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 June 30, 2006ORo
                TRANSITION
                    REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
                    OF 1934For
                    the transition period from _______ to
                    _________
 
 Commission
          file number: 0-22635
  RC2
                      Corporation(Exact
                      Name of Registrantas
                      Specified in Its Charter)
 Delaware
                
                36-4088307(State
                    or other jurisdiction of incorporation or organization)
                
                (IRS
                    Employer Identification No.)
  1111
                    West 22ndStreet, Suite 320, Oak Brook, Illinois,
                    60523(Address
                    of principal executive
                    offices)
 
 Registrant's
          telephone number, including area code:  630-573-7200
 
 Indicate
          by check mark whether the Registrant (1) has filed all reports required to
          be filed by sections 13 or 15(d) of the Securities Exchange Act of 1934
          during the preceding 12 months (or for such shorter period that the
          Registrant was required to file such reports), and (2) has been subject to
          such filing requirements for the past 90 days.
  Yes
                X
                
                No
  Indicate
          by check mark whether the Registrant is a large accelerated filer, an
          accelerated filer, or a non-accelerated filer. See definition of "accelerated
          filer and large accelerated filer" in Exchange Act Rule 12b-2.
 
 Large
                    accelerated filer
                X
                
                Accelerated
                    filer
                
                Non-accelerated
                    filer
 
 Indicate
          by check mark whether the Registrant is a shell company (as defined in
          Exchange
          Act Rule 12b-2).
  Yes
                  
                  
                  No
                  X
 On
        July
        27, 2006, there were outstanding 20,912,284 shares of the Registrant's $0.01
        par
        value common stock.









RC2
      CORPORATION


FORM
      10‐Q


JUNE
      30,
      2006


INDEX


PART
      I -
      FINANCIAL INFORMATION




PageItem
                1.
            Condensed
                Consolidated Balance Sheets as of June
                30,
              2006
                and December 31,
                2005.....................................................................................
            3Condensed
                Consolidated Statements
                of Earnings for the Three
              Months and Six Months Ended June 30, 2006 and
                2005......................................
            4Condensed
                Consolidated Statements of
                Cash Flows for the
              Six
                Months
                Ended June 30, 2006 and
                2005..............................................................
            5Notes
                to Condensed Consolidated
                Financial Statements.........................................
            6Item
                2.
            Management's
                Discussion and Analysis of
                Financial Condition
              and
                Results of
                Operations.........................................................................................
            17Item
                3.
            Quantitative
                and Qualitative Disclosures
                about Market Risk...................................
            25Item
                4.
            Controls
                and
                Procedures................................................................................................
            25




PART
      II -
      OTHER INFORMATION




Item
                1.
            Legal
                Proceedings............................................................................................................
            26Item
                1A.
            Risk
                Factors......................................................................................................................
            26Item
                2.
            Unregistered
                Sales of Equity
                Securities and Use of Proceeds.................................
            26Item
                3.
            Defaults
                Upon Senior
                Securities....................................................................................
            26Item
                4.
            Submission
                of Matters to a Vote of
                Security Holders...............................................
            26Item
                5.
            Other
                Information............................................................................................................
            27Item
                6.
            Exhibits..............................................................................................................................
            27Signatures.........................................................................................................................
            28






