%, to $177.8 million for the nine months
      ended September 30, 2006 from $171.6 million for the nine months ended September
      30, 2005. However, as a percentage of net sales, the gross profit margin
      decreased to 47.2% for the nine months ended September 30, 2006 compared to
      49.3% for the nine months ended September 30, 2005 primarily due to a less
      favorable product and distribution mix and higher product costs, especially
      in
      die-cast products. There were no major changes in the components of cost of
      sales.





*Selling,
      general and administrative expenses.* Selling,
      general and administrative expenses increased $5.3 million, or 4.7%, to $117.2
      million for the nine months ended September 30, 2006 from $111.9 million for
      the
      nine months ended September 30, 2005. As a percentage of net sales, selling,
      general and administrative expenses decreased to 31.1% for the nine months
      ended
      September 30, 2006 from 32.2% for the nine months ended September 30, 2005.
      Selling, general and administrative expenses for the nine months ended September
      30, 2006 include $3.0 million of compensation expense for stock options and
      $1.0
      million in expenses related to litigation involving TFY which preceded its
      acquisition by RC2. Results for the nine months ended September 30, 2005 do
      not
      include compensation expense for stock options.





*Operating
      income.* Operating
      income decreased to $59.7 million for the nine months ended September 30, 2006
      from $60.5 million for the nine months ended September 30, 2005. As a percentage
      of net sales, operating income decreased to 15.8% for the nine months ended
      September 30, 2006 from 17.4% for the nine months ended September 30, 2005.
      Operating income for the nine months ended September 30, 2005 was positively
      impacted by $2.0 million in gain from the sale of the W. Britain product line
      and negatively impacted by $0.6 million in catch-up amortization related to
      the
      completion of the valuation of assets acquired with the TFY
      transaction.


20


*Net
      interest expense* .
      Net
      interest expense of $2.8 million for the nine months ended September 30, 2006
      and $4.6 million for the nine months ended September 30, 2005 relates primarily
      to bank term loans and lines of credit. The decrease in net interest expense
      was
      primarily due to the decrease in average outstanding debt balances offset
      slightly by higher interest rates.





*Income
      tax.* Income
      tax expense for the nine months ended September 30, 2006 and 2005 includes
      provisions for federal, state and foreign income taxes at an effective rate
      of
      36.9% and 37.1%, respectively. However, the tax rate for the nine months ended
      September 30, 2006 and 2005 is 36.5% and 36.4%, respectively, which include
      discrete items. During the second quarter of 2005, the Company reduced its
      income tax accruals by approximately $0.7 million, or $0.03 per diluted share,
      due to the resolution of specific outstanding state and foreign tax issues.





**Related
      Party Transactions**





The
      Company purchased some of its finished goods during the nine months ended
      September 30, 2006 and 2005 from two companies in which a relative of a
      Company’s stockholder/director has ownership interests.





LIQUIDITY
      AND CAPITAL RESOURCES





The
      Company’s operations provided net cash of $27.4 million during the nine months
      ended September 30, 2006. Accounts receivable and inventory increased $8.1
      million and $23.9 million, respectively, during the nine months ended September
      30, 2006 and were the primary uses of cash from operations. Capital expenditures
      for the nine months ended September 30, 2006 were $10.9 million, of which $7.7
      million was for molds and tooling. Payments on the Company’s credit
      facilities were $38.2 million for the nine months ended September 30, 2006.
      Borrowings on the Company's credit facilities were $14.0 million during the
      nine
      months ended September 30, 2006.  Cash and cash equivalents decreased by
      $4.9 million during the nine months ended September 30, 2006.





Upon
      the
      closing of the acquisition of TFY on September 15, 2004, the Company entered
      into a new credit facility, which has subsequently been amended, to replace
      its
      previous credit facility. The credit facility is comprised of an $85.0 million
      term loan and a $100.0 million revolving line of credit, both of which mature
      on
      September 14, 2008. The credit facility also provides an additional $75.0
      million of capacity under the revolving line of credit. This additional capacity
      is currently uncommitted by the lenders and must be approved by the lenders
      upon
      the Company’s request for borrowing. Principal payments ranging from $3.8
      million to $6.9 million are scheduled quarterly beginning December 31, 2004
      and
      continue thereafter with a final balloon payment upon maturity. A portion of
      the
      term loan has an interest rate of 3.45% plus applicable margin through the
      first
      three years of the facility. The remaining term loan and revolving line of
      credit bear interest, at the Company’s option, at a base rate or at a LIBOR rate
      plus applicable margin. The applicable margin is based on the Company’s ratio of
      consolidated debt to consolidated EBITDA (earnings before interest, taxes,
      depreciation, amortization and non-cash expense related to equity awards) and
      varies between 0.75% and 1.625%. The Company is also required to pay a
      commitment fee of 0.20% to 0.35% per annum on the average daily unused portion
      of the revolving line of credit. At September 30, 2006, the margin in effect
      was
      0.75% for LIBOR loans, and the commitment fee in effect was 0.20% 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, incur additional debt
      and
      make acquisitions above certain amounts. The key financial covenants include
      minimum EBITDA and interest coverage and leverage ratios. The credit facility
      is
      secured by working capital assets and certain intangible assets. On September
      30, 2006, the Company had $58.8 million outstanding on this credit facility
      and
      was in compliance with all covenants.


