SECURITIES
AND EXCHANGE COMMISSION


WASHINGTON,
D.C.  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, 2009ORTRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
      EXCHANGE ACT OF 1934For
      the transition period from ________ to
________





Commission
      file number:
            0-22635RC2
      Corporation(Exact
      name of Registrant as specified in its charter)Delaware
            
            36-4088307(State
      or other jurisdiction of incorporation or organization)
            
            (IRS
      Employer Identification No.)1111
      West 22nd
      Street, Suite 320, Oak Brook, Illinois  60523(Address
      of principal executive offices)Registrant’s
      telephone number, including area
    code:  630-573-7200





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





Yes
            X
            
            No





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





Yes
            
            
            No





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





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





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





Yes
            
            
            No
            X





On
October 22, 2009, there were outstanding 21,384,179 shares of the Registrant’s
$0.01 par value common stock.





RC2
CORPORATION





FORM
10-Q





SEPTEMBER
30, 2009





INDEX





PART
      I – FINANCIAL INFORMATION
            
            Page  Item
      1.
            Condensed Consolidated Balance Sheets as
      of September 30, 2009
              and December 31, 2008
            3Condensed Consolidated Statements of Earnings
      for the Three
              Months and Nine Months Ended September 30, 2009 and
      2008
            4Condensed Consolidated Statements of Cash
      Flows for the Nine
              Months
      Ended September 30, 2009 and 2008
            5Notes to Condensed Consolidated
      Financial Statements
            6Item
      2.
            Management’s Discussion and Analysis of
      Financial Conditionand
      Results of Operations
            18Item
      3.
            Quantitative and Qualitative Disclosures
      about Market Risk
            27Item
      4.
            Controls and Procedures
            28  PART
      II – OTHER INFORMATION  Item
      1.
            Legal Proceedings
            29Item
      1A.
            Risk Factors
            29Item
      2.
            Unregistered Sales of Equity Securities and Use
      of Proceeds
            29Item
      3.
            Defaults Upon Senior
      Securities
            29Item
      4.
            Submission of Matters to a Vote of Security
      Holders
            29Item
      5.
            Other Information
            29Item
      6.
            Exhibits
            30Signatures
            31





2


PART
I – FINANCIAL INFORMATION





Item
1.   Financial Statements





RC2
Corporation and Subsidiaries


Condensed
Consolidated Balance Sheets


(Unaudited
and in thousands)





September
      30,
              2009
            
            
            December
      31,
              2008AssetsCash
      and cash equivalents
            
            $
            86,778
            
            
            $
            32,095Accounts
      receivable, net
            
            
            94,690
            
            
            
            91,647Inventory
            
            
            70,630
            
            
            
            73,989Other
      current assets
            
            
            16,677
            
            
            
            19,562Total
      current assets
            
            
            268,775
            
            
            
            217,293Property
      and equipment, net
            
            
            28,326
            
            
            
            30,901Intangibles,
      net
            
            
            82,392
            
            
            
            82,504Other
      non-current assets
            
            
            6,632
            
            
            
            5,952Total
      assets
            
            $
            386,125
            
            
            $
            336,650Liabilities
      and stockholders’ equityAccounts
      payable and accrued expenses
            
            $
            69,846
            
            
            $
            73,986Current
      maturities of bank term loan
            
            
            11,250
            
            
            
            15,000Other
      current liabilities
            
            
            2,475
            
            
            
            2,508Total
      current liabilities
            
            
            83,571
            
            
            
            91,494Line
      of credit
            
            
            ---
            
            
            
            20,120Bank
      term loan
            
            
            48,750
            
            
            
            60,000Other
      non-current liabilities
            
            
            18,791
            
            
            
            16,347Total
      liabilities
            
            
            151,112
            
            
            
            187,961Stockholders’
      equity
            
            
            235,013
            
            
            
            148,689Total
      liabilities and stockholders’ equity
            
            $
            386,125
            
            
            $
            336,650





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 monthsended
              September
      30,2009
            
            
            2008
            
            
            2009
            
            
            2008Net
      sales
            
            $
            126,507
            
            
            $
            132,856
            
            
            $
            299,814
            
            
            $
            315,339Cost
      of sales
            
            
            67,982
            
            
            
            72,114
            
            
            
            169,884
            
            
            
            171,162Recall-related
      items
            
            
            (197
            )
            
            
            (1,357
            )
            
            
            (197
            )
            
            
            (936
            )Gross
      profit
            
            
            58,722
            
            
            
            62,099
            
            
            
            130,127
            
            
            
            145,113Selling,
      general andadministrative
      expenses
            
            
            36,869
            
            
            
            41,026
            
            
            
            96,157
            
            
            
            112,388Recall-related
      items
            
            
            (112
            )
            
            
            (1,464
            )
            
            
            437
            
            
            
            15,185Terminated
      acquisition costs
            
            
            ---
            
            
            
            1,416
            
            
            
            ---
            
            
            
            1,416Amortization
      of intangible assets
            
            
            153
            
            
            
            219
            
            
            
            514
            
            
            
            670Operating
      income
            
            
            21,812
            
            
            
            20,902
            
            
            
            33,019
            
            
            
            15,454Interest
      expense
            
            
            819
            
            
            
            1,714
            
            
            
            2,968
            
            
            
            4,378Interest
      income
            
            
            (153
            )
            
            
            (476
            )
            
            
            (344
            )
            
            
            (1,325
            )Write-off
      of investment
            
            
            ---
            
            
            
            2,057
            
            
            
            ---
            
            
            
            2,057Other
      (income) expense, net
            
            
            (311
            )
            
            
            229
            
            
            
            614
            
            
            
            171Income
      before income taxes
            
            
            21,457
            
            
            
            17,378
            
            
            
            29,781
            
            
            
            10,173Income
      tax expense
            
            
            7,864
            
            
            
            6,269
            
            
            
            11,071
            
            
            
            3,476Net
      income
            
            $
            13,593
            
            
            $
            11,109
            
            
            $
            18,710
            
            
            $
            6,697Earnings
      per common share:Basic
            
            $
            0.68
            
            
            $
            0.65
            
            
            $
            1.03
            
            
            $
            0.38Diluted
            
            $
            0.66
            
            
            $
            0.64
            
            
            $
            1.01
            
            
            $
            0.38Weighted
      average shares outstanding:Basic
            
            
            20,078
            
            
            
            17,210
            
            
            
            18,215
            
            
            
            17,460Diluted
            
            
            20,602
            
            
            
            17,463
            
            
            
            18,517
            
            
            
            17,715





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
      30,2009
            
            
            2008Cash
      flows from operating activitiesNet
      income
            
            $
            18,710
            
            
            $
            6,697Depreciation
      and amortization
            
            
            9,162
            
            
            
            10,114Amortization
      of deferred financing costs
            
            
            706
            
            
            
            463Write-off
      of investment
            
            
            ---
            
            
            
            2,057Stock-based
      compensation
            
            
            3,811
            
            
            
            4,034Excess
      tax benefit on stock option exercises
            
            
            (16
            )
            
            
            (182
            )Loss
      on disposition of assets
            
            
            129
            
            
            
            13Changes
      in operating assets and liabilities
            
            
            8,300
            
            
            
            (29,833
            )Net
      cash provided by (used in) operating activities
            
            
            40,802
            
            
            
            (6,637
            )Cash
      flows from investing activitiesPurchase
      of property and equipment
            
            
            (6,023
            )
            
            
            (6,747
            )Proceeds
      from disposition of property and equipment
            
            
            33
            
            
            
            8Recovery
      of purchase price of acquisitions
            
            
            270
            
            
            
            13Change
      in restricted cash
            
            
            (157
            )
            