2


PART
        I. FINANCIAL
        INFORMATION
 
 **Item
        1.  Financial Statements**
 
 **RC2
        Corporation and Subsidiaries**
 **Condensed
        Consolidated Balance
        Sheets**
 **(Unaudited
        and in thousands)**
  **June
                  30, 2006**
              **December
                  31, 2005****Assets**Cash
                  and cash equivalents
              $
                  14,937
              $
                  25,262Accounts
                  receivable, net
              82,869
              113,066Inventory
              98,915
              71,260Other
                  current assets
              17,117
              17,597Total
                  current assets
              213,838
              227,185Property
                  and equipment, net
              47,680
              47,039Goodwill
              253,751
              253,571Intangible
                  assets, net
              99,527
              99,611Other
                  non-current assets
              3,357
              2,330Total
                  assets
              $618,153
              $629,736**Liabilities
                  and stockholders’ equity**Accounts
                  payable and accrued expenses
              $
                  80,658
              $
                  87,322Line
                  of credit
              ---
              3,979Current
                  maturities of bank term loans
              21,250
              21,250Other
                  current liabilities
              1,010
              1,348Total
                  current liabilities
              102,918
              113,899Lines
                  of credit
              ---
              13,980Bank
                  term loans, less current maturities
              32,813
              43,438Other
                  non-current liabilities
              58,954
              59,468Total
                  liabilities
              194,685
              230,785Stockholders’
                  equity
              423,468
              398,951Total
                  liabilities and stockholders' equity
              $618,153
              $629,736
 
 See
        accompanying notes to condensed consolidated financial statements.
 
  3
  **RC2
        Corporation and Subsidiaries**
 **Condensed
        Consolidated Statements of
        Earnings**
 **(Unaudited
        and in thousands, except per share data)**
 
 **For
                  the three months ended**
                **June
                  30,**
              
              **For
                  the six months ended**
                **June
                  30,****2006**
              
              
              
              **2005**
              
              
              
              **2006**
              
              
              
              **2005**Net
                  sales
              
              $
              112,707
              
              
              $
              108,811
              
              
              $
              216,216
              
              
              $
              205,300Cost
                  of sales
              
              
              58,755
              
              
              
              56,067
              
              
              
              114,148
              
              
              
              103,434Gross
                  profit
              
              
              53,952
              
              
              
              52,744
              
              
              
              102,068
              
              
              
              101,866Selling,
                  general and administrative expenses
              
              
              38,436
              
              
              
              36,413
              
              
              
              73,512
              
              
              
              71,974Amortization
                  of intangible assets
              
              
              315
              
              
              
              156
              
              
              
              630
              
              
              
              250Operating
                  income
              
              
              15,201
              
              
              
              16,175
              
              
              
              27,926
              
              
              
              29,642Interest
                  expense, net
              
              
              856
              
              
              
              1,714
              
              
              
              1,871
              
              
              
              3,035Other
                  expense (income)
              
              
              37
              
              
              
              (266
              )
              
              
              (120
              )
              
              
              (351
              )Income
                  before income taxes
              
              
              14,308
              
              
              
              14,727
              
              
              
              26,175
              
              
              
              26,958Income
                  tax expense
              
              
              5,173
              
              
              
              4,964
              
              
              
              9,550
              
              
              
              9,367Net
                  income
              
              $
              9,135
              
              
              $
              9,763
              
              
              $
              16,625
              
              
              $
              17,591Net
                  income per share:Basic
              
              $
              0.44
              
              
              $
              0.47
              
              
              $
              0.80
              
              
              $
              0.86Diluted
              
              $
              0.43
              
              
              $
              0.45
              
              
              $
              0.78
              
              
              $
              0.82Weighted
                  average shares outstanding:Basic
              
              
              20,863
              
              
              
              20,593
              
              
              
              20,807
              
              
              
              20,545Diluted
              
              
              21,347
              
              
              
              21,545
              
              
              
              21,313
              
              
              
              21,488
 
 See
        accompanying notes to condensed consolidated financial statements.
 