21


During
      2005, the Company’s United Kingdom subsidiary entered into a line of credit with
      a bank for $8.0 million that was to expire on September 14, 2008. The line
      of
      credit bore interest at 1.15% over the LIBOR rate, and the total amount was
      secured by a guarantee of the Company. During the first half of 2006, all
      borrowings under the line of credit were repaid and the Company cancelled the
      availability thereunder.





During
      the nine months ended September 30, 2006, the Company made total payments of
      $22.3 million on its lines of credit and $15.9 million on its term loan.
      Additionally, the Company borrowed $14.0 million on one of its lines of credit
      during the nine months ended September 30, 2006. At September 30, 2006, the
      Company had $89.6 million available on its line of credit.





The
      Company has met its working capital needs through funds generated from
      operations and available borrowings under our lines of credit. 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
      2006, principally for molds and tooling, will be approximately $15.0
      million.





The
      Company believes that its cash flows from operations, cash on hand 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 2006. However, if the Company’s capital
      requirements vary materially from those currently planned, the Company may
      require additional debt or equity financing. 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.





*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 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 has purchased
      credit insurance that covers a portion of its receivables from major customers.
      The Company will continue to proactively review its credit risks and adjust
      its
      customer terms to reflect the current environment.





22


*Inventory.* Inventory, which consists of finished goods, has been written down for excess
      quantities and obsolescence, and is stated at lower of cost or market. Cost
      is
      determined by 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
      and
      order bookings. Changes in public and consumer preferences and demand for
      product or changes in customer buying patterns and inventory management 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 Statement of
      Financial Accounting Standards (SFAS) No. 144, "Accounting for the Impairment
      of
      Long-Lived Assets and for Long-Lived Assets to be Disposed Of." This statement
      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 SFAS No. 142,
      "Goodwill and Other Intangible Assets." Under this Statement, goodwill and
      other
      intangible assets that have indefinite useful lives are not amortized, but
      rather tested at least annually for impairment. The Company's management reviews
      for indicators that might suggest an impairment loss could exist. 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, deterioration in the political environment 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.





*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. In determining the
      required liability, management considers certain tax exposures and all available
      evidence. However, 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 non-current liabilities on the
      accompanying condensed consolidated balance sheets.


23


*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 for defective merchandise, volume
      programs and co-op advertising. All allowances are accrued for 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. The Company’s products currently carry a limited
      warranty which guarantees the product to be free from defects in material and
      workmanship under normal and intended use for a period of 90 days from the
      date
      of consumer purchase. Historical results of these product warranties have shown
      that they have had an immaterial impact on the Company. Based upon the
      historical results, appropriate allowances for product warranty claims are
      accrued throughout the year.





*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 on the accompanying condensed consolidated statements
      of
      earnings.





**Recently
      Issued Accounting Pronouncements**





In
      June
      2006, the FASB issued FASB Interpretation 48, “Accounting for Uncertainty in
      Income Taxes - an interpretation of FASB Statement No. 109.” This Interpretation
      clarifies the accounting for uncertainty in income taxes recognized in an
      enterprise’s financial statements in accordance with FASB Statement No. 109,
“Accounting for Income Taxes.” This Interpretation prescribes a recognition
      threshold and measurement attribute for the financial statement recognition
      and
      measurement of a tax position taken or expected to be taken in a tax return.
      This Interpretation also provides guidance on derecognition, classification,
      interest and penalties, accounting in interim periods, disclosure, and
      transition. This Interpretation is effective for fiscal years beginning after
      December 15, 2006. The Company is evaluating the effect that this Interpretation
      will have on the Company’s financial statements.





In
      September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.” This
      Statement defines fair value, establishes a framework for measuring fair value
      in generally accepted accounting principles and expands disclosures about fair
      value measurements. This Statement applies under other accounting pronouncements
      that require or permit fair value measurement. However, this Statement does
      not
      require any new fair value measurements. This Statement is effective for
      financial statements issued for fiscals years beginning after November 15,
      2007,
      and interim periods within those fiscal years. The Company is evaluating the
      effect that this Statement will have on the Company’s financial
      statements.