            
            ---Increase
      in other current assets
            
            
            (4,645
            )
            
            
            ---Increase
      in other non-current assets
            
            
            (131
            )
            
            
            (117
            )Net
      cash used in investing activities
            
            
            (10,653
            )
            
            
            (6,843
            )Cash
      flows from financing activitiesNet
      cash proceeds from public stock offering
            
            
            57,090
            
            
            
            ---Issuance
      of stock upon option exercises
            
            
            45
            
            
            
            956Excess
      tax benefit on stock option exercises
            
            
            16
            
            
            
            182Issuance
      of stock under ESPP
            
            
            116
            
            
            
            128Purchase
      of treasury stock
            
            
            ---
            
            
            
            (24,660
            )Payments
      on bank term loan
            
            
            (15,000
            )
            
            
            ---Net
      (payments) borrowings on line of credit
            
            
            (20,120
            )
            
            
            43,100Financing
      fees paid
            
            
            (157
            )
            
            
            (219
            )Net
      cash provided by financing activities
            
            
            21,990
            
            
            
            19,487Effect
      of exchange rate changes on cash
            
            
            2,544
            
            
            
            (1,858
            )Net
      increase in cash
            
            
            54,683
            
            
            
            4,149Cash
      and cash equivalents, beginning of year
            
            
            32,095
            
            
            
            57,809Cash
      and cash equivalents, end of period
            
            $
            86,778
            
            
            $
            61,958Supplemental
      information:Interest
      paid
            
            $
            2,365
            
            
            $
            3,787Income
      taxes paid
            
            
            4,595
            
            
            
            5,837Income
      tax refunds received
            
            $
            2,145
            
            
            $
            4,168





See
accompanying notes to condensed consolidated financial
statements.


5


RC2
Corporation and Subsidiaries


Notes to Unaudited Condensed Consolidated
Financial Statements





Note
1 – Basis of Presentation





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





The
accompanying unaudited condensed consolidated financial statements have been
prepared by management, and in the opinion of management, contain all
adjustments, consisting of normal recurring adjustments, necessary to present
fairly the financial position of the Company as of September 30, 2009, and the
results of operations and cash flows for the three-month and nine-month periods
ended September 30, 2009 and 2008.





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, 2008.  The condensed consolidated balance sheet
information as of December 31, 2008, 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 – Business Segments





The
Company is a leading designer, producer and marketer of innovative, high-quality
toys, collectibles, and infant and toddler products.





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





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.





6


Results
are not necessarily those that would be achieved if each segment were an
unaffiliated business enterprise.  Information by segment and a
reconciliation to reported amounts for the three months ended and nine months
ended September 30, 2009 and 2008, are as follows:





Three
      Months Ended September 30,(in
      thousands)
            
            2009
            
            
            2008Net
      sales:North
      America
            
            $
            99,471
            
            
            $
            98,998International
            
            
            27,437
            
            
            
            34,106Sales
      and transfers between segments
            
            
            (401
            )
            
            
            (248
            )Combined
      total
            
            $
            126,507
            
            
            $
            132,856Operating
      income:North
      America
            
            $
            16,268
            
            
            $
            14,441International
            
            
            5,515
            
            
            
            6,409Sales
      and transfers between segments
            
            
            29
            
            
            
            52Combined
      total
            
            $
            21,812
            
            
            $
            20,902





Nine
      Months Ended September 30,(in
      thousands)
            
            2009
            
            
            2008Net
      sales:North
      America
            
            $
            232,195
            
            
            $
            234,264International
            
            
            68,343
            
            
            
            81,761Sales
      and transfers between segments
            
            
            (724
            )
            
            
            (686
            )Combined
      total
            
            $
            299,814
            
            
            $
            315,339Operating
      income:North
      America
            
            $
            22,743
            
            
            $
            6,781International
            
            
            10,295
            
            
            
            8,624Sales
      and transfers between segments
            
            
            (19
            )
            
            
            49Combined
      total
            
            $
            33,019
            
            
            $
            15,454





(in
      thousands)
            
            September
      30,
              2009
            
            
            December
      31,
              2008Total
      assets:North
      America
            
            $
            274,085
            
            
            $
            235,499International
            
            
            112,040
            
            
            
            101,151Combined
      total
            
            $
            386,125
            
            
            $
            336,650





7


Under the
entity-wide disclosure requirements of the Business Segments Topic of the FASB
Accounting Standards Codification, the Company reports net sales by product
category and by distribution channel.  The Company groups its products
into two product categories: mother, infant and toddler products, and preschool,
youth and adult products.  The following table presents consolidated
net sales by product category and by distribution channel for the three months
and nine months ended September 30, 2009 and 2008:





Three
      Months Ended September 30,(in
      thousands)
            
            2009
            
            
            2008Mother,
      infant and toddler products
            
            $
            44,718
            
            
            $
            47,004Preschool,
      youth and adult products
            
            
            81,789
            
            
            
            85,852Net
      sales
            
            $
            126,507
            
            
            $
            132,856Chain
      retailers
            
            $
            93,117
            
            
            $
            90,580Specialty
      retailers, wholesalers, OEM dealers andother
            
            
            33,390
            
            
            
            42,276Net
      sales
            
            $
            126,507
            
            
            $
            132,856





Nine
      Months Ended September 30,(in
      thousands)
            
            2009
            
            
            2008Mother,
      infant and toddler products
            
            $
            137,688
            
            
            $
            134,770Preschool,
      youth and adult products
            
            
            162,126
            
            
            
            180,569Net
      sales
            
            $
            299,814
            
            
            $
            315,339Chain
      retailers
            
            $
            224,681
            
            
            $
            220,552Specialty
      retailers, wholesalers, OEM dealers andother
            
            
            75,133
            
            
            
            94,787Net
      sales
            
            $
            299,814
            
            
            $
            315,339





Note
3 – Cash and cash equivalents





The
Company considers all highly liquid investments with original maturities of 90
days or less to be cash equivalents.  Such investments are stated at
cost, which approximates fair value.





During
the third quarter of 2009, the Company purchased unrestricted certificates of
deposit with maturities greater than 90 days.  These unrestricted
certificates of deposit are included in other current assets in the accompanying
condensed consolidated balance sheet at September 30, 2009.  The
carrying amounts of these unrestricted certificates of deposit of $4.6 million
approximate their fair value.





8


Note
4 – Intangible Assets





The
components of intangible assets, net are as follows:





(in
      thousands)
            
            September
      30,
              2009
            
            
            December
      31,
              2008Gross
      amounts of amortizable intangible assets:Customer
      relationships
            
            $
            8,582
            
            
            $
            8,582Other
            
            
            4,351
            
            
            
            4,32112,933
            
            
            
            12,903Accumulated
      amortization of amortizable intangible assets:Customer
      relationships
            
            
            1,114
            
            
            
            939Other
            
            
            3,810
            
            
            
            3,4714,924
            
            
            
            4,410Intangible
      assets not subject to amortization:Licenses
      and trademarks
            
            
            74,383
            
            
            
            74,011Total
      intangible assets, net
            
            $
            82,392
            
            
            $
            82,504





Other
amortizable intangible assets consist primarily of patents, non-compete
agreements and trademarks and licenses.  Amortization expense related
to amortizable intangible assets for 2009 is estimated to be approximately $0.6
million.