  4
  **RC2
        Corporation and Subsidiaries**
 **Condensed
        Consolidated Statements of Cash
        Flows**
 **(Unaudited
        and in thousands)**
 
 **For
                  the six months ended June 30,****2006**
              
              
              
              **2005****Cash
                  flows from operating activities**Net
                  income
              
              $
              16,625
              
              
              $
              17,591Depreciation
                  and amortization
              
              
              7,776
              
              
              
              6,918Stock-based
                  compensation
              
              
              2,123
              
              
              
              ---Amortization
                  of deferred financing costs
              
              
              242
              
              
              
              241Gain
                  on disposition of assets
              
              
              (6
              )
              
              
              (90
              )Changes
                  in operating assets and liabilities
              
              
              (3,466
              )
              
              
              2,599Net
                  cash provided by operating activities
              
              
              23,294
              
              
              
              27,259**Cash
                  flows from investing activities**Purchase
                  of property and equipment
              
              
              (7,602
              )
              
              
              (6,582
              )Adjustments
                  to the purchase price of TFY
              
              
              ---
              
              
              
              38Proceeds
                  from disposition of property and equipment
              
              
              18
              
              
              
              527Increase
                  in other non-current assets
              
              
              (56
              )
              
              
              (87
              )Investment
                  in Meteor The Monster Truck Company, LLC
              
              
              (1,214
              )
              
              
              ---Net
                  cash used in investing activities
              
              
              (8,854
              )
              
              
              (6,104
              )**Cash
                  flows from financing activities**Payments
                  to bank on lines of credit
              
              
              (18,270
              )
              
              
              (23,000
              )Payments
                  to bank on bank term loans
              
              
              (10,625
              )
              
              
              (7,500
              )Issuance
                  of common stock upon option exercises
              
              
              2,067
              
              
              
              928Tax
                  benefit on stock option exercises
              
              
              1,648
              
              
              
              ---Issuance
                  of common stock for ESPP
              
              
              102
              
              
              
              82Net
                  cash used in financing activities
              
              
              (25,078
              )
              
              
              (29,490
              )Effect
                  of exchange rate changes on cash
              
              
              313
              
              
              
              (524
              )Net
                  decrease in cash and cash equivalents
              
              
              (10,325
              )
              
              
              (8,859
              )Cash
                  and cash equivalents, beginning of year
              
              
              25,262
              
              
              
              20,123Cash
                  and cash equivalents, end of period
              
              $
              14,937
              
              
              $
              11,264Supplemental
                  information:Cash
                  flows during the period for:Interest
              
              $
              2,096
              
              
              $
              2,547Income
                  taxes
              
              $
              14,752
              
              
              $
              5,605Income
                  tax refunds received
              
              $
              384
              
              
              $
              4,564
 
 See
        accompanying notes to condensed consolidated financial
        statements.
  5
  **RC2
        Corporation and Subsidiaries**
 **Notes
        to Condensed Consolidated Financial
        Statements**
 
 **Note
        1 - Basis of Presentation**
 
 The
        condensed consolidated financial statements include the accounts of RC2
        Corporation and its subsidiaries (the Company or RC2). All intercompany
        transactions and balances have been eliminated.
 
 The
        accompanying unaudited condensed consolidated financial statements have been
        prepared by management and, in the opinion of management, contain all
        adjustments, consisting of normal recurring adjustments, necessary to present
        fairly the financial position of the Company as of June 30, 2006, the results
        of
        its operations for the three-month and six-month periods ended June 30, 2006
        and
        2005, and its cash flows for the six-month periods ended June 30, 2006 and
        2005.
 
 Certain
        information and note disclosures normally included in financial statements
        prepared in accordance with U.S. generally accepted accounting principles
        have
        been omitted. It is suggested that these condensed consolidated financial
        statements be read in conjunction with the consolidated financial statements
        and
        related notes included in the Company's Form 10-K for the year ended December
        31, 2005. The condensed consolidated balance sheet information as of December
        31, 2005 appearing herein is derived from the consolidated balance sheet
        in the
        Form 10-K.
 
 Due
        to
        the seasonality of our business, the results of operations for interim periods
        are not necessarily indicative of the operating results for a full
        year.
 