24


In
      September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined
      Benefit Pension and Other Postretirement Plans - an Amendment of FASB SFAS
      No.
      87, 88, 106 and 132(R).” This Statement requires an employer to recognize the
      overfunded or underfunded status of a defined benefit postretirement plan as
      an
      asset or liability in its statement of financial position and to recognize
      changes in that funded status in the year in which the changes occur through
      comprehensive income of a business entity. This Statement also requires an
      employer to measure the funded status of a plan as of the date of its year-end
      statement of financial position. The provisions of SFAS No. 158 are effective
      for fiscal years beginning after December 15, 2006. The Company is evaluating
      the effect that this Statement will have on the Company’s financial
      statements.





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," "believe," "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 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;
      increases in the cost of raw materials used to manufacture the Company’s
      products and increases in freight costs could increase the Company’s cost of
      sales and reduce the Company’s gross margins; currency exchange rate
      fluctuations, particularly in the Chinese Renminbi or the Hong Kong dollar,
      could increase the Company’s expenses; 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; competition in the markets for
      the
      Company's products may increase significantly; the Company is dependent upon
      continuing licensing arrangements with owners of popular and classic licensed
      properties such as *Thomas
      & Friends, Bob the Builder, Winnie the Pooh,* John
      Deere and *Sesame
      Street* ,
      vehicle
      manufacturers, agricultural equipment manufacturers, major race sanctioning
      bodies, race team owners, drivers, sponsors, agents and other licensors; the
      Company may experience unanticipated negative results of litigation; the Company
      relies upon a limited number of independently owned factories located in China
      to manufacture a significant portion of its vehicle replicas and certain other
      products; the Company is dependent upon the continuing willingness of leading
      retailers to purchase and provide shelf space for the Company's products; and
      general economic conditions in the Company's markets *.* 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, 2005. 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.


25


**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 facilities 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, 2006, a one percentage point increase in average interest
      rates on the Company's borrowings would increase future interest expense by
      $29,841 per month and a five percentage point increase would increase future
      interest expense by $0.1 million per month. The Company determined these amounts
      based on approximately $35.8 million of variable rate borrowings at
      September 30, 2006, 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.





During
      July 2005, China revalued the Chinese Renminbi, abandoning the former method
      of
      pegging the Chinese Renminbi to the U.S. dollar. As expenses for the Company’s
      Chinese manufacturers are primarily denominated in Chinese Renminbi, a material
      increase in the value of the Chinese Renminbi relative to the U.S. dollar would
      increase the Company’s expenses and therefore could adversely affect the
      Company’s profitability.





**Item
      4.   Controls and
      Procedures**





As
      of the
      end of the period covered by this report, the Company carried out an evaluation,
      under the supervision and with the participation of the Company's management,
      including the Company's Chief Executive Officer and Chief Financial Officer,
      of
      the Company's disclosure controls and procedures (as defined in
      Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as
      amended). Based on this evaluation, the Company's Chief Executive Officer and
      Chief Financial Officer concluded that, as of the end of such period, the
      Company's disclosure controls and procedures were effective in recording,
      processing, summarizing and reporting, on a timely basis, information required
      to be disclosed by the Company in reports that the Company files with or submits
      to the Securities and Exchange Commission. It should be noted that 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 and based on the
      evaluation described above, the Company's Chief Executive Officer and Chief
      Financial Officer concluded that the Company's disclosure controls and
      procedures were effective at reaching that level of reasonable
      assurance.





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.


26




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 our Form 10-K for the year ended December 31,
      2005. Please refer to that section for disclosures regarding the risks and
      uncertainties relating to our 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.





**Item4.** **Submission
      of Matters to a Vote of Security Holders.**





Not
      applicable.





**Item5.** **Other
      Information.**





Not
      applicable.





**Item6.** **Exhibits.**





3.1 Amended
      and Restated Certificate of Incorporation of the Company (incorporated by
      reference to
      Exhibit 3.1 of the Company's Quarterly 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).





3.2
            First
                Amendment to the Amended and Restated Certificate of Incorporation
                of the
                Company (incorporated by reference to Exhibit 3.2 of the Company's
                Quarterly 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).





3.3
            Certificate
                of Ownership and Merger changing the Company's name to Racing Champions
                Ertl Corporation (incorporated by reference to Exhibit 3.3 of the
                Company's Quarterly 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 Form 10-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
                Exhibit
                3.5 of the Company’s Quarterly Report on Form 10-Q for the quarter ended
                March 31, 2004 (File No. 0-22635) filed by the Company with the Securities
                and Exchange Commission on May 10,
                2004).





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-Oxley Act 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.


27




SIGNATURES





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





Dated
      this 31st day of October, 2006.





RC2
      CORPORATION





By /s/
      Curtis W. Stoelting


Curtis W. Stoelting, Chief Executive Officer








By /s/
      Jody L.
      Taylor


Jody
      L.
      Taylor, Chief Financial Officer


and
      Secretary








28