SECURITIES
      AND EXCHANGE COMMISSION


WASHINGTON,
      DC 20549





FORM
      10-Q





(Mark
                One)x
            QUARTERLY
                REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
                ACT
                OF 1934For
                the quarterly period ended September 30, 2005ORo
            TRANSITION
                REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
                ACT
                OF 1934For
                the transition period from _______ to
                _________





Commission
      file number: 0-22635


RC2
                  Corporation(Exact
                  Name of Registrant as Specified in Its
                  Charter)
 
 Delaware
              
              36-4088307(State
                  or other jurisdiction of incorporation or organization)
              
              (IRS
                  Employer Identification No.)
 
 1111
                  West 22ndStreet, Suite 320, Oak Brook, Illinois, 60523(Address
                  of principal executive offices)
 Registrant's
        telephone number, including area code: 630-573-7200





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




Yes
            
            X
            
            No





Indicate
      by check mark whether the Registrant is an accelerated filer (as defined in
      Exchange Act Rule 12b-2).


Yes
              
              X
              
              No


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


Yes
              
              
              
              No
              X


On
      November 1, 2005, there were outstanding 20,696,546 shares of the Registrant's
      $0.01 par value common stock.








RC2
      CORPORATION





FORM
      10-Q





SEPTEMBER
      30, 2005





INDEX ****







PART
      I -
      FINANCIAL INFORMATION





PageItem
                1.
            Condensed
                Consolidated Balance Sheets as of September
                30,
              2005
                  and December 31,
                  2004
            3Condensed
                Consolidated Statements of Earnings for
                the Three
              Months
                  and Nine Months Ended September 30, 2005 and
                  2004
            4Condensed
                Consolidated Statements of Cash Flows for
                the
              Nine
                  Months Ended September 30, 2005 and
                  2004
            5Notes
                to Condensed Consolidated Financial Statements
            6Item
                2.
            Management's
                Discussion and Analysis of Financial
                Condition
              and
                  Results of Operations
            19Item
                3.
            Quantitative
                and Qualitative Disclosures about Market
                Risk
            27Item
                4.
            Controls
                and Procedures
            27








PART
      II -
      OTHER INFORMATION





Item
                1.
            Legal
                Proceedings
            28Item
                2.
            Unregistered
                Sales of Equity Securities and Use of
                Proceeds
            28Item
                3.
            Defaults
                Upon Senior Securities
            28Item
                4.
            Submission
                of Matters to a Vote of Security
                Holders
            28Item
                5.
            Other
                Information
            28Item
                6.
            Exhibits
            28Signatures
            30





2


PART
      I.  FINANCIAL
      INFORMATION





**Item
      1. Financial Statements**





**RC2
      Corporation and Subsidiaries**


**Condensed
      Consolidated Balance
      Sheets**


**(In
      thousands)**





**September
                30,**
              **2005**
            
            December
                30,
              2004**(Unaudited)****Assets**Cash
                and cash equivalents
            
            $
            20,077
            
            $
            20,123Accounts
                receivable, net
            
            
            113,861
            
            
            93,616Inventory
            
            
            88,097
            
            
            55,023Assets
                held for sale
            
            
            5,115
            
            
            4,186Other
                current assets
            
            
            12,782
            
            
            21,432Total
                current assets
            
            
            239,932
            
            
            194,380Property
                and equipment, net
            
            
            47,015
            
            
            48,857Goodwill
            
            
            253,575
            
            
            282,367Intangible
                assets, net
            
            
            100,028
            
            
            58,243Other
                non-current assets
            
            
            2,161
            
            
            1,901Total
                assets
            
            $
            642,711
            
            $
            585,748**Liabilities
                and stockholders’ equity**Accounts
                payable and accrued expenses
            
            $
            85,495
            
            $
            64,040Current
                maturities of term loan
            
            
            21,250
            
            
            16,562Other
                current liabilities
            
            
            880
            
            
            847Total
                current liabilities
            
            
            107,625
            
            
            81,449Revolving
                line of credit
            
            
            47,000
            
            
            50,000Non-current
                portion of term loan
            
            
            48,750
            
            
            64,688Other
                non-current liabilities
            
            
            56,516
            
            
            42,849Total
                liabilities
            
            
            259,891
            
            
            238,986Stockholders’
                equity
            
            
            382,820
            
            
            346,762Total
                liabilities and stockholders' equity
            
            $
            642,711
            
            $
            585,748





See
      accompanying notes to condensed consolidated financial
      statements.


3


**RC2
      Corporation and Subsidiaries**


**Condensed
      Consolidated Statements of
      Earnings**


**(In
      thousands, except per share data)**




**For
                the three months ended**
              **September
                30,**
            
            **For
                the nine months ended**
              **September
                30,****2005**
            
            **2004**
            
            **2005**
            
            **2004****(Unaudited)**
            
            **(Unaudited)**
            
            **(Unaudited)**
            
            **(Unaudited)**Net
                sales
            
            $
            142,567
            
            $
            110,289
            
            $
            347,867
            
            $
            240,988Cost
                of sales
            
            
            72,833
            
            
            54,283
            
            
            176,267
            
            
            117,235Gross
                profit
            
            
            69,734
            
            
            56,006
            
            
            171,600
            
            
            123,753Selling,
                general and administrative expenses
            
            
            39,943
            
            
            33,497
            
            
            111,917
            
            
            85,638Amortization
                of intangible assets
            
            
            845
            
            
            ---
            
            
            1,095
            
            
            ---Gain
                on sale of W. Britain product line
            
            
            (1,953
            )
            
            ---
            
            
            (1,953
            )
            
            ---Operating
                income
            
            
            30,899
            
            
            22,509
            
            
            60,541
            
            
            38,115Interest
                expense, net
            
            
            1,522
            
            
            1,011
            
            
            4,557
            
            
            2,465Other
                expense (income)
            
            
            4
            
            
            (345
            )
            
            (347
            )
            
            (430
            )Income
                before income taxes
            
            
            29,373
            
            
            21,843
            
            
            56,331
            
            
            36,080Income
                tax expense
            
            
            11,113
            
            
            7,864
            
            
            20,480
            
            
            12,989Net
                income
            
            $
            18,260
            
            $
            13,979
            
            $
            35,851
            
            $
            23,091Net
                income per share:Basic
            
            $
            0.88
            
            $
            0.72
            
            $
            1.74
            
            $
            1.28Diluted
            
            $
            0.85
            
            $
            0.68
            
            $
            1.67
            
            $
            1.20Weighted
                average shares outstanding:Basic
            
            
            20,656
            
            
            19,348
            
            
            20,582
            
            
            18,108Diluted
            
            
            21,594
            
            
            20,443
            
            
            21,525
            
            
            19,205





See
      accompanying notes to condensed consolidated financial
      statements.


4


**RC2
      Corporation and Subsidiaries**


**Condensed
      Consolidated Statements of Cash
      Flows**


**(In
      thousands)**


**For
                the nine months ended September 30,****2005**
            
            **2004****(Unaudited)**
            
            **(Unaudited)****Cash
                flows from operating activities**Net
                income
            
            $
            35,851
            
            $
            23,091Depreciation
                and amortization
            
            
            11,429
            
            
            9,342Amortization
                of deferred financing costs
            
            
            362
            
            
            709(Gain)
                loss on sale of assets
            
            
            (2,031
            )
            
            44Changes
                in operating assets and liabilities
            
            
            (25,253
            )
            
            979Net
                cash provided by operating activities
            
            
            20,358
            
            
            34,165**Cash
                flows from investing activities**Purchase
                of property and equipment
            
            
            (9,948
            )
            
            (10,955
            )Purchase
                of Playing Mantis, net of cash acquired
            
            
            ---
            
            
            (17,238
            )Purchase
                of TFY, net of cash acquired
            
            
            39
            
            
            (155,745
            )Proceeds
                from disposal of property and equipment
            
            
            608
            
            
            92Proceeds
                from sale of W. Britain product line
            
            
            2,850
            
            
            ---Investment
                in Meteor
            
            
            (529
            )
            