 **Note
        2 - Stock-Based Payment Arrangements**
 
 On
        January 1, 2006, the Company adopted SFAS No. 123R, “Share-Based Payment.” This
        Statement is a revision of SFAS No. 123, “Accounting for Stock-Based
        Compensation” and supersedes APB Opinion No. 25, “Accounting for Stock Issued to
        Employees.” This Statement establishes standards for the accounting for
        transactions in which an entity exchanges its equity instruments for goods
        or
        services and also addresses transactions in which an entity incurs liabilities
        in exchange for goods and services that are based on the fair value of the
        entity’s equity instruments or that may be settled by the issuance of those
        instruments. The Company adopted this Statement on a modified prospective
        basis,
        and therefore, no compensation expense related to stock-based payment
        arrangements was recognized in the financial statements prior to
        adoption.
  
  6
  At
        June
        30, 2006, the Company has four stock incentive plans, three of which are
        dormant, and an employee stock purchase plan (ESPP), which are described
        below.
        Amounts recognized in the financial statements with respect to these stock-based
        payment arrangements for the three months and six months ended June 30, 2006
        are
        as follows:
 
 (in
        thousands)
 **For
                  the three**
                **months
                  ended**
              **For
                  the six**
                **months
                  ended****June
                  30, 2006**
              **June
                  30, 2006**Total
                  expense recognized for stock-based payment plans
              $1,081
              $2,123Amount
                  of related income tax benefit recognized in net income
              $ 
                   401
              $  
                  788
 
 Stock-based
        compensation expense is included in selling, general and administrative expenses
        in the accompanying condensed consolidated statements of earnings for the
        three
        months and six months ended June 30, 2006.
 
 Prior
        to
        January 1, 2006, the Company accounted for stock-based compensation arrangements
        with employees in accordance with the provisions of APB Opinion No. 25 and
        complied with the disclosure provisions of SFAS No. 123. If compensation
        costs
        for stock options issued, including options for shares issued under the ESPP,
        had been determined based on the fair value at their grant date consistent
        with
        SFAS No. 123, the Company’s net income and net income per share would have been
        reduced to the following pro forma amounts:
 
 (in
                  thousands, except per share data)
              
              
              **For
                  the three months ended June 30, 2005**
              
              
              
              **For
                  the six months ended June 30, 2005**Net
                  income as reported
              
              $
              9,763
              
              
              $
              17,591Deduct:
                  total stock-based employee compensation
                expense
                  determined under fair value based method
                for
                  all awards, net of related income tax benefit
              
              
              (545
              )
              
              
              (986
              )Pro
                  forma net income
              
              $
              9,218
              
              
              $
              16,605Basic
                  net income per share:As
                  reported
              
              $
              0.47
              
              
              $
              0.86Pro
                  forma
              
              $
              0.45
              
              
              $
              0.81Diluted
                  net income per share:As
                  reported
              
              $
              0.45
              
              
              $
              0.82Pro
                  forma
              
              $
              0.43
              
              
              $
              0.77
  
  7
  **Employee
        Stock Purchase Plan**
 
 The
        Company has an ESPP to provide employees of the Company with an opportunity
        to
        purchase common stock of the Company through accumulated payroll deductions.
        The
        plan allows eligible employees to purchase shares of the Company’s common stock
        through quarterly offering periods, commencing on each January 1, April 1,
        July
        1 and October 1. The option price for each share of common stock purchased
        equals 90% of the last quoted sales price of a share of the Company’s common
        stock as reported by the NASDAQ National Market on the first day of the
        quarterly offering period or the last day of the quarterly offering period,
        whichever is lower. The Company has reserved 500,000 shares of common stock
        held
        in treasury for issuance under the plan. The plan will terminate on July
        1,
        2007, unless sooner terminated by the Board of Directors.
 
 The
        fair
        value of each option for shares issued under the ESPP during the six months
        ended June 30, 2006 and 2005 is estimated on the date of grant based on the
        Black-Scholes option pricing model with the following assumptions: weighted
        average risk-free rates of return of 4.4% and 2.6%, respectively, weighted
        average volatility factors of 23.1% and 32.2%, respectively, and expected
        life
        of three months. The weighted average fair value of those purchase rights
        granted during the six months ended June 30, 2006 and 2005 was $4.77 and
        $4.88,
        respectively.
 
 The
        Company calculates the volatility factor for those options issued under the
        ESPP
        based on the volatility of the Company’s common stock during the most recent
        three-month period. The expected term of share options granted represents
        the
        period of time that share options granted are expected to be outstanding.
        The
        risk-free rate for the period within the contractual term of the share option
        is
        based on the U.S. Treasury yield curve in effect at the time of
        grant.
 
 **Stock
        Incentive Plans**
 
 The
        Company maintains an employee stock option plan for its key employees. The
        Company had reserved 415,041 shares of common stock for issuance under the
        plan.
        These options vested in equal installments over a five-year period. The options
        will expire on the earlier of the tenth anniversary of the date of grant
        or 30
        days after the date of termination of the employee’s employment with the
        Company. This plan is dormant, and no future issuances are authorized from
        this
        plan.
 
 The
        Company maintains a stock incentive plan, under which options could be granted
        to purchase up to 2,300,000 shares of common stock to executives or key
        employees of the Company. Some of the options that were granted vested
        immediately, and the rest vest over a five-year period. These options expire
        on
        the tenth anniversary of the date of grant or 90 days after the date of
        termination of the employee’s employment with the Company. Under this plan,
        cancelled options revert back into the plan. This plan became dormant in
        2005
        upon the approval of the 2005 Stock Incentive Plan, as discussed below. No
        future issuances are authorized from this plan.
   
  8
  The
        Company also maintains an omnibus stock plan, under which the Company had
        400,000 shares of its common stock reserved for issuance. This plan is dormant,
        and no future issuances are authorized from this plan.
 
 During
        2005, a stock incentive plan was approved by the Company’s stockholders. Under
        this plan, restricted stock awards or options to purchase stock may be granted
        for up to 1,200,000 shares of common stock to executives or key employees
        of the
        Company. Options granted may vest immediately or over a five-year period.
        These
        options expire on the tenth anniversary of the date of grant or 90 days after
        the date of termination of the employee’s employment with the Company. Under
        this plan, cancelled options revert back into the plan and are available
        for
        future issuances.
 
 The
        fair
        value of stock options granted under the stock incentive plans during the
        six
        months ended June 30, 2006 and 2005 is estimated on the date of grant based
        on
        the Black-Scholes option pricing model that assumes, among other things,
        no
        dividend yield, weighted average risk-free rates of return of 4.6% and 4.2%,
        respectively, weighted average volatility factors of 54.5% and 54.6%,
        respectively, and expected life of seven years.
 
 The
        Company calculates the expected volatility factor for those options issued
        under
        the stock incentive plan to correspond with the average volatility factor
        of
        those companies included in a peer group study conducted by a third-party
        on
        behalf of the Company. The historical stock price movements of the Company’s
        common stock are not considered to be a good indicator of expected future
        volatility because the Company’s business has changed significantly as a result
        of acquisitions completed. However, the Company continues to monitor its
        actual
        volatility to assess whether the peer group volatility remains appropriate
        and
        updates the peer group study at least annually.
 
 The
        Company uses historical data to estimate share option exercise and employee
        departure behavior used in the Black-Scholes option pricing model. The expected
        term of share options granted represents the period of time that share options
        granted are expected to be outstanding based upon historical experience.
        The
        risk-free rate for the period within the contractual term of the share option
        is
        based on the U.S. Treasury yield curve in effect at the time of
        grant.
 
 A
        summary
        of stock option activity for the Company’s stock incentive plans for the six
        months ended June 30, 2006 is as follows:
 
 **Number
                  of Shares**
              
              
              **Weighted
                  Average Exercise Price**
              
              
              **Weighted
                  Average Remaining Contractual Life**
              
              
              **Aggregate
                  Intrinsic Value (000)**Outstanding
                  at beginning of the year
              
              
              1,562,842
              
              $
              16.14Changes
                  during the period:Granted
              
              
              253,730
              
              $
              35.71Exercised
              
              
              176,450
              
              $
              11.72Cancelled
              
              
              32,890
              
              $
              27.43Outstanding
                  at end of period
              
              
              1,607,232
              
              $
              19.49
              
              
              6.7
              
              $
              27,889Exercisable
                  at end of period
              
              
              814,524
              
              $
              11.86
              
              
              5.3
              
              $
              20,346
  
  9
  The
        weighted average fair value of options granted under the Company’s stock
        incentive plans for the six months ended June 30, 2006 and 2005 was $21.48
        and
        $18.65 per share, respectively. The total intrinsic value of options exercised
        during the six months ended June 30, 2006 and 2005 was $4.5 million and $4.6
        million, respectively.
 
 As
        of
        June 30, 2006, there was $12.1 million of total unrecognized compensation
        cost
        related to nonvested stock-based compensation arrangements granted under
        the
        Company’s stock incentive plans. That cost is expected to be recognized over a
        weighted average period of 2.8 years. The total fair value of options vested
        during the six months ended June 30, 2006 was $2.8 million.
 
 **Note
        3 - Goodwill and Intangible Assets**
 
 The
        change in carrying value of goodwill by reporting unit for the six months
        ended
        June 30, 2006 is shown below:
 
 (in
        thousands)
 
 **North
                  America**
              
              
              
              **International**
              
              
              
              **Total**Balance
                  at January 1, 2006
              
              $
              240,130
              
              
              $
              13,441
              
              
              $
              253,571Other
                  adjustments
              
              
              (523
              )
              
              
              703
              
              
              
              180Balance
                  at June 30, 2006
              
              $
              239,607
              
              
              $
              14,144
              
              
              $
              253,751
 
 Adjustments
        made during the six months ended June 30, 2006 primarily relate to currency
        exchange rate changes, release of certain purchase accounting liabilities
        and
        other adjustments.
 
 The
        components of intangible assets, net are as follows:
 
 (in
        thousands)
 
 **June
                  30, 2006**
              
              
              **December
                  31, 2005****Gross
                  amount of amortizable intangible assets:**Customer
                  relationships
              
              $
              8,704
              
              $
              8,704Other
              
              
              3,262
              
              
              2,962$
              11,966
              
              $
              11,666**Accumulated
                  amortization of amortizable intangible assets:**Customer
                  relationships
              
              $
              380
              
              $
              275Other
              
              
              1,729
              
              
              1,204$
              2,109
              
              $
              1,479**Intangible
                  assets not subject to amortization:**Licenses
                  and trademarks
              
              $
              89,518
              
              $
              89,272Other
              
              
              152
              
              
              152$
              89,670
              
              $
              89,424**Total
                  intangible assets, net**
              
              $
              99,527
              
              $
              99,611
  
  10
  Other
        amortizable intangible assets consist primarily of patents, non-compete
        agreements, licenses and trademarks. Amortization expense of amortizable
        intangible assets for the year 2006 is estimated to be approximately $1.1
        million.
 
 **Note
        4 - Business Segments**
  The
        Company is a leading designer, producer and marketer of innovative, high-quality
        toys, collectibles, hobby and infant care products targeted to consumers
        of all
        ages.
 
 The
        Company’s reportable segments under SFAS No. 131, “Disclosure About Segments of
        an Enterprise and Related Information,” are North America and International. The
        North America segment includes the United States, Canada and Mexico. The
        International segment includes non-North America markets.
 
 Segment
        performance is measured at the operating income level. Segment assets are
        comprised of all assets, net of applicable reserves and allowances.
 
 Results
        are not necessarily those that would be achieved if each segment was an
        unaffiliated business