Note
5 – Income Taxes





The
uncertain tax positions were $3.0 million and $3.6 million as of September 30,
2009 and December 31, 2008, respectively.  At each of September 30,
2009 and December 31, 2008, approximately $2.5 million of the total gross
unrecognized tax benefits represents the amount that, if recognized, would
affect the effective income tax rate in future periods.  The Company
and its subsidiaries are subject to U.S. federal income tax, as well as income
tax of multiple state and foreign jurisdictions.  The Company has
substantially concluded all U.S. federal income tax matters for years through
2005.  Substantially all material state and local and foreign income
tax matters have been concluded for years through 2005.  U.S. federal
income tax returns for 2006 through 2008 are currently open for
examination.  In the next twelve months, the Company expects to reduce
the unrecognized tax position reserves by approximately $1.4 million, primarily
due to the settlement of various state and international income tax audits, the
filing of amended returns and the closing of various statutes.  The
Company’s continuing practice is to recognize interest and/or penalties related
to income tax matters in income tax expense.  During the nine months
ended September 30, 2009, the Company recorded an adjustment to interest of $0.1
million and an immaterial amount for potential penalties, related to these
unrecognized tax benefits.  In total, as of September 30, 2009 and
December 31, 2008, the Company has recorded a liability for interest of $2.1
million and $2.0 million, respectively, and a liability for potential penalties
of $0.4 million and $0.3 million, respectively.





9


Note
6 – Debt





On
November 3, 2008, the Company entered into a new credit facility to replace its
previous credit facility.  The credit facility is comprised of a term
loan and provides for borrowings up to $70.0 million under a revolving line of
credit.  The total borrowing capacity available under the credit
facility is subject to a formula based on the Company’s leverage ratio, as
defined in the credit agreement.  The term loan and the revolving line
of credit both have a scheduled maturity date of November 1,
2011.  Under this credit facility, the term loan and the revolving
line of credit bear interest, at the Company’s option, at a base rate or at
LIBOR, plus applicable margins, which are based on the Company's leverage
ratio.  Applicable margins vary between 2.25% and 3.25% on LIBOR borrowings
and 1.25% and 2.25% on base rate borrowings.  At September 30, 2009,
the applicable margins in effect were 2.50% for LIBOR borrowings and 1.50% for
base rate borrowings.  Principal payments on the term loan are $3.8
million per calendar quarter, with the remaining principal of $33.8 million due
on November 1, 2011.  During the third quarter of 2009, the Company
prepaid its fourth quarter 2009 required principal payment.  The Company is
also required to pay a commitment fee which varies from 0.45% and 0.50% per
annum on the average daily unused portion of the revolving line of
credit.  At September 30, 2009, the commitment fee in effect was 0.50%
per annum.





Under the
terms of the new credit facility, the Company is required to comply with certain
financial and non-financial covenants.  Among other restrictions, the
Company is restricted in its ability to pay dividends, buy back its stock, incur
additional debt and make acquisitions above certain amounts.  The
credit facility also includes a clean down provision that limits the maximum
amount of borrowings under the revolving line of credit for a period of 60
consecutive days during the first four calendar months.  The clean
down provision limits are $27.5 million for a period of 60 consecutive days
during the first four calendar months of 2010 and $25.0 million for a period of
60 consecutive days during the first four calendar months of
2011.  The Company has met its clean down provision for the year
2009.  The credit facility is secured by the Company's domestic
assets along with a portion of the Company’s equity interests in its
foreign subsidiaries.  On September 30, 2009, the Company had $60.0
million outstanding on its bank term loan and no borrowings under its revolving
line of credit.  Additionally at September 30, 2009, the Company had
$70.0 million available on its revolving line of credit and was in compliance
with all covenants.





The
carrying amounts of the line of credit and bank term loan approximate fair
value.





Note
7 – Commitments and Contingencies





The
Company leases office and warehouse/distribution space under various
non-cancelable operating lease arrangements, which expire through November 30,
2019.  In the third quarter 2009, the Company entered into a ten year
lease agreement for a 174,375 square foot office and distribution facility
located in Dandenong South, Victoria, Australia, to replace an existing facility
whose lease will expire in December 2009.  The Company’s total rent
commitment over the ten year term is approximately $10.9 million, which equates
to an average annual rent expense of $1.1 million.





10


The
Company markets a significant portion of its products under licenses from other
parties.  These licenses are limited in scope and duration and
authorize the sale of specific licensed products generally on a nonexclusive
basis.  The Company has license agreements with, among others, various
entertainment, publishing and media companies, automotive and truck
manufacturers, and agricultural and construction vehicle and equipment
manufacturers.  The Company is a party to more than 300 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, 2009 and
2008.





Note
8 – Legal Proceedings





See Note
13 – Product Recalls for a description of certain legal proceedings with respect
to the products subject to the 2007 recalls.





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





Note
9 – Common Stock





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





(in
      thousands, except par value)
            
            Authorized
      Shares
            
            
            Par
      Value
            
            
            Shares
              Outstanding
      at
              September
      30,
              2009
            
            
            Shares
              Outstanding
      at
              December
      31,
              2008Voting
      common stock
            
            
            28,000
            
            
            $
            0.01
            
            
            
            21,353
            
            
            
            17,245





At
September 30, 2009 and December 31, 2008, the Company held 2.9 million and 5.9
million shares of its common stock in treasury, respectively.  During the
nine months ended September 30, 2009 and 2008, the Company sold a total of
20,737 shares and 6,681 shares, respectively, out of treasury to Company
employees under the Employee Stock Purchase Plan (ESPP) for $0.1 million and
$0.1 million, respectively.





In August
2009, the Company completed a public offering of 4.0 million shares of common
stock, of which 3.0 million were issued out of treasury, at a price of $15.00
per share.  The Company received net proceeds of $57.1 million and
intends to use the net proceeds from the offering for general corporate and
working capital purposes, including potential repayment of long-term debt and
the funding of future acquisitions.





The
Company’s Board of Directors authorized the adoption of a program to repurchase
up to $150.0 million of the Company’s common stock through December 31,
2008.  Under this program, shares could be repurchased from time to
time in open market transactions or privately negotiated transactions at the
Company’s discretion, subject to market conditions and other
factors.  Shares repurchased by the Company are held as treasury
shares.  During the nine months ended September 30, 2008, the Company
repurchased 1.2 million shares for $24.7 million under this
program.  These repurchases were funded with borrowings on the
Company’s revolving line of credit and with cash flow from
operations.


11


Note
10 – Stock-Based Payment Arrangements





At
September 30, 2009, the Company has three stock incentive plans, two of which
are dormant, and an ESPP. Amounts recognized in the condensed consolidated
financial statements with respect to these stock-based payment arrangements for
the three months and nine months ended September 30, 2009 and 2008, are as
follows:





Three
      Months Ended September 30,(in
      thousands)
            
            2009
            
            
            2008Total
      expense recognized for stock-basedpayment
      plans
            
            $
            1,465
            
            
            $
            1,361Amount
      of related income tax benefit recognized indetermining
      net income
            
            $
            516
            
            
            $
            513





Nine
      Months Ended September 30,(in
      thousands)
            
            2009
            
            
            2008Total
      expense recognized for stock-basedpayment
      plans
            
            $
            3,811
            
            
            $
            4,034Amount
      of related income tax benefit recognized indetermining
      net income
            
            $
            1,314
            
            
            $
            1,521





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, 2009 and
2008.