            ---Increase
                in other non-current assets
            
            
            (84
            )
            
            (16
            )Net
                cash used in investing activities
            
            
            (7,064
            )
            
            (183,862
            )**Cash
                flows from financing activities**Net
                proceeds from public offering of common stock
            
            
            ---
            
            
            77,498Proceeds
                from bank on credit facility
            
            
            20,000
            
            
            197,000Payments
                to bank on credit facility
            
            
            (34,250
            )
            
            (117,000
            )Issuance
                of common stock upon option exercise
            
            
            1,349
            
            
            1,590Purchase
                of treasury stock
            
            
            ---
            
            
            (822
            )Issuance
                of common stock for ESPP
            
            
            139
            
            
            104Net
                cash (used in) provided by financing activities
            
            
            (12,762
            )
            
            158,370Effect
                of exchange rate changes on cash
            
            
            (578
            )
            
            (126
            )Net
                (decrease) increase in cash and cash equivalents
            
            
            (46
            )
            
            8,547Cash
                and cash equivalents, beginning of year
            
            
            20,123
            
            
            16,548Decrease
                in restricted cash
            
            
            ---
            
            
            33Cash
                and cash equivalents, end of period
            
            $
            20,077
            
            $
            25,128Supplemental
                information:Cash
                flows during the period for:Interest
            
            $
            4,356
            
            $
            1,774Income
                taxes
            
            $
            13,080
            
            $
            10,390Income
                tax refunds received
            
            $
            4,997
            
            $
            216Non-cash
                investing and financing activity during the period:
              91,388
                  shares of stock issued for the purchase
                of
                  Playing Mantis
            
            $
            ---
            
            $
            2,868





See
      accompanying notes to condensed consolidated financial
      statements.


5


**RC2
      Corporation and Subsidiaries**


**Notes
      to Condensed Consolidated Financial
      Statements**





**Note
      1 - Basis of Presentation**





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





The
      accompanying 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, 2005 and December 31,
      2004, the results of its operations for the three-month and nine-month periods
      ended September 30, 2005 and 2004, and its cash flows for the nine-month periods
      ended September 30, 2005 and 2004.





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, 2004.





Due
      to
      the seasonality of our business, the results of operations for the interim
      periods ended September 30, 2005 are not necessarily indicative of the
      operating results for the full year.





**Note
      2 - Business Combinations**





**RC2
      Corporation and The First Years Inc.**





On
      September 15, 2004, the Company acquired The First Years Inc. (TFY) for
      approximately $156.1 million in cash (excluding transaction expenses). TFY
      is an
      international developer and marketer of infant and toddler care and play
      products sold under The First Years ® brand
      name and under various licenses, including Disney’s Winnie the Pooh. TFY’s
      products are sold at toy, mass merchandising, drug and grocery chains, and
      at
      specialty retailers. This transaction has been accounted for under the purchase
      method of accounting and, accordingly, the operating results of TFY have been
      included in our consolidated statements of earnings since the effective date
      of
      acquisition. The purchase was funded with the Company’s credit facility (see
      Note 8 - “Debt”). The excess of the aggregate purchase price over the fair
      market value of net assets acquired of approximately $73.1 million and $97.6
      million has been recorded as goodwill in the accompanying condensed consolidated
      balance sheets at September 30, 2005 and December 31, 2004, respectively. During
      the quarter ended September 30, 2005, the Company completed its valuation of
      the
      assets acquired in the TFY transaction. As a result, approximately $40 million
      in other intangible assets have been recorded on the balance sheet that
      previously were reflected in goodwill.


6


The
      purchase price was allocated to the net assets of TFY based on their estimated
      relative fair values as of September 15, 2004 as follows:





(In
      thousands)





Total
                purchase price, including expenses, net of cash acquired
            
            
            
            
            $
            154,528Less:Current
                assets
            
            $
            45,965Property,
                plant and equipment
            
            
            11,100Intangible
                assets
            
            
            58,238Other
                long-term assets
            
            
            175Liabilities
            
            
            (34,043
            )
            
            (81,435
            )Excess
                of purchase price over net assets acquired
            
            
            
            
            $
            73,093





See
      table
      following the discussion of Playing Mantis, Inc. for pro forma combined
      results.





**RC2
      Corporation and Playing Mantis, Inc.**





On
      June
      7, 2004, the Company acquired substantially all of the assets of Playing Mantis,
      Inc. (Playing Mantis) with an effective date of June 1, 2004. Closing
      consideration consisted of $17.0 million of cash (excluding transaction
      expenses) and 91,388 shares of the Company’s common stock. Additional cash
      consideration of up to $4.0 million may be earned in the transaction by Playing
      Mantis of which $2.0 million was based on achieving net sales and margin targets
      in 2004 and the remaining $2.0 million is based on achieving net sales targets
      for 2005. The contingent consideration for 2004 was not payable because the
      net
      sales and margin targets were not met in 2004. Playing Mantis designs and
      markets collectible vehicle replicas under the Johnny Lightning® and Polar
      Lights® brands and collectible figures under the Memory LaneTM brand. Playing
      Mantis’ products are primarily sold at mass merchandising, hobby, craft, drug
      and grocery chains. This transaction has been accounted for under the purchase
      method of accounting and, accordingly, the operating results of Playing Mantis
      have been included in our condensed consolidated statements of earnings since
      the effective date of the acquisition. The excess of the aggregate purchase
      price over the fair market value of net assets acquired of approximately $11.0
      million and $14.1 million has been recorded as goodwill in the accompanying
      condensed consolidated balance sheets at September 30, 2005 and December 31,
      2004, respectively. During the quarter ended June 30, 2005, the Company
      completed its valuation of the assets acquired in the Playing Mantis
      transaction. As a result, approximately $3 million in other intangible assets
      have been recorded on the balance sheet that previously were reflected in
      goodwill.


7


The
      purchase price was allocated to the net assets of Playing Mantis based on their
      estimated relative fair values as of June 1, 2004 as follows:





(In
      thousands)





Total
                purchase price, including expenses, net of cash acquired
            
            
            
            
            $
            20,106Less:Current
                assets
            
            $
            5,424Property,
                plant and equipment
            
            
            4,111Intangible
                assets
            
            
            3,314Liabilities
            
            
            (3,777
            )
            
            (9,072
            )Excess
                of purchase price over net assets acquired
            
            
            
            
            $
            11,034





The
      following table presents the unaudited pro forma combined results of operations
      for the three months and the nine months ended September 30, 2004 and assumes
      that the TFY and Playing Mantis acquisitions occurred as of January 1,
      2004.





(In
      thousands, except per share data)





**Three
                Months Ended**
            
            **Nine
                Months Ended****September
                30, 2004**
            
            **September
                30, 2004**Net
                sales
            
            $
            137,328
            
            $
            349,045Net
                income
            
            $
            14,666
            
            $
            25,484Net
                income per share:Basic
            
            $
            0.76
            
            $
            1.40Diluted
            
            $
            0.72
            
            $
            1.32





Pro
      forma
      data does not purport to be indicative of the results that would have been
      obtained had these acquisitions actually occurred at January 1, 2004 and is
      not
      intended to be a projection of future results.


8


**RC2
      Corporation and Learning Curve International, Inc.**





On
      March
      4, 2003, with an effective date of February 28, 2003, the Company acquired
      Learning Curve International, Inc. (Learning Curve) and certain of its
      affiliates (collectively, LCI) through the merger of a wholly owned subsidiary
      of RC2 with and into Learning Curve for approximately $104.4 million in cash
      (excluding transaction expenses) and 666,666 shares of the Company's common
      stock, including $12.0 million in escrow to secure Learning Curve’s
      indemnification obligations under the merger agreement. LCI develops and markets
      a variety of high-quality, award-winning children's and infant toys for every
      stage of childhood from birth through age eight. This transaction has been
      accounted for under the purchase method of accounting and, accordingly, the
      operating results of LCI have been included in our consolidated statements
      of
      earnings since the effective date of the acquisition. The purchase was funded
      with a credit facility (see Note 8 - “Debt”).