Restricted
stock awards, options to purchase stock or stock-settled stock appreciation
rights (SARs) may be granted under the current stock incentive
plan.  A summary of stock option and SARs activity for the Company’s
stock incentive plans for the nine months ended September 30, 2009, is as
follows:





Number
              of
      Shares
            
            
            Weighted
              Average
              Exercise
              Price
            
            
            Weighted
              Average
              Remaining
      Contractual
              Life
            
            
            Aggregate
              Intrinsic
              Value
              (000)Outstanding,
      beginning of year
            
            
            1,921,142
            
            
            $
            22.80Changes
      during the period:Granted
            
            
            998,300
            
            
            
            5.19Exercised
            
            
            9,000
            
            
            
            5.04Forfeited
            
            
            36,277
            
            
            
            18.23Expired
            
            
            83,660
            
            
            
            27.44Cancelled
            
            
            124,600
            
            
            
            35.87Outstanding,
      end of period
            
            
            2,665,905
            
            
            $
            15.57
            
            
            
            4.6
            
            
            $
            2,719Exercisable
      and vested as ofSeptember
      30, 2009
            
            
            1,093,021
            
            
            $
            20.37Expected
      to vest
            
            
            1,547,669
            
            
            
            12.25Total
      vested and expected to vest
            
            
            2,640,690
            
            
            $
            15.61
            
            
            
            7.1
            
            
            $
            11,621








12










Restricted
stock awards require no payment from the grantee.  The related
compensation cost of each award is calculated using either the market price on
the grant date or the market price on the last day of the reported period and is
expensed equally over the vesting period, which is generally over two to three
years.  A summary of restricted stock awards for the Company’s stock
incentive plans for the nine months ended September 30, 2009, is as
follows:





Number
              of
      Shares
            
            
            Weighted
              Average
              Fair
      Value
            
            Weighted
              Average
              Remaining
              Contractual
              LifeUnvested
      restricted stock awards, beginning of year
            
            
            57,851
            
            
            $
            21.90Changes
      during the period:Granted
            
            
            53,656
            
            
            
            10.72Vested
            
            
            20,271
            
            
            
            27.89Forfeited
            
            
            ---
            
            
            
            ---Unvested
      restricted stock awards, end of period
            
            
            91,236
            
            
            $
            14.39
            
            2.0





As of
September 30, 2009, there was $0.9 million of total unrecognized compensation
cost related to nonvested stock-based compensation arrangements granted under
the Company’s stock incentive plans for restricted stock awards.  That
cost is expected to be recognized over a weighted average period of 2.0
years.





Note
11 – Related Party Transactions





The
Company purchased some of its finished goods during the nine months ended
September 30, 2008, from a company in which a relative of a Company stockholder
and former director of the Company has an ownership interest.  The
former director completed his board of directors tenure in May
2008.





Note
12 – Employee Benefit Plans





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





13


The
components of net periodic benefit cost for the three months and nine months
ended September 30, 2009 and 2008, are as follows:





Three
      Months Ended September 30,(in
      thousands)
            
            2009
            
            
            2008Service
      cost
            
            $
            31
            
            
            $
            26Interest
      cost
            
            
            223
            
            
            
            213Expected
      return on plan assets
            
            
            (242
            )
            
            
            (277
            )Amortization
      of prior service costs
            
            
            4
            
            
            
            4Amortization
      of net loss
            
            
            57
            
            
            
            47Net
      periodic benefit cost
            
            $
            73
            
            
            $
            13





Nine
      Months Ended September 30,(in
      thousands)
            
            2009
            
            
            2008Service
      cost
            
            $
            94
            
            
            $
            76Interest
      cost
            
            
            668
            
            
            
            640Expected
      return on plan assets
            
            
            (728
            )
            
            
            (832
            )Amortization
      of prior service costs
            
            
            14
            
            
            
            14Amortization
      of net loss
            
            
            173
            
            
            
            142Net
      periodic benefit cost
            
            $
            221
            
            
            $
            40





The
Company did not make any contributions to the Plan during the nine months ended
September 30, 2009, and currently does not expect to make any additional
contributions during the remainder of the fiscal 2009 year.





Note
13 – Product Recalls





During
2008, the Company reached a settlement in the various class action lawsuits
against the Company in the U.S. which arose from or relate to the Company’s
recall of certain products in June 2007 and September 2007.  With the
final approval of the settlement agreement and the end of the claim period, the
class action lawsuits in the U.S. relating to the June 2007 and September 2007
recalls have been resolved.  The Company may be subject to individual
claims for personal injuries or other claims or government inquiries in the U.S.
or other jurisdictions (including the inquiry by the Consumer Product Safety
Commission (CPSC) described in the next paragraph) relating to the 2007
recalls.  No assurances can be given as to the outcome of any such
claims or government inquiries.





During
2008, the Company received an inquiry from the CPSC for information regarding
the recalls of certain products in June 2007 and September 2007 for the purpose
of assessing whether the CPSC may impose a fine on the Company.  The
Company is responding to this inquiry, and at this time, the CPSC has not yet
imposed a fine upon the Company.





14


The
Company recorded (benefits) charges related to the 2007 recalls of $(0.7)
million and $(3.2) million for the three months ended September 30, 2009 and
2008, respectively, and $(0.2) million and $13.9 million for the nine months
ended September 30, 2009 and 2008, respectively.  The Company has $2.8
million and $6.0 million of accrued recall-related items included in accounts
payable and accrued expenses in the accompanying condensed consolidated balance
sheets at September 30, 2009 and December 31, 2008,
respectively.  These items are based on the latest estimates of
retailer inventory returns, consumer product replacement costs, shipping costs
and fines and penalties as of the date of this filing, as well as additional
replacement costs or refunds, claims administration and unpaid legal fees to
defend recall-related matters incurred to date.  It is reasonably
possible that actual costs associated with the recalls and related litigation
could differ significantly from the estimates recorded.





Note
14 – Reclassifications





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





Note
15 – 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
16 – Fair Value





The Fair
Value Measurements and Disclosures Topic of the FASB Accounting Standards
Codification defines fair value, establishes a framework for measuring fair
value in generally accepted accounting principles and expands disclosures about
fair value measurements.  As of January 1, 2008, the Company adopted
the provisions of this Topic with respect to its financial assets and
liabilities that are measured at fair value within the financial statements, and
as of January 1, 2009, the Company adopted the provisions of this Topic with
respect to its non-financial assets and non-financial
liabilities.  The adoption of this Topic did not have a material
impact on the Company’s financial statements.





Note
17 – Comprehensive Income (Loss)





The
Company reports comprehensive income (loss) in accordance with the requirements
of the Comprehensive Income Topic of the FASB Accounting Standards Codification,
which requires companies to report all changes in equity during a period, except
those resulting from investment by owners and distributions to owners, in a
financial statement for the period in which they are
recognized.  Comprehensive income (loss) for the nine months ended
September 30, 2009 and 2008, is calculated as follows:





Nine
      Months Ended September 30,(in
      thousands)
            2009
            
            2008Net
      income
            
            $
            18,710
            
            
            $
            6,697Other
      comprehensive income (loss) – foreign currencytranslation
      adjustments
            
            
            7,903
            
            
            
            (7,789
            )Comprehensive
      income (loss)
            
            $
            26,613
            
            
            $
            (1,092
            )








15


Note 18 – Earnings Per Common
Share




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








Three
      Months Ended September 30,2009
            
            
            2008Net
      income
            
            $
            13,593
            
            
            $
            11,109Weighted
      average common and commonequivalent
      shares outstanding:Weighted
      average common shares outstanding
            
            
            20,078
            
            
            
            17,210Add
      effect of diluted securities – assumed
              exercise
      of stock options and SARs and
              vesting
      of restricted stock awards
            
            
            524
            
            
            
            253Weighted
      average common and common equivalent
      shares outstanding
            
            
            20,602
            
            
            
            17,463Earnings
      per common share:Basic
            
            $
            0.68
            
            
            $
            0.65Diluted
            
            $
            0.66
            
            
            $
            0.64





Nine
      Months Ended September 30,2009
            
            
            2008Net
      income
            
            $
            18,710
            
            
            $
            6,697Weighted
      average common and commonequivalent
      shares outstanding:Weighted
      average common shares outstanding
            
            
            18,215
            
            
            
            17,460Add
      effect of diluted securities – assumed
              exercise
      of stock options and SARs and
              vesting
      of restricted stock awards
            
            
            302
            
            
            
            255Weighted
      average common and commonequivalent
      shares outstanding
            
            
            18,517
            
            
            
            17,715Earnings
      per common share:Basic
            
            $
            1.03
            
            
            $
            0.38Diluted
            
            $
            1.01
            
            
            $
            0.38





Options
and SARs to purchase 1,264,609 shares and 1,500,863 shares of common stock were
outstanding during the three months ended September 30, 2009 and 2008,
respectively, but were not included in the computation of diluted earnings per
common share because the options and SARs were anti-dilutive.  Options
and SARs to purchase 1,369,356 shares and 1,381,104 shares of common stock were
outstanding during the nine months ended September 30, 2009 and 2008,
respectively, but were not included in the computation of diluted earnings per
common share because the options and SARs were anti-dilutive.





16




Note 19 – Recently Issued Accounting
Codification




Effective
with the quarter ended September 30, 2009, the Company applies the Financial
Accounting Standards Board’s Accounting Standards Codification (the
“Codification”), which is now the exclusive authoritative reference for
nongovernmental U.S. GAAP. Where applicable, titles and references to accounting
standards have been updated to reflect the Codification.





In
December 2007, the FASB issued new requirements under the Business Combinations
Topic of the FASB Accounting Standards Codification.  The requirements
under this Topic establish principles and requirements of how the acquirer
recognizes and measures in its financial statements the identifiable assets
acquired, the liabilities assumed and any non-controlling interest in the
acquiree; recognize and measure the goodwill acquired in the business
combination or a gain from a bargain purchase; and determine what information to
disclose to enable users of the financial statements to evaluate the nature and
financial effects of the business combination.  The requirements under
this Topic apply prospectively to business combinations for which the
acquisition date is on or after the beginning of the first annual reporting
period beginning on or after December 15, 2008.  The Company adopted
these requirements on January 1, 2009. The adoption of these requirements did
not have a material impact on the Company’s financial statements.





In
September 2006 and February 2008, the FASB issued new requirements under the
Fair Value Measurements and Disclosures Topic of the FASB Accounting Standards
Codification.  These requirements under this Topic define fair value,
establish a framework for measuring fair value in generally accepted accounting
principles and expand disclosures about fair value
measurements.  These requirements apply under other accounting
pronouncements that require or permit fair value
measurement.  However, these requirements do not require any new fair
value measurements.  These requirements are effective for the
financial statements issued for the fiscal years beginning after November 15,
2007, and interim periods within those fiscal years.  The Company
adopted these requirements with respect to its financial assets and liabilities
that are measured at fair value within the financial statements as of January 1,
2008, and with respect to its non-financial assets and non-financial liabilities
as of January 1, 2009.  The adoption of these requirements did not
have a material impact on the Company’s financial statements.





Note
20 – Evaluation of Subsequent Events





In June
2009, the FASB issued new requirements under the Subsequent Events Topic of the
FASB Accounting Standards Codification.  The requirements under this
Topic establish general standards of accounting for and disclosure of events
that occur after the balance sheet date but before financial statements are
issued or are available to be issued.  In accordance with this Topic,
an entity should apply these requirements to interim or annual financial periods
ending after June 15, 2009.  The Company adopted these requirements
June 30, 2009.  In preparing these financial statements, the Company
evaluated the events and transactions that occurred between September 30, 2009
and October 29, 2009, the date these financial statements were
issued.








17


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.


RESULTS
OF OPERATIONS





Operating
Highlights





Net sales
for the three months ended September 30, 2009, decreased 4.8% compared to net
sales for the three months ended September 30, 2008.  Gross profit
margin decreased to 46.4% for the three months ended September 30, 2009, from
46.7% for the three months ended September 30, 2008.  Selling, general
and administrative expenses, as a percentage of net sales, decreased to 29.2%
for the three months ended September 30, 2009, from 30.9% for the three months
ended September 30, 2008.  Operating income was $21.8 million for the
three months ended September 30, 2009, compared to $20.9 million for the three
months ended September 30, 2008.  As a percentage of net sales,
operating income was 17.2% for the three months ended September 30, 2009,
compared to 15.7% for the three months ended September 30, 2008.





Net sales
for the nine months ended September 30, 2009, decreased 4.9% compared to net
sales for the nine months ended September 30, 2008.  Gross profit
margin decreased to 43.4% for the nine months ended September 30, 2009, from
46.0% for the nine months ended September 30, 2008.  Selling, general
and administrative expenses, as a percentage of net sales, decreased to 32.1%
for the nine months ended September 30, 2009, from 35.6% for the nine months
ended September 30, 2008.  Operating income was $33.0 million for the
nine months ended September 30, 2009, compared to $15.5 million for the nine
months ended September 30, 2008.  As a percentage of net sales,
operating income was 11.0% for the nine months ended September 30, 2009,
compared to 4.9% for the nine months ended September 30, 2008.





Operating
income for the three months and nine months ended September 30, 2008, include
(benefits) charges of $(1.8) million and $15.3 million, respectively, of
recall-related and non-recurring charges.  Included in the
non-recurring charges for the three months and nine months ended September 30,
2008, are costs related to the termination of the acquisition of a
privately-held company and is included in terminated acquisition costs in the
accompanying condensed consolidated statements of
earnings.  Recall-related charges for the nine months ended September
30, 2008, include a one-time payment of $15.0 million to a licensor, in exchange
for a release from indemnification claims that were related to certain 2007
recalls.  This payment is included in recall-related items in the
accompanying condensed consolidated statement of earnings for the nine months
ended September 30, 2008.





Three
Months Ended September 30, 2009, Compared to Three Months Ended September 30,
2008





Net
sales.  Net sales for the three months ended September 30,
2009, decreased $6.4 million, or 4.8%, to $126.5 million from $132.9 million for
the three months ended September 30, 2008.  Net sales in our North
America segment increased 0.5% and net sales in our international segment
decreased 19.6%, which includes a 7.5% negative impact in changes from currency
exchange rates.





Net sales
in our mother, infant and toddler products category decreased 4.9%, primarily
driven by lower sales in our health/safety and infant toy product
lines.  Net sales in our preschool, youth and adult products category
decreased 4.7%, primarily due to softness across almost all product lines, with
the exception of strong sales in our Thomas & Friends Wooden
Railway product line and our new Super WHY! product
line.


18





Gross
profit.  Gross profit decreased $3.4 million, or 5.5%, to $58.7
million for the three months ended September 30, 2009, from $62.1 million for
the three months ended September 30, 2008.  As a percentage of net
sales, gross profit margin decreased to 46.4% for the three months ended
September 30, 2009, from 46.7% for the three months ended September 30, 2008,
primarily due to less favorable product mix, less recall-related benefit,
unfavorable foreign exchange rate fluctuations and higher product costs, which
more than offset cost improvement initiatives and price
increases.  Our quarterly gross margins can be affected by the mix of
product that is shipped during each quarter.  Our mother, infant and
toddler products category has higher sales of non-licensed products that carry
lower selling prices and gross margins that vary significantly and cause
quarterly fluctuations, based on the timing of these individual shipments
throughout the year.  There were no major changes in the components of
cost of sales.





Selling, general
and administrative expenses.  Selling, general and
administrative expenses decreased $4.1 million, or 10.0%, to $36.9 million for
the three months ended September 30, 2009, from $41.0 million for the three
months ended September 30, 2008.  Selling, general and administrative
expenses, as a percentage of net sales, decreased to 29.2% for the three months
ended September 30, 2009, from 30.9% for the three months ended September 30,
2008.  The decrease in selling, general and administrative expenses is
primarily due to the impact of the Company’s operating cost reduction plan
implemented in the fourth quarter of 2008, lower variable costs, lower freight
out costs resulting from freight rate savings and sales mix and to a lesser
extent the impact from foreign currency translation.





Operating
income.  Operating income was $21.8 million for the three
months ended September 30, 2009, compared to $20.9 million for the three months
ended September 30, 2008.  As a percentage of net sales, operating
income was 17.2% for the three months ended September 30, 2009, compared to
15.7% for the three months ended September 30, 2008.  Operating income
for the three months ended September 30, 2009 and 2008, includes benefits of
$0.7 million and $1.8 million, respectively, of recall-related and non-recurring
items.





Interest
expense.  Interest expense of $0.8 million and $1.7 million for
the three months ended September 30, 2009 and 2008, respectively, relates
primarily to borrowings under our credit facility.  The decrease in
interest expense is due to lower average debt outstanding and lower interest
rates, partially offset by higher debt issuance cost amortization.





Interest income and Other (income)
expense, net.  Interest income decreased to $0.2 million
for the three months ended September 30, 2009, from $0.5 million for the three
months ended September 30, 2008, primarily as a result of lower investible cash
balances on hand and lower interest rates.  Other (income) expense,
net increased to $(0.3) million for the three months ended September 30, 2009,
from $0.2 million for the three months ended September 30, 2008, primarily as a
result of favorable foreign currency transaction fluctuations.





19




Income tax
expense.  Income tax expense for the three months ended
September 30, 2009 and 2008, includes provisions for federal, state and foreign
income taxes at an effective rate of 36.7% and 36.1%, respectively, including
discrete items.  Discrete items include significant, infrequent,
unusual or non-recurring items.





Nine
Months Ended September 30, 2009, Compared to Nine Months Ended September 30,
2008





Net
sales.  Net sales for the nine months ended September 30, 2009,
decreased $15.5 million, or 4.9%, to $299.8 million from $315.3 million for the
nine months ended September 30, 2008.  Net sales in our North America
segment decreased 0.9% and net sales in our international segment decreased
16.4%, which includes a 15.9% negative impact in changes from currency exchange
rates.





Net sales
in our mother, infant and toddler products category increased 2.2%, primarily
driven by higher sales in our infant and toddler feeding and care product lines
marketed under The First Years® brand, which were partially offset by sales
declines in our infant and toddler play product lines.  Net sales in
our preschool, youth and adult products category decreased 10.2%, primarily due
to softness across almost all product lines, with the exception of strong sales
in our Thomas &
Friends Wooden Railway product line and our new Super WHY! product
line.





Gross
profit.  Gross profit decreased $15.0 million, or 10.3%, to
$130.1 million for the nine months ended September 30, 2009, from $145.1 million
for the nine months ended September 30, 2008.  As a percentage of net
sales, gross profit margin decreased to 43.4% for the nine months ended
September 30, 2009, from 46.0% for the nine months ended September 30, 2008,
primarily due to less favorable product mix, unfavorable foreign exchange rates,
and higher product costs, which more than offset cost improvement initiatives
and price increases.  There were no major changes in the components of
cost of sales.





Selling, general
and administrative expenses.  Selling, general and
administrative expenses decreased $16.2 million, or 14.4%, to $96.2 million for
the nine months ended September 30, 2009, from $112.4 million for the nine
months ended September 30, 2008.  Selling, general and administrative
expenses, as a percentage of net sales, decreased to 32.1% for the nine months
ended September 30, 2009, from 35.6% for the nine months ended September 30,
2008.  The decrease in selling, general and administrative expenses is
primarily due to the impact of the Company’s operating cost reduction plan
implemented in the fourth quarter of 2008, and to a lesser extent, foreign
currency rate fluctuations and lower variable costs.





Operating
income.  Operating income was $33.0 million for the nine months
ended September 30, 2009, compared $15.5 million for the nine months ended
September 30, 2008.  As a percentage of net sales, operating income
was 11.0% for the nine months ended September 30, 2009, compared to 4.9% for the
nine months ended September 30, 2008. Operating income for the nine months ended
September 30, 2009 and 2008, includes (benefits) charges of $(0.2) million and
$15.3 million, respectively, of recall-related and non-recurring
items.





Interest
expense.  Interest expense of $3.0 million and $4.4 million for
the nine months ended September 30, 2009 and 2008, respectively, relates
primarily to borrowings under our credit facility.  The decrease in
interest expense is due to lower average debt outstanding and lower interest
rates, which more than offset higher debt issuance cost
amortization.





20


Interest income
and Other expense, net.  Interest income decreased to $0.3
million for the nine months ended September 30, 2009, from $1.3 million for the
nine months ended September 30,





Income tax
expense.  Income tax expense for the nine months ended
September 30, 2009 and 2008, includes provisions for federal, state and foreign
income taxes at an effective rate of 37.2% and 34.2%, respectively, including
discrete items.  Discrete items include significant, infrequent,
unusual or non-recurring items.





LIQUIDITY
AND CAPITAL RESOURCES





The
Company’s operations provided net cash of $40.8 million and used net cash of
$6.6 million for the nine months ended September 30, 2009 and 2008,
respectively.  Cash flows from operations were favorably impacted by a
decrease in inventory of $6.4 million during the nine months ended September 30,
2009, primarily due to the seasonality of the Company’s business and increased
focus on working capital.





Net cash
used in investing activities was $10.7 million and $6.8 million for the nine
months ended September 30, 2009 and 2008, respectively.  The increase
in net cash used in investing activities is primarily due to the investment in
unrestricted certificates of deposit during the third quarter of 2009 of $4.6
million.  Capital expenditures for the nine months ended September 30,
2009, were $6.0 million, of which $4.3 million were for molds and
tooling.





Net cash
provided by financing activities was $22.0 million and $19.5 million for the
nine months ended September 30, 2009 and 2008, respectively.  The
increase in net cash provided by financing activities is primarily due to $57.1
million of net cash proceeds from the public offering during the third quarter
of 2009 partially offset by payments made on the Company’s term loan and
revolving line of credit during the nine months ended September 30,
2009.  The Company made payments on its term loan and revolving line
of credit of $15.0 million and $23.1 million, respectively, during the nine
months ended September 30, 2009.





Cash and
cash equivalents increased $54.7 million during the nine months ended September
30, 2009.





21


On
November 3, 2008, the Company entered into a new credit facility to replace its
previous credit facility.  The credit facility is comprised of a term
loan and provides for borrowings up to $70.0 million under a revolving line of
credit.  The total borrowing capacity available under the credit
facility is subject to a formula based on the Company’s leverage ratio, as
defined in the credit agreement.  The term loan and the revolving line
of credit both have a scheduled maturity date of November 1,
2011.  Under this credit facility, the term loan and the revolving
line of credit bear interest, at the Company’s option, at a base rate or at
LIBOR, plus applicable margins, which are based on the Company’s leverage
ratio.  Applicable margins vary between 2.25% and 3.25% on LIBOR
borrowings and 1.25% and 2.25% on base rate borrowings.  At September
30, 2009, the applicable margins in effect were 2.50% for LIBOR borrowings and
1.50% for base rate borrowings.  Principal payments on the term loan
are $3.8 million per calendar quarter, with the remaining principal of $33.8
million due on November 1, 2011.  During the third quarter of 2009,
the Company prepaid its required fourth quarter 2009 principal payment. The
Company is also required to pay a commitment fee which varies from 0.45% and
0.50% per annum on the average daily unused portion of the revolving line of
credit.  At September 30, 2009, the commitment fee in effect was 0.50%
per annum.





Under the
terms of the new credit facility, the Company is required to comply with certain
financial and non-financial covenants.  Among other restrictions, the
Company is restricted in its ability to pay dividends, buy back its stock, incur
additional debt and make acquisitions above certain amounts.  The
credit facility also includes a clean down provision that limits the maximum
amount of borrowings under the revolving line of credit for a period of 60
consecutive days during the first four calendar months.  The clean
down provision limits are $27.5 million for a period of 60 consecutive days
during the first four calendar months of 2010 and $25.0 million for a period of
60 consecutive days during the first four calendar months of
2011.  The Company has met its clean down provision requirement for
the year 2009.  The credit facility is secured by the Company's
domestic assets along with a portion of the Company’s equity interests in
its foreign subsidiaries.  On September 30, 2009, the Company had
$60.0 million outstanding on its bank term loan and was in compliance with all
covenants.  Additionally, at September 30, 2009, the Company had $70.0
million available on its revolving line of credit.





In August
2009, the Company completed a public offering of 4.0 million shares of common
stock, of which 3.0 million were issued out of treasury, at a price of $15.00
per share.  The Company received net proceeds of $57.1 million and
intends to use the net proceeds from the offering for general corporate and
working capital purposes, including potential repayment of long-term debt and
the funding of future acquisitions.





The
Company has met its working capital needs through funds generated from
operations and available borrowings under its line 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 2009, principally for molds and tooling, will
be approximately $10.0 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 2009.  However, if the Company’s
capital requirements vary materially from those currently planned, the Company
may require additional debt or equity financing beyond the available borrowings
under its senior credit facility.  There can be no assurance that
financing, if needed, would be available on terms acceptable to the Company, if
at all.


22


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 estimated net realizable value.  The
Company’s allowance is based on management’s assessment of the business
environment, customers’ financial condition, historical trends, customer payment
practices, receivable aging and customer disputes.  The Company 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.





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





Impairment of
long-lived assets, goodwill and other intangible
assets.  Long-lived assets have been reviewed for impairment
based on the requirements under the Intangibles – Goodwill and Other Topic of
the FASB Accounting Standards Codification.  This Topic requires that
an impairment loss be recognized whenever the carrying value of an asset exceeds
the sum of the undiscounted cash flows expected to result from the use and
eventual disposition of that asset, excluding future interest costs the entity
would recognize as an expense when incurred.  Goodwill and other
intangible assets have been reviewed for impairment based on the requirements
under the Intangibles – Goodwill and Other Topic of the FASB Accounting
Standards Codification. Under this Topic, goodwill and other intangible assets
that have indefinite useful lives are not amortized, but rather tested at least
annually for impairment.  In the fourth quarter of 2008, the Company
recorded an impairment charge, writing-off its entire balance of
goodwill.  The next scheduled annual test for impairment on its other
indefinite lived intangibles will be as of October 1, 2009, and will be
completed in the fourth quarter of 2009.  The Company’s management
reviews for indicators that might suggest an impairment loss could
exist.  An interim test for impairment is performed if a triggering
event occurs suggesting possible impairment.  Testing for impairment
requires estimates of expected cash flows to be generated from the use of the
assets.  Various uncertainties, including changes in consumer
preferences, ability to maintain related licenses, deterioration in the
political environment, continued adverse conditions in the capital markets or
changes in general economic conditions, could impact the expected cash flows to
be generated by an asset or group of assets.  Intangible assets that
have finite useful lives are amortized over their useful lives.





23


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





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





Product
recalls.  The Company establishes a reserve for product recalls
on a product-specific basis during the period in which the circumstances giving
rise to the recall become known and estimable.  Facts underlying the
recall, including, among others, estimates of retailer inventory returns,
consumer replacement costs, shipping costs and fines and penalties are
considered when establishing a product recall reserve.  The Company
also considers additional replacement costs or refunds, donations, notice
charges, claims administration, licensor indemnification claims and plaintiffs’
legal fees related to settlement of litigation related to the
recalls.  The Company’s legal costs to defend recall-related matters
are expensed as incurred.  When facts or circumstances become known
that would indicate that the recall reserve is either not sufficient to cover or
exceeds the estimated product recall expenses, the reserve is adjusted, as
appropriate.





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





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





24


Stock-based
compensation.  The Company accounts for stock-based
compensation in accordance with the requirements under the Compensation – Stock
Compensation Topic of the FASB Accounting Standards Codification.  The
Company elected to use the modified prospective application of this Topic for
awards issued prior to January 1, 2006.





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





The fair
value of restricted stock awards granted under the stock incentive plan is
calculated either using the market price on the grant date or the market price
on the last day of the reported period.





Recently
Issued Accounting Codification





Effective
with the quarter ended September 30, 2009, the Company applies the Financial
Accounting Standards Board’s Accounting Standards Codification (the
Codification), which is now the exclusive authoritative reference for
nongovernmental U.S. GAAP. Where applicable, titles and references to accounting
standards have been updated to reflect the Codification.





In June
2009, the FASB issued new requirements under the Subsequent Events Topic of the
FASB Accounting Standards Codification.  The requirements under this
Topic establish general standards of accounting for and disclosure of events
that occur after the balance sheet date but before financial statements are
issued or are available to be issued.  In accordance with this Topic,
an entity should apply these requirements to interim or annual financial periods
ending after June 15, 2009.  The Company adopted these requirements on
June 30, 2009.  In preparing the accompanying condensed consolidated
financial statements, the Company evaluated the events and transactions that
occurred between September 30, 2009 and October 29, 2009, the date the
accompanying condensed consolidated financial statements were
issued.





In
December 2007, the FASB issued new requirements under the Business Combinations
Topic of the FASB Accounting Standards Codification.  The requirements
under this Topic establish principles and requirements of how the acquirer
recognizes and measures in its financial statements the identifiable assets
acquired, the liabilities assumed and any non-controlling interest in the
acquiree; recognize and measure the goodwill acquired in the business
combination or a gain from a bargain purchase; and determine what information to
disclose to enable users of the financial statements to evaluate the nature and
financial effects of the business combination.  The requirements under
this Topic apply prospectively to business combinations for which the
acquisition date is on or after the beginning of the first annual reporting
period beginning on or after December 15, 2008.  The Company adopted
these requirements on January 1, 2009. The adoption of these requirements did
not have a material impact on the Company’s financial statements.





25


In
September 2006 and February 2008, the FASB issued new requirements under the
Fair Value Measurements and Disclosures Topic of the FASB Accounting Standards
Codification.  These requirements under this Topic define fair value,
establish a framework for measuring fair value in generally accepted accounting
principles and expand disclosures about fair value
measurements.  These requirements apply under other accounting
pronouncements that require or permit fair value
measurement.  However, these requirements do not require any new fair
value measurements.  These requirements are effective for the
financial statements issued for the fiscal years beginning after November 15,
2007, and interim periods within those fiscal years.  The Company
adopted these requirements with respect to its financial assets and liabilities
that are measured at fair value within the financial statements as of January 1,
2008, and with respect to its non-financial assets and non-financial liabilities
as of January 1, 2009.  The adoption of these requirements did not
have a material impact 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,'' "estimate,'' "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 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 and other licensors;
 the effect on the Company’s business of the expected termination of the
license of the Take Along Thomas & Friends die-cast
product line at the end of 2009; risks related to product recalls or product
liability claims, compliance with product safety standards and the effect of
recalls on the Company’s relationship with licensors, including the effect on
renewal and retention of licenses; uncertainty and potential adverse changes in
the general economic conditions in the Company's markets, including fluctuating
oil prices, declining consumer confidence, unemployment, fluctuations in stock
markets, contraction of credit availability, bankruptcy or liquidity problems
with our customers or other factors affecting economic conditions generally;
currency exchange rate fluctuations, including in the Chinese renminbi, the Hong
Kong dollar, the British pound sterling, the Australian dollar, the Euro or the
Canadian dollar, could increase the Company’s expenses or reduce the U.S. dollar
value of the Company’s assets denominated in foreign currencies, including funds
the Company needs to transfer to the U.S.; the effect of the reduced borrowing
capacity in the Company’s new credit facility on the Company’s ability to access
sufficient working capital, the risk that the Company may not have sufficient
cash flows to comply with the payment terms of the new credit facility and the
Company’s ability to comply with more restrictive covenants in the new credit
facility; increases in the cost of raw materials, labor and other costs to
manufacture the Company’s products could increase the Company’s cost of sales
and reduce the Company’s gross margins; competition in the markets for the
Company's products may increase significantly;  the Company is dependent
upon the continuing willingness of leading retailers to purchase and provide
shelf space for the Company's products;  the Company may not be able to
collect outstanding accounts receivable from its major retail customers; the
Company relies upon a limited number of independently owned factories located in
China to manufacture a significant portion of its products; the Company may not
be able to manufacture, source and ship new and continuing products on a timely
basis; the Company is dependent upon timely shipping of product and unloading of
product through West Coast ports as well as timely rail/truck delivery to the
Company’s warehouse and/or customers’ warehouses; customers
and consumers may not accept the Company’s products at prices sufficient for the
Company to profitably recover development, manufacturing, marketing, royalty and
other costs; the inventory policies of retailers, together with increased
reliance by retailers on quick response inventory management techniques, may
increase the risk of underproduction of popular items, overproduction of less
popular items and failure to achieve tight shipping schedules; the risk of
future write-downs of intangible assets; and the Company may experience
unanticipated negative results of litigation.  Such uncertainties and
other risks that may affect the Company’s performance are discussed further in
Part I, Item 1A, “Risk Factors,” in the Company's Form 10-K for the year ended
December 31, 2008.  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.


26




Item
3.  Quantitative and Qualitative
Disclosures about Market Risk





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





Based on
the Company’s interest rate exposure on variable rate borrowings at September
30, 2009, a one percentage point increase in average interest rates on the
Company’s borrowings would increase future interest expense by $0.1 million per
month and a five percentage point increase would increase future interest
expense by approximately $0.3 million per month.  The Company
determined these amounts based on $60.0 million of variable rate borrowings at
September 30, 2009, multiplied by 1.0% and 5.0%, respectively, and divided by
twelve.  The Company is currently not using any interest rate collars,
hedges or other derivative financial instruments to manage or reduce interest
rate risk.  As a result, any increase in interest rates on the
Company’s variable rate borrowings would increase interest expense and reduce
net income.





The
Company’s net sales are primarily denominated in U.S. dollars, with 20.5% of net
sales for the nine months ended September 30, 2009, denominated in British
pounds sterling, Australian dollars, Euros and Canadian dollars.  The
Company’s purchases of finished goods from Chinese manufacturers are primarily
denominated in Hong Kong dollars.  Expenses for these manufacturers
are primarily denominated in Chinese renminbi.  During July 2005,
China revalued the Chinese renminbi, abandoning the former model of pegging the
Chinese renminbi to the U.S. dollar.  As a result, any 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.  The Hong Kong dollar is currently pegged to
the U.S. dollar.


27


If the
Hong Kong dollar ceased to be pegged to the U.S. dollar, a material increase in
the value of the Hong Kong dollar relative to the U.S. dollar would increase our
expenses, and therefore, could adversely affect our profitability.  A
10.0% change in the exchange rate of the U.S. dollar with respect to the Hong
Kong dollar for the nine months ended September 30, 2009, would have changed the
total dollar amount of our gross profit by 10.4%.  A 10.0% change in
the exchange rate of the U.S. dollar with respect to the translation of
financial reporting denominated in the British pound sterling, the Australian
dollar or the Euro for the nine months ended September 30, 2009, individually
would not have had a significant impact on the Company’s net
income.  The Company is also subject to exchange rate risk relating to
transfers of funds or other transactions denominated in British pounds sterling,
Australian dollars, Canadian dollars or Euros from its foreign subsidiaries to
the United States, such as for purchases of inventory by certain of our foreign
subsidiaries, effectively in U.S. dollars.  A 10.0% change in the
exchange rate of the U.S. dollar with respect to the British pound sterling, the
Australian dollar and the Canadian dollar for the nine months ended September
30, 2009, would have changed the total dollar amount of our gross profit by
1.3%, 0.7% and 0.8%, respectively.  The Company is not currently using
and has not historically used hedges or other derivative financial instruments
to manage or reduce exchange rate risk.





Item
4.  Controls and
Procedures





The
Company maintains disclosure controls and procedures (as defined in Rules
13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) designed to
ensure that information required to be disclosed by the Company in the reports
that it files or submits under the Securities Exchange Act of 1934 is recorded,
processed, summarized and reported within the time periods specified in the
SEC’s rules and forms, and that the information required to be disclosed by the
Company in reports that it files or submits under the Securities Exchange Act of
1934 is accumulated and communicated to its management, including its Chief
Executive Officer and Chief Financial Officer, as appropriate to allow timely
decisions regarding required disclosure.  The Company carried out an
evaluation as of September 30, 2009, under the supervision and with the
participation of the Company’s management, including its Chief Executive Officer
and Chief Financial Officer, of the effectiveness of the design and operation of
the Company’s disclosure controls and procedures.  Based on such
evaluation, the Company’s Chief Executive Officer and Chief Financial Officer
concluded that the Company’s disclosure controls and procedures were effective
as of September 30, 2009, at reaching a level of reasonable
assurance.  In designing and evaluating the disclosure controls and
procedures, management recognized that any controls and procedures, no matter
how well designed and operated, can provide only reasonable assurance of
achieving the desired control objectives, and management necessarily was
required to apply its judgment in evaluating the cost-benefit relationship of
possible controls and procedures.  The Company has designed its
disclosure controls and procedures to reach a level of reasonable assurance of
achieving the desired control objectives.





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





28


PART
II.  OTHER INFORMATION





Item
1.  Legal Proceedings





During
2008, the Company reached a settlement in the various class action lawsuits
against the Company in the U.S. which arose from or relate to the Company’s
recall of certain products in June 2007 and September 2007.  With the
final approval of the settlement agreement and the end of the claim period, the
class action lawsuits in the U.S. relating to the June 2007 and September 2007
recalls have been resolved.  The Company may be subject to individual
claims for personal injuries or other claims or government inquiries in the U.S.
or other jurisdictions (including the inquiry by the Consumer Product Safety
Commission (CPSC) described in the next paragraph) relating to the 2007
recalls.  No assurances can be given as to the outcome of any such
claims or government inquiries.





During
2008, the Company received an inquiry from the CPSC for information regarding
the recalls of certain products in June 2007 and September 2007 for the purpose
of assessing whether the CPSC may impose a fine on the Company.  The
Company is responding to this inquiry, and at this time, the CPSC has not yet
imposed a fine upon the Company.





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,
2008.  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.





Item
4.  Submission of Matters to a Vote of
Security Holders





Not
applicable.





Item
5.  Other Information





Not
applicable.





29


Item
6.  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
      3.1 of the Company’s Current Report on Form 8-K (File No. 0-22635) filed
      by the Company with the Securities and Exchange Commission on July 30,
      2009).31.1
              
              Certification of Chief Executive Officer
      pursuant to Section 302 of the Sarbanes-Oxley Act of
    2002.31.2
              
              Certification of Chief Financial Officer
      pursuant to Section 302 of the Sarbanes-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.






30


SIGNATURES





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





Dated
this 29th day of October, 2009.


RC2
CORPORATION
  /s/ Curtis W.
Stoelting
    /s/ Peter A.
Nicholson