The
      escrow amount to secure Learning Curve’s indemnification obligations under the
      merger agreement was approximately $2.9 million at September 30, 2005. In the
      merger agreement, Learning Curve agreed to indemnify the Company for losses
      relating to breaches of Learning Curve’s representations, warranties and
      covenants in the merger agreement and for specified liabilities relating to
      Learning Curve’s historical business. The Company may make indemnification
      claims against the escrow account until the later of March 31, 2005 or the
      10 th day
      following resolution of any tax audit or similar proceeding subject to potential
      indemnification under the merger agreement. Learning Curve is currently subject
      to a tax audit which is subject to potential indemnification under the merger
      agreement, and as a result, the escrow account will not close before the
      10 th day
      following the resolution of this tax audit. In February 2005, the Company
      notified the representatives of the former Learning Curve shareholders of the
      tax audit and an additional indemnification claim, and in April 2005, the
      Company notified the representatives of the former Learning Curve shareholders
      of another indemnification claim.


9


**Note
      3 - Intangible Assets and Goodwill**





The
      components of intangible assets, net are as follows:





(In
      thousands)


**September
                30, 2005**
            
            **December
                31, 2004****Carrying
                amount of amortizable intangible assets:**Customer
                relationships
            
            $
            8,703
            
            $
            ---Other
            
            
            2,962
            
            
            750$
            11,665
            
            $
            750**Accumulated
                amortization of amortizable intangible assets:**Customer
                relationships
            
            $
            222
            
            $
            ---Other
            
            
            966
            
            
            94$
            1,188
            
            $
            94**Intangible
                assets not subject to amortization:**Licenses
                and trademarks
            
            $
            89,380
            
            $
            57,416Other
            
            
            171
            
            
            171$
            89,551
            
            $
            57,587**Total
                intangible assets, net**
            
            $
            100,028
            
            $
            58,243





Other
      amortizable intangible assets consist primarily of patents, non-compete
      agreements and licenses. The future quarterly amortization expense of
      amortizable intangible assets is approximately $0.3 million.





Goodwill
      consists of the following:





(In
      thousands)


**North
                America**
            
            **International**
            
            **Total**Balance
                as of January 1, 2005
            
            $
            267,362
            
            $
            15,005
            
            $
            282,367Playing
                Mantis acquisition
            
            
            (3,085
            )
            
            ---
            
            
            (3,085
            )TFY
                acquisition
            
            
            (24,472
            )
            
            ---
            
            
            (24,472
            )Impact
                of currency exchange rate changes
            
            
            ---
            
            
            (1,235
            )
            
            (1,235
            )Balance
                as of September 30, 2005
            
            $
            239,805
            
            $
            13,770
            
            $
            253,575





10


**Note
      4 - Accounting for Stock-Based Compensation**





The
      Company accounts for stock-based compensation arrangements with employees in
      accordance with the provisions of Accounting Principles Board (APB) Opinion
      No.
      25, "Accounting for Stock Issued to Employees," and complies with the disclosure
      provisions of Statement of Financial Accounting Standards (SFAS) No. 123,
      "Accounting for Stock-Based Compensation." Under APB No. 25, compensation
      expense is based on the difference, if any, on the measurement date, between
      the
      estimated fair value of the Company's stock and the exercise price of options
      to
      purchase that stock. The compensation expense is amortized on a straight-line
      basis over the vesting period of the options. To date, no compensation expense
      has been recorded related to stock-based compensation agreements with
      employees.





If
      compensation costs for stock options issued, including options issued for shares
      under the employee stock purchase plan (ESPP), had been determined based on
      the
      fair value at their grant date consistent with SFAS No. 123, the Company's
      net
      income and net income per share would have been reduced to the following pro
      forma amounts:





**For
                the three months ended**
              **September
                30,**
            
            **For
                the nine months ended September 30,****2005**
            
            **2004**
            
            **2005**
            
            **2004**(In
                thousands, except per share data)
            
            **(Unaudited)**
            
            **(Unaudited)**
            
            **(Unaudited)**
            
            **(Unaudited)**Net
                income as reported
            
            $
            18,260
            
            $
            13,979
            
            $
            35,851
            
            $
            23,091Deduct:
                total stock-based employee
              compensation
                expense determined under fair
              value-based
                method for all awards, net of
              related
                tax effects
            
            
            (541
            )
            
            (799
            )
            
            (1,527
            )
            
            (1,478
            )Pro
                forma net income
            
            $
            17,719
            
            $
            13,180
            
            $
            34,324
            
            $
            21,613Basic
                net income per shareAs
                reported
            
            $
            0.88
            
            $
            0.72
            
            $
            1.74
            
            $
            1.28Pro
                forma
            
            $
            0.86
            
            $
            0.68
            
            $
            1.67
            
            $
            1.19Diluted
                net income per shareAs
                reported
            
            $
            0.85
            
            $
            0.68
            
            $
            1.67
            
            $
            1.20Pro
                forma
            
            $
            0.82
            
            $
            0.64
            
            $
            1.59
            
            $
            1.13





The
      fair
      value of each stock option, excluding options issued for shares under the ESPP,
      is estimated on the date of grant based on the Black-Scholes option pricing
      model that assumes, among other things, no dividend yield, risk-free rates
      of
      return from 3.53% to 5.74%, volatility factors of 54.50% to 87.76% and expected
      life of 7 to 10 years. The weighted average fair value of options granted under
      the Company’s stock option plan during the nine months ended September 30, 2005
      and 2004 was $18.69 and $19.39, respectively.





The
      fair
      value of each option issued under the ESPP was estimated using the Black-Scholes
      model with the following assumptions: risk-free rates of return from 0.93%
      to
      3.17%, volatility factors of 29.79% to 79.16% and expected life of three months.
      The weighted average fair value of those purchase rights granted during the
      nine
      months ended September 30, 2005 and 2004 was $7.18 and $8.03, respectively.


11


During
      the first quarter of 2005, the Company evaluated the method that had
      historically been used to calculate the volatility factors used in valuing
      stock
      options issued, both under the stock option plan and the ESPP. The Company
      had
      been using historical Company results to compute the volatility used in valuing
      the stock options issued. As the Company’s business has changed significantly as
      a result of the acquisitions completed, the historical stock price movements
      are
      not a good indicator of expected future results. Therefore, the Company has
      changed the method used to calculate the volatility factor for those options
      issued under the stock option plan to correspond with the average volatility
      factor of those companies included in a recent peer group study. The Company
      also changed the method used to calculate the volatility factor for those
      options issued under the ESPP to that of the volatility during the most recent
      three month period, as it more accurately projects the expected volatility
      over
      the three month ESPP period being valued.





The
      pro
      forma disclosure is not likely to be indicative of pro forma results that may
      be
      expected in future years because of the fact that options vest over several
      years. Compensation expense is recognized as the options vest and additional
      awards may be granted.





**Note
      5 - Business Segments**




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





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





Segment
      performance is measured at the operating income level. Segment assets are
      comprised of all assets, net of applicable reserves and allowances.





Results
      are not necessarily those that would be achieved if each segment were an
      unaffiliated business enterprise. Information by segment and a reconciliation
      to
      reported amounts for the three months and nine months ended September 30, 2005
      and 2004 are as follows:





**Three
                Months Ended September 30,**(In
                thousands)
            
            **2005**
            
            **2004****Net
                sales:**North
                America
            
            $
            121,661
            
            $
            97,237International
            
            
            21,378
            
            
            13,303Sales
                and transfers between segments
            
            
            (472
            )
            
            (251
            )Combined
                total
            
            $
            142,567
            
            $
            110,289**Operating
                income:**North
                America
            
            $
            24,079
            
            $
            19,916International
            
            
            6,820
            
            
            2,593Combined
                total
            
            $
            30,899
            
            $
            22,509





12





(In
                thousands)
            
            **September
                30,**
              **2005**
            
            **December
                31,**
              **2004****Total
                assets:**North
                America
            
            $
            571,394
            
            $
            525,526International
            
            
            71,317
            
            
            60,222Combined
                total
            
            $
            642,711
            
            $
            585,748





**Nine
                Months Ended September 30,**(In
                thousands)
            
            **2005**
            
            **2004****Net
                sales:**North
                America
            
            $
            299,704
            
            $
            206,998International
            
            
            49,264
            
            
            34,628Sales
                and transfers between segments
            
            
            (1,101
            )
            
            (638
            )Combined
                total
            
            $
            347,867
            
            $
            240,988**Operating
                income:**North
                America
            
            $
            48,534
            
            $
            31,934International
            
            
            12,007
            
            
            6,181Combined
                total
            
            $
            60,541
            
            $
            38,115





Under
      the
      enterprise-wide disclosure requirements of SFAS No. 131, the Company reports
      net
      sales by each group of product categories and by distribution channel. With
      the
      acquisitions of Playing Mantis and TFY in 2004, the Company revised its product
      categories to reflect the Company’s three product platforms: collectible
      products, children’s toys and infant products. The presentation is consistent
      with how the Company views its business. The following tables present
      consolidated net sales by product category and by distribution channel for
      the
      three months and nine months ended September 30, 2005 and 2004:





**Three
                Months Ended September 30,**(In
                thousands)
            
            **2005**
            
            **2004**Collectible
                products
            
            $
            34,862
            
            $
            51,505Children’s
                toys
            
            
            66,543
            
            
            47,227Infant
                products
            
            
            41,162
            
            
            11,557Net
                sales
            
            $
            142,567
            
            $
            110,289Chain
                retailers
            
            $
            88,901
            
            $
            57,969Specialty
                and hobby wholesalers
              and
                retailers
            
            
            34,252
            
            
            31,710OEM
                dealers
            
            
            13,268
            
            
            13,436Corporate
                promotional
            
            
            5,643
            
            
            4,488Direct
                to consumers
            
            
            503
            
            
            2,686Net
                sales
            
            $
            142,567
            
            $
            110,289





13





**Nine
                Months Ended September 30,**(In
                thousands)
            
            **2005**
            
            **2004**Collectible
                products
            
            $
            90,201
            
            $
            110,639Children’s
                toys
            
            
            140,121
            
            
            109,281Infant
                products
            
            
            117,545
            
            
            21,068Net
                sales
            
            $
            347,867
            
            $
            240,988Chain
                retailers
            
            $
            214,212
            
            $
            114,061Specialty
                and hobby wholesalers
              and
                retailers
            
            
            92,290
            
            
            83,842OEM
                dealers
            
            
            27,084
            
            
            24,690Corporate
                promotional
            
            
            12,575
            
            
            11,405Direct
                to consumers
            
            
            1,706
            
            
            6,990Net
                sales
            
            $
            347,867
            
            $
            240,988





**Note
      6 - Comprehensive Income**





The
      Company reports comprehensive income in accordance with SFAS No. 130, "Reporting
      Comprehensive Income." SFAS No. 130 requires companies to report all changes
      in
      equity during a period, except those resulting from investment by owners and
      distributions to owners, in a financial statement for the period in which they
      are recognized. Comprehensive income for the nine month periods ended
      September 30, 2005 and 2004 is calculated as follows:





(In
                thousands)
            
            **2005**
            
            **2004**Net
                income
            
            $
            35,851
            
            $
            23,091Other
                comprehensive (loss) income - foreign currencytranslation
                adjustments
            
            
            (3,742
            )
            
            45Comprehensive
                income
            
            $
            32,109
            
            $
            23,136





**Note
      7 - Common Stock**





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





**Authorized**
            **Par**
            **Shares
                Outstanding at**
            **Shares
                Outstanding at****Shares**
            **Value**
            **September
                30, 2005**
            **December
                31, 2004**Voting
                Common Stock
            28,000,000
            $0.01
            20,686,339
            20,462,659





At
      December 31, 2004, the Company held 1,832,174 shares of its common stock in
      treasury. During the nine months ended September 30, 2005, the Company sold
      a
      total of 4,729 shares out of treasury to Company employees under the ESPP for
      $138,973. During the nine months ended September 30, 2004, the Company sold
      a
      total of 5,006 shares out of treasury to Company employees under the ESPP for
      $104,094.


14


In
      August
      2004, the Company completed a public offering of 2,655,000 shares of common
      stock and certain selling stockholders sold 220,000 shares of common stock
      at a
      price of $31.00 per share. The Company received proceeds of $77.8 million from
      the offering, net of underwriting discount, and used $74.0 million of the
      proceeds to repay outstanding debt. Additionally, the Company incurred $0.3
      million of costs associated with the offering and these costs have been
      reflected as a reduction of stockholders’ equity on the Company’s condensed
      consolidated balance sheets at September 30, 2005 and December 31,
      2004.





As
      discussed in Note 2, the Company issued 91,388 shares of the Company’s common
      stock in June 2004 in connection with its acquisition of Playing
      Mantis.





**Note
      8 - Debt**





Upon
      the
      closing of the acquisition of TFY on September 15, 2004, the Company entered
      into a new credit facility to replace its March 4, 2003 credit facility (see
      below). This credit facility is comprised of an $85.0 million term loan and
      a
      $100.0 million revolving line of credit, both of which mature on September
      14,
      2008 with scheduled quarterly principal payments ranging from $3.8 million
      to
      $6.9 million commencing on December 31, 2004 and continuing thereafter with
      a
      final balloon payment upon maturity. A portion of the term loan has an interest
      rate of 3.45% plus applicable margin through the first three years of the
      agreement. The remaining term loan and revolving loan bear interest, at the
      Company’s option, at a base rate or at a LIBOR rate plus applicable margin. The
      applicable margin is based on the Company’s ratio of consolidated debt to
      consolidated EBITDA (earnings before interest, taxes, depreciation and
      amortization) and varies between 1.00% and 1.75%. At September 30, 2005, the
      margin in effect was 1.25% for LIBOR loans. The Company is also required to
      pay
      a commitment fee of 0.30% to 0.45% per annum on the average daily unused portion
      of the revolving loan. Under the terms of this credit facility, the Company
      is
      required to comply with certain financial and non-financial covenants. Among
      other restrictions, the Company is restricted in its ability to pay dividends,
      incur additional debt and make acquisitions above certain amounts. The key
      financial covenants include minimum EBITDA and interest coverage and leverage
      ratios. The credit facility is secured by working capital assets and certain
      intangible assets. On September 30, 2005, the Company had $117.0 million
      outstanding on this credit facility and was in compliance with all
      covenants. ****





In
      conjunction with the new credit facility, the Company expensed approximately
      $0.5 million of deferred financing fees related to the Company’s March 2003
      credit facility in interest expense during the third quarter of 2004. In
      addition, the Company incurred approximately $1.9 million in financing fees
      on
      the new credit facility, which is included in other non-current assets in the
      accompanying condensed consolidated balance sheets at September 30, 2005 and
      December 31, 2004 and is being charged to interest expense through September
      2008.





In
      August
      2004, the Company completed a public offering of 2,655,000 shares of common
      stock and certain selling stockholders sold 220,000 shares of common stock
      at a
      price of $31.00 per share. The Company received proceeds of $77.8 million from
      the offering, net of underwriting discount, and used $74.0 million of the
      proceeds to repay outstanding debt.


15


Upon
      the
      closing of the acquisition of LCI on March 4, 2003, with an effective date
      of
      February 28, 2003, the Company entered into a credit facility to replace its
      previous credit facility. This credit facility was comprised of a $60.0 million
      term loan and an $80.0 million revolving loan, both of which were to mature
      on
      April 30, 2006. Thirty million dollars of the term loan had an interest rate
      of
      2.61% plus applicable margin through the maturity of the agreement. The
      remaining term loan and revolving loan bore interest, at the Company's option,
      at a base rate or at a LIBOR rate plus applicable margin. The applicable margin
      was based on the Company's ratio of consolidated debt to consolidated EBITDA
      and
      varied between 0.75% and 1.75%. The facility was replaced with the September
      2004 credit facility discussed above.





**Note
      9 - Net Income Per Share**





The
      Company computes net income per share in accordance with SFAS No. 128, "Earnings
      Per Share." Under the provisions of SFAS No. 128, basic net income per share
      is
      computed by dividing net income for the period by the weighted average number
      of
      common shares outstanding during the period. Diluted net income per share is
      computed by dividing the net income for the period by the weighted average
      number of common and common equivalent shares outstanding during the period.
      Options to purchase 2,927 shares of common stock at $36.54 per share were
      outstanding during the nine months ended September 30, 2005, but were not
      included in the computation of diluted earnings per share because the options’
      exercise price was greater than the average market price of the common
      shares. **** Options
      to purchase 851 shares of common stock at $34.65 per share were outstanding
      during the three months ended September 30, 2004, but were not included in
      the
      computation of diluted earnings per share because the options’ exercise price
      was greater than the average market price of the common shares. **** Options
      to purchase 82,192 shares of common stock at prices between $29.02 and $34.65
      per share were outstanding during the nine months ended September 30, 2004,
      but
      were not included in the computation of diluted earnings per share because
      the
      options’ exercise price was greater than the average market price of the common
      shares. ****





**Note
      10 - Legal Proceedings**





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





**Note
      11 - 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
      12 - Reclassifications**





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


16


**Note
      13 - Related Party Transactions**





The
      Company purchased some of its product during the nine months ended September
      30,
      2005 and 2004, from a company in which a relative of one of the Company’s
      stockholders/directors has ownership interests. Additionally, in 2005, the
      Company began purchasing product from a second company in which the same
      relative of one of the Company’s stockholders/directors has a partial ownership
      interest.





**Note
      14 - Commitments and Contingencies**





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





The
      Company markets a significant portion of its products under licenses from other
      parties. These licenses are generally limited in scope and duration and
      authorize the sale of specific licensed products on a nonexclusive basis. The
      Company has over 700 licenses with various vehicle and equipment manufacturers,
      race team owners, drivers, sponsors, agents and entertainment and media
      companies, generally for terms of one to three years. Many of the licenses
      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, 2005 and 2004.





In
      conjunction with the acquisition of TFY during the third quarter of 2004, the
      Company acquired purchase commitments with certain vendors relating to product
      and product components which are kept on hand to shorten lead times. In the
      event the product is discontinued, the Company would be required to reimburse
      the vendor for the cost of the products and product components on hand. At
      September 30, 2005, the total commitment to these vendors was approximately
      $45,000. ****





**Note
      15 - Insurance Recovery**





During
      the nine months ended September 30, 2004, the Company received an insurance
      recovery of approximately $303,000 relating to the lost margin on product
      destroyed during a fire at the Company’s third-party warehouse in the United
      Kingdom in October 2003. This insurance recovery is included in the Company’s
      cost of sales for the nine months ended September 30, 2004.





**Note
      16 - Employee Benefit Plans**





The
      Company maintains a funded noncontributory defined benefit pension plan that
      covers a select group of the Company’s workforce. The plan provides defined
      retirement benefits based on the employees’ years of
      service.


17


The
      components of net periodic benefit cost for the three months ended September
      30,
      2005 and 2004 are as follows:





(In
                thousands)
            
            **2005**
            
            **2004**Service
                cost
            
            $
            27
            
            $
            27Interest
                cost
            
            
            192
            
            
            172Expected
                return on plan assets
            
            
            (244
            )
            
            (216
            )Amortization
                of prior service costs
            
            
            5
            
            
            5Amortization
                of net loss
            
            
            93
            
            
            45Net
                periodic benefit cost
            
            $
            73
            
            $
            33





The
      components of net periodic benefit cost for the nine months ended September
      30,
      2005 and 2004 are as follows:





(In
                thousands)
            
            **2005**
            
            **2004**Service
                cost
            
            $
            81
            
            $
            82Interest
                cost
            
            
            576
            
            
            516Expected
                return on plan assets
            
            
            (734
            )
            
            (648
            )Amortization
                of prior service costs
            
            
            15
            
            
            15Amortization
                of net loss
            
            
            279
            
            
            135Net
                periodic benefit cost
            
            $
            217
            
            $
            100





The
      Company contributed $0.7 million to the pension benefit plan during the nine
      months ended September 30, 2005. The Company does not expect to make any
      additional contributions during the remainder of 2005.





**Note
      17 - Assets Held for Sale**





During
      the second quarter of 2005, the Company accepted and signed a letter of intent
      related to the sale of the land and building located in Avon, Massachusetts.
      Assets held for sale in the amount of $5.1 million primarily represents the
      land
      and building at this location. The Company expects to close on the sale of
      the
      land and building during the fourth quarter of 2005.





**Note
      18 - Investment in Meteor The Monster Truck Company, LLC**





In
      July
      2005, the Company invested in Meteor The Monster Truck Company, LLC (Meteor).
      After recovery of its capital contributions and preferred returns, the Company
      will share in 7.5% of the profits and losses of Meteor. The Company has
      committed to contribute $750,000 to Meteor, of which approximately $530,000
      has
      been funded. The Company determined that the investment in Meteor will be
      accounted for using the equity method of accounting based on the Company’s
      ability to exercise significant influence over the operating and financial
      policies of Meteor as a result of its representation on the board of directors.
      The investment in Meteor of $0.5 million is included in other non-current assets
      on the accompanying condensed consolidated balance sheet at September 30,
      2005.





Subsequent
      to the third quarter-end, the Company funded the remainder of its commitment,
      bringing its total investment in Meteor to $750,000.


18


**Note
      19 - Sale of Product Line**





During
      the third quarter of 2005, the Company completed the sale of its W. Britain
      product line of collectible pewter toy soldiers and accessories for $2.9 million
      in cash. The sale resulted in a gain of $2.0 million which is included in
      operating income on the accompanying condensed consolidated statements of
      earnings.





**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 condensed consolidated
      financial statements and notes thereto included elsewhere herein.





RESULTS
      OF OPERATIONS





**Operating
      Highlights**





Net
      sales
      for the quarter ended September 30, 2005 increased approximately 29% primarily
      due to the addition of TFY. Gross margin decreased to 48.9% for the third
      quarter of 2005 from 50.8% for the third quarter of 2004 primarily due to the
      impact of the TFY acquisition which had historical gross margins lower than
      RC2’s historical gross margins, as well as a less favorable product mix and
      higher freight and product costs than that experienced in the third quarter
      of
      2004. Selling, general and administrative expenses as a percentage of net sales
      decreased to 28.0% for the third quarter of 2005 from 30.4% for the third
      quarter of 2004. Operating income increased to $30.9 million for the third
      quarter of 2005 compared to $22.5 million for the third quarter of 2004. As
      a
      percentage of net sales, operating income increased to 21.7% for the third
      quarter of 2005 from 20.4% for the third quarter of 2004.





Net
      sales
      for the nine months ended September 30, 2005 increased approximately 44%
      primarily due to the addition of TFY. Gross margin decreased to 49.3% for the
      nine months ended September 30, 2005 from 51.4% for the nine months ended
      September 30, 2004 primarily due to the impact of the 2004 acquisitions which
      had historical gross margins lower than RC2’s historical gross margins, as well
      as a less favorable product mix and higher freight and product costs than that
      experienced in the first nine months of 2004. Selling, general and
      administrative expenses as a percentage of net sales decreased to 32.2% for
      the
      nine months ended September 30, 2005 from 35.5% for the nine months ended
      September 30, 2004. Operating income increased to $60.5 million for the nine
      months ended September 30, 2005 compared to $38.1 million for the nine months
      ended September 30, 2004. As a percentage of net sales, operating income
      increased to 17.4% for the nine months ended September 30, 2005 from 15.8%
      for
      the nine months ended September 30, 2004.





**Three
      Months Ended September 30, 2005 Compared to Three Months Ended September 30,
      2004**





*Net
      sales.* Net
      sales
      for the third quarter of 2005 increased $32.3 million, or 29%, to $142.6 million
      from $110.3 million for the third quarter of 2004. The sales increase was
      primarily attributable to the addition of TFY which is reflected in the
      significant increase in our infant products category. Net sales also increased
      in our children’s toys product category, but these increases were partially
      offset by a decrease in our collectible products category.


19





Net
      sales
      in our infant products category increased approximately 256% primarily due
      to
      the addition of TFY. Net sales in our children’s toys category increased
      approximately 41% primarily driven by Thomas & Friends and John Deere toy
      vehicles and our ride-on products, as well as sales of our new Bob the Builder
      product line. Net sales in our collectible products category decreased
      approximately 32% primarily due to the continued tough comparisons with both *The
      Fast and The Furious* and
      Orange County/American Chopper product lines in the third quarter of 2004,
      the
      discontinuance of the Memory Lane seasonal figures which primarily shipped
      during the second half of 2004, lower overall NASCAR product sales and the
      discontinuance of distribution at NASCAR trackside events in 2005.





Actual
      net sales for the third quarter of 2005, excluding $0.8 million in net sales
      of
      previously discontinued product lines, increased 8% when compared to the third
      quarter of 2004 pro forma net sales excluding $6.5 million in net sales from
      these same discontinued product lines. The pro forma net sales assume that
      the
      Playing Mantis and TFY acquisitions occurred as of January 1, 2004.





*Gross
      profit.* Gross
      profit increased $13.7 million, or 25%, to $69.7 million for the third quarter
      of 2005 from $56.0 million for the third quarter of 2004. The gross profit
      margin (as a percentage of net sales) decreased to 48.9% in the third quarter
      of
      2005 compared to 50.8% in the third quarter of 2004 primarily due to the impact
      of the TFY acquisition which had historical gross margins lower than RC2’s
      historical gross margins, as well as a less favorable product mix and higher
      freight and product costs than experienced in the third quarter of 2004. Our
      quarterly gross margins can be affected by the mix of product that is shipped
      during each quarter. Historically, all of our product categories approximated
      a
      similar gross margin; however, individual product lines within a category
      carried gross margins that varied significantly and caused quarterly
      fluctuations, based on the timing of these individual shipments throughout
      the
      year. Due to the 2004 acquisition of TFY, which has higher sales of non-licensed
      products that carry lower selling prices and gross margins than the Company
      has
      had historically, our quarterly gross margins could not only significantly
      fluctuate, but could be lower than those historically reported. There were
      no
      major changes in the components of cost of sales.





*Selling,
      general and administrative expenses.* Selling,
      general and administrative expenses increased $6.4 million, or 19%, to $39.9
      million for the third quarter of 2005 from $33.5 million for the third quarter
      of 2004. As a percentage of net sales, selling, general and administrative
      expenses decreased to 28.0% for the third quarter of 2005 from 30.4% for the
      third quarter of 2004. The decrease in selling, general and administrative
      expenses as a percentage of net sales was primarily due to operating leverage
      gained from increased sales and integration cost savings from the 2004
      acquisitions and disciplined control over discretionary operating
      costs.





*Operating
      income.* Operating
      income increased to $30.9 million for the third quarter of 2005 from $22.5
      million for the third quarter of 2004. As a percentage of net sales, operating
      income increased to 21.7% of net sales in the third quarter of 2005 from 20.4%
      in the prior year third quarter. Operating income for the third quarter of
      2005
      includes $2.0 million in gain on the sale of assets related to the sale of
      our
      W. Britain product line. Operating income also includes $0.8 million in
      amortization expense, $0.6 million of which is “catch-up” amortization for the
      period September 16, 2004 through September 30, 2005 recorded in the third
      quarter related to the completion of the valuation of the assets acquired in
      the
      TFY transaction.





*Net
      interest expense* .
      Net
      interest expense of $1.5 million for the third quarter of 2005 and $1.0 million
      for the third quarter of 2004 relates primarily to bank term loans and lines
      of
      credit. The increase in net interest expense was primarily due to the increase
      in average outstanding debt balances.





*Income
      tax.* Income
      tax expense for the third quarter of 2005 and 2004 includes provisions for
      federal, state and foreign income taxes at an effective rate of 37.8% and 36.0%,
      respectively. During the third quarter of 2005, the Company changed its tax
      rate
      to 37.1% based on updated estimates of projected state tax costs.


20


**Nine
      Months Ended September 30, 2005 Compared to Nine Months Ended September 30,
      2004**





*Net
      sales.* Net
      sales
      for the nine months ended September 30, 2005 increased $106.9 million, or 44%,
      to $347.9 million from $241.0 million for the nine months ended September 30,
      2004. This sales increase was primarily attributable to the addition of TFY
      which is reflected in the significant increase in the infant products category.
      Net sales also increased in our children’s toys category, but these increases
      were partially offset by a decrease in our collectible products
      category.





Net
      sales
      in our infant products category increased approximately 458% primarily due
      to
      the addition of TFY. Net sales in our children’s toys category increased
      approximately 28% primarily driven by strong performance of Thomas & Friends
      and John Deere toy vehicles and our ride-on products, as well as sales of our
      new Bob the Builder product line. Net sales in our collectible products category
      decreased approximately 19% primarily due to the continued tough comparisons
      to
      both *The
      Fast and The Furious* and
      Orange County/American Chopper product lines in the first nine months of 2004,
      the discontinuance of the Memory Lane seasonal figures, lower overall NASCAR
      product sales and the discontinuance of distribution at NASCAR trackside events
      in 2005.





Actual
      net sales for the nine months ended September 30, 2005, excluding $2.5 million
      in net sales of previously discontinued product lines, increased 4% when
      compared to the nine months ended September 30, 2004 pro forma net sales,
      excluding $17.4 million in net sales from these same discontinued product lines.
      The pro forma net sales assume that the Playing Mantis and TFY acquisitions
      occurred as of January 1, 2004.





*Gross
      profit.* Gross
      profit increased $47.8 million, or 39%, to $171.6 million for the nine months
      ended September 30, 2005 from $123.8 million for the nine months ended September
      30, 2004. The gross profit margin (as a percentage of net sales) decreased
      to
      49.3% in the nine months ended September 30, 2005 compared to 51.4% in the
      nine
      months ended September 30, 2004 primarily due to the impact of the TFY
      acquisition which had historical gross margins lower than RC2’s historical gross
      margins, a less favorable product mix and higher freight and product costs
      than
      that experienced in the first nine months of 2004. There were no major changes
      in the components of cost of sales.





*Selling,
      general and administrative expenses.* Selling,
      general and administrative expenses increased $26.3 million, or 31%, to $111.9
      million for the nine months ended September 30, 2005 from $85.6 million for
      the
      nine months ended September 30, 2004. As a percentage of net sales, selling,
      general and administrative expenses decreased to 32.2% for the nine months
      ended
      September 30, 2005 from 35.5% for the nine months ended September 30, 2004.
      The
      decrease in selling, general and administrative expenses as a percentage of
      net
      sales was primarily due to operating leverage gained from the increased sales
      from the 2004 acquisitions and disciplined control over discretionary operating
      expenses.





*Operating
      income.* Operating
      income increased to $60.5 million for the nine months ended September 30, 2005
      from $38.1 million for the nine months ended September 30, 2004. As a percentage
      of net sales, operating income increased to 17.4% of net sales in the nine
      months ended September 30, 2005 from 15.8% in the nine months ended September
      30, 2004. Operating income for the nine months ended September 30, 2005 includes
      $2.0 million in gain on the sale of assets related to the sale of our W. Britain
      product line. Operating income also includes $1.1 million in amortization
      expense, $0.6 million of which is “catch-up” amortization for the period
      September 16, 2004 through September 30, 2005 recorded in the third quarter
      related to the completion of the valuation of the assets acquired in the TFY
      transaction.


21


*Net
      interest expense* .
      Net
      interest expense of $4.6 million for the nine months ended September 30, 2005
      and $2.5 million for the nine months ended September 30, 2004 relates primarily
      to bank term loans and lines of credit. The increase in net interest expense
      was
      primarily due to the increase in average outstanding debt balances and an
      increase in the Company’s incremental borrowing rate.





*Income
      tax.* Income
      tax expense for the nine months ended September 30, 2005 and 2004 includes
      provisions for federal, state and foreign income taxes at an effective rate
      of
      36.4% and 36.0%, respectively. During the third quarter of 2005, the Company
      changed its tax rate to 37.1% based on updated estimates of projected state
      tax
      costs. Additionally during the second quarter of 2005, the Company released
      approximately $0.7 million, or $0.03 per diluted share, of income tax accruals
      stemming from the resolution of specific outstanding state and foreign tax
      issues.





**Related
      Party Transactions**





The
      Company purchased some of its product during the nine months ended September
      30,
      2005 and 2004 from a company in which a relative of one of the Company’s
      stockholders/directors has ownership interests. Additionally, in 2005 the
      Company began purchasing product from a second company in which the same
      relative of one of the Company’s stockholders/directors has a partial ownership
      interest.





LIQUIDITY
      AND CAPITAL RESOURCES





The
      Company’s operations provided net cash of approximately $20.4 million during the
      nine months ended September 30, 2005. Inventory increased approximately $33.0
      million and accounts receivable increased approximately $20.0 million during
      the
      nine months ended September 30, 2005 and were two of the primary uses of cash
      from operations. Capital expenditures for the nine months ended September 30,
      2005 were approximately $9.9 million, of which approximately $8.3 million was
      for molds and tooling. Payments on the Company’s credit facility were
      approximately $34.3 million for the nine months ended September 30, 2005.
      Borrowings on the Company’s credit facility were $20.0 million during the nine
      months ended September 30, 2005. Cash and cash equivalents remained relatively
      constant during the nine months ended September 30, 2005.





Upon
      the
      closing of the acquisition of TFY on September 15, 2004, the Company entered
      into a new credit facility to replace its March 4, 2003 credit facility (see
      below). This credit facility is comprised of an $85.0 million term loan and
      a
      $100.0 million revolving line of credit, both of which mature on September
      14,
      2008 with scheduled quarterly principal payments ranging from $3.8 million
      to
      $6.9 million commencing on December 31, 2004 and continuing thereafter with
      a
      final balloon payment upon maturity. A portion of the term loan has an interest
      rate of 3.45% plus applicable margin through the first three years of the
      agreement. The remaining term loan and revolving loan bear interest, at the
      Company’s option, at a base rate or at a LIBOR rate plus applicable margin. The
      applicable margin is based on the Company’s ratio of consolidated debt to
      consolidated EBITDA (earnings before interest, taxes, depreciation and
      amortization) and varies between 1.00% and 1.75%. At September 30, 2005, the
      margin in effect was 1.25% for LIBOR loans. The Company is also required to
      pay
      a commitment fee of 0.30% to 0.45% per annum on the average daily unused portion
      of the revolving loan. Under the terms of this credit facility, the Company
      is
      required to comply with certain financial and non-financial covenants. Among
      other restrictions, the Company is restricted in its ability to pay dividends,
      incur additional debt and make acquisitions above certain amounts. The key
      financial covenants include minimum EBITDA and interest coverage and leverage
      ratios. The credit facility is secured by working capital assets and certain
      intangible assets. On September 30, 2005, the Company had $117.0 million
      outstanding on this credit facility and was in compliance with all
      covenants.


22


In
      August
      2004, the Company completed a public offering of 2,655,000 shares of common
      stock and certain selling stockholders sold 220,000 shares of common stock
      at a
      price of $31.00 per share. The Company received proceeds of $77.8 million from
      the offering, net of underwriting discount, and used $74.0 million of the
      proceeds to repay outstanding debt.





Upon
      the
      closing of the acquisition of LCI on March 4, 2003, with an effective date
      of
      February 28, 2003, the Company entered into a credit facility to replace its
      previous credit facility. This credit facility was comprised of a $60.0 million
      term loan and an $80.0 million revolving loan, both of which were to mature
      on
      April 30, 2006. Thirty million dollars of the term loan had an interest rate
      of
      2.61% plus applicable margin through the maturity of the agreement. The
      remaining term loan and revolving loan bore interest, at the Company's option,
      at a base rate or at a LIBOR rate plus applicable margin. The applicable margin
      was based on the Company's ratio of consolidated debt to consolidated EBITDA
      and
      varied between 0.75% and 1.75%. The facility was replaced with the September
      2004 credit facility discussed above.





During
      the nine months ended September 30, 2005, the Company made total payments of
      $23.0 million on its line of credit and $11.3 million on its term loan and
      borrowed $20 million on its line of credit. At September 30, 2005, the Company
      had $52.2 million available on its line of credit.





The
      Company has met its working capital needs through funds generated from
      operations and available borrowings under the credit agreement. 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
      2005, principally for molds and tooling, will be approximately $15.0
      million.





The
      Company believes that its cash flows from operations, cash on hand and available
      borrowings will be sufficient to meet its working capital and capital
      expenditure requirements and provide the Company with adequate liquidity to
      meet
      anticipated operating needs for 2005. However, if the Company’s capital
      requirements vary materially from those currently planned, the Company may
      require additional debt or equity financing. There can be no assurance that
      financing, if needed, would be available on terms acceptable to the Company,
      if
      at all.





CRITICAL
      ACCOUNTING POLICIES AND ESTIMATES





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


23


*Allowance
      for Doubtful Accounts.* The
      allowance for doubtful accounts represents adjustments to customer trade
      accounts receivable for amounts deemed uncollectible. The allowance for doubtful
      accounts reduces gross trade receivables to their net realizable value. The
      Company's allowance is based on management's assessment of the business
      environment, customers' financial condition, historical trends, customer payment
      practices, receivable aging and customer disputes. The Company has purchased
      credit insurance that covers a portion of its receivables from major customers.
      The Company will continue to proactively review its credit risks and adjust
      its
      customer terms to reflect the current environment.





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





*Impairment
      of Long-Lived Assets, Goodwill and Other Intangible Assets.* Long-lived assets have been reviewed for impairment based on Statement of
      Financial Accounting Standards (SFAS) No. 144, "Accounting for the Impairment
      of
      Long-Lived Assets and for Long-Lived Assets to be Disposed Of." This statement
      requires that an impairment loss be recognized whenever the sum of the expected
      future cash flows (undiscounted and without interest charges) resulting from
      the
      use and ultimate disposal of an asset is less than the carrying amount of the
      asset. Goodwill and other intangible assets have been reviewed for impairment
      based on Statement No. 142, "Goodwill and Other Intangible Assets." Under SFAS
      No. 142, goodwill and other intangible assets that have indefinite useful lives
      are not amortized, but rather are tested at least annually for impairment.
      The
      Company's management reviews for indicators that might suggest an impairment
      loss could exist. Testing for impairment requires estimates of expected cash
      flows to be generated from the use of the assets. Various uncertainties,
      including changes in consumer preferences, deterioration in the political
      environment or changes in general economic conditions, could impact the expected
      cash flows to be generated by an asset or group of assets. Intangible assets
      that have finite useful lives will continue to be amortized over their useful
      lives.





*Income
      Taxes.* The
      Company records current and deferred income tax liabilities. Management
      considers all available evidence in evaluating the realizability of the deferred
      tax assets and records valuation allowances against its deferred tax assets
      as
      needed. Management believes it is more likely than not that the Company will
      generate sufficient taxable income in the appropriate carry-forward periods
      to
      realize the benefit of its deferred tax assets. In determining the required
      liability, management considers certain tax exposures and all available
      evidence. However, if the available evidence were to change in the future,
      an
      adjustment to the tax-related balances may be required.


24


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





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





**Recently
      Issued Accounting Pronouncements**





In
      December 2004, the FASB issued SFAS No. 123R, “Share-Based Payment.” This
      statement is a revision of SFAS No. 123, “Accounting for Stock-Based
      Compensation” and supersedes APB Opinion No. 25, “Accounting for Stock Issued to
      Employees.” This statement establishes standards for the accounting for
      transactions in which an entity exchanges its equity instruments for goods
      or
      services and also addresses transactions in which an entity incurs liabilities
      in exchange for goods and services that are based on the fair value of the
      entity’s equity instruments or that may be settled by the issuance of those
      instruments. This statement applies to all awards granted after the required
      effective date and to awards modified, repurchased, or cancelled after that
      date. This statement is effective as of the beginning of the first annual period
      beginning after June 15, 2005. The Company will adopt this statement for the
      quarter beginning January 1, 2006. We believe the best indication of the
      approximate impact on net income of adopting the provisions of this revised
      Statement may be determined by reviewing the table provided under Note 4 -
      Accounting for Stock-Based Compensation. We plan to use the prospective method
      and accordingly will not be restating prior periods upon adoption of SFAS No.
      123R.


25


In
      December 2004, the FASB issued FASB Staff Position (FSP) 109-2, “Accounting and
      Disclosure Guidance for the Foreign Earnings Repatriation Provision within
      the
      American Jobs Creation Act of 2004.” This FSP was issued to provide accounting
      and disclosure guidance for the repatriation provision of the American Jobs
      Creation Act of 2004 (the Act) which was signed into law on October 22, 2004.
      This FSP was effective upon issuance. Pursuant to the Act, the Company is in
      the
      process of evaluating those provisions relating to the repatriation of certain
      foreign earnings that are repatriated, as defined in the Act. The Company
      expects to complete its evaluation during the fourth quarter of 2005 and
      anticipates that any repatriation of funds will occur during the fourth quarter,
      at which time the Company will incur an additional tax charge. Currently, the
      range of possible amounts the Company is considering repatriating is between
      zero and $10.0 million.





FORWARD-LOOKING
      STATEMENTS





Certain
      statements contained in this report are considered "forward-looking statements"
      within the meaning of the Private Securities Litigation Reform Act of 1995.
      These statements may be identified by the use of forward-looking words or
      phrases such as "anticipate," "believe," "could," "expect," "intend," "may,"
      "planned," "potential," "should," "will," "would" or the negative of those
      terms
      or other words of similar meaning. Such forward-looking statements are
      inherently subject to known and unknown risks and uncertainties. The Company's
      actual results and future developments could differ materially from the results
      or developments expressed in, or implied by, these forward-looking
      statements *.* Factors
      that may cause actual results to differ materially from those contemplated
      by
      such forward-looking statements include, but are not limited to, the following:
      the Company may not be able to manufacture, source and ship new and continuing
      products on a timely basis; the Company is dependent upon timely shipping of
      product and unloading of product through West Coast ports as well as timely
      rail/truck delivery to the Company's warehouse and/or customers' warehouses;
      increases in the cost of raw materials used to manufacture the Company’s
      products and increases in freight costs could increase the Company’s cost of
      sales and reduce the Company’s gross margins; currency exchange rate
      fluctuations, particularly in the Chinese Renminbi or the Hong Kong dollar,
      could increase the Company’s expenses; customers and consumers may not accept
      the Company's products at prices sufficient for the Company to profitably
      recover development, manufacturing, marketing, royalty and other costs; the
      inventory policies of retailers, together with increased reliance by retailers
      on quick response inventory management techniques, may increase the risk of
      underproduction of popular items, overproduction of less popular items and
      failure to achieve tight shipping schedules; competition in the markets for
      the
      Company's products may increase significantly; the Company is dependent upon
      continuing licensing arrangements with vehicle manufacturers, agricultural
      equipment manufacturers, major race sanctioning bodies, race team owners,
      drivers, sponsors, agents and other licensors; the Company may experience
      unanticipated negative results of litigation; the Company relies upon a limited
      number of independently owned factories located in China to manufacture a
      significant portion of its vehicle replicas and certain other products; the
      Company is dependent upon the continuing willingness of leading retailers to
      purchase and provide shelf space for the Company's products; and general
      economic conditions in the Company's markets *.* 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 its credit agreement and foreign currency exchange rate risk associated
      with its foreign operations.





Based
      on
      the Company's interest rate exposure on variable rate borrowings at
      September 30, 2005, a one-percentage-point increase in average interest
      rates on the Company's borrowings would increase future interest expense by
      approximately $70,049 per month and a five-percentage point increase would
      increase future interest expense by approximately $350,245 per month. The
      Company determined these amounts based on approximately $84.1 million of
      variable rate borrowings at September 30, 2005, multiplied by 1% and
      5%,
      respectively, and divided by 12. The Company is currently not using any interest
      rate collars, hedges or other derivative financial instruments to manage or
      reduce interest rate risk. As a result, any increase in interest rates on the
      Company's variable rate borrowings would increase interest expense and reduce
      net income.





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





**Item
      4.   Controls and
      Procedures**





As
      of the
      end of the period covered by this report, the Company carried out an evaluation,
      under the supervision and with the participation of the Company's management,
      including the Company's Chief Executive Officer and Chief Financial Officer,
      of
      the Company's disclosure controls and procedures (as defined in
      Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934,
      as
      amended). Based on this evaluation, the Company's Chief Executive Officer and
      Chief Financial Officer concluded that, as of the end of such period, the
      Company's disclosure controls and procedures were effective in recording,
      processing, summarizing and reporting, on a timely basis, information required
      to be disclosed by the Company in reports that the Company files with or submits
      to the Securities and Exchange Commission. It should be noted that in designing
      and evaluating the disclosure controls and procedures, management recognized
      that any controls and procedures, no matter how well designed and operated,
      can
      provide only reasonable assurance of achieving the desired control objectives,
      and management necessarily was required to apply its judgment in evaluating
      the
      cost-benefit relationship of possible controls and procedures. The Company
      has
      designed its disclosure controls and procedures to reach a level of reasonable
      assurance of achieving the desired control objectives and based on the
      evaluation described above, the Company's Chief Executive Officer and Chief
      Financial Officer concluded that the Company's disclosure controls and
      procedures were effective at reaching that level of reasonable
      assurance.





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


27




PART II.  OTHER
      INFORMATION





**Item 1. 
       Legal Proceedings.**





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





**Item
      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.





**Item
      6.   Exhibits.**




3.1
              Amended and Restated Certificate of Incorporation
                of the
                Company (incorporated by referenceto
                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).





28


3.4
            Certificate
                of Ownership and Merger changing the Company's name to RC2 Corporation
                (incorporated by reference to Exhibit 3.4 of the Company's Quarterly
                Report on Form 10-Q for the quarter ended March 31, 2003 (File No.
                0-22635) filed by the Company with the Securities and Exchange Commission
                on May 14, 2003).





3.5
            Amended
                and Restated By-Laws of the Company (incorporated by reference to
                Exhibit
                3.5 of the Company’s Quarterly Report on Form 10-Q for the quarter ended
                March 31, 2004 (File No. 0-22635) filed by the Company with the Securities
                and Exchange Commission on May 10,
                2004).





31.1
            Certification
                of Chief Executive
                Officer pursuant to Section 302 of the Sarbanes-Oxley Act of
                2002.





31.2
            Certification
                of Chief Financial
                Officer pursuant to Section 302 of the Sarbanes-Oxley Act of
                2002.





32.1*
            Certification
                of Chief Executive
                Officer and Chief Financial Officer pursuant to 18 U.S.C. Section
                1350
                (Section 906 of the Sarbanes-Oxley Act of
                2002).




_______________________





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





29


SIGNATURES




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




Dated
      this
      9th day of November 2005.





RC2
      CORPORATION





By  /s/
      Curtis W.
      Stoelting


Curtis
      W.
      Stoelting,


Chief Executive Officer








By 
       /s/ Jody L.
      Taylor


Jody
      L.
      Taylor,


Chief
      Financial Officer and Secretary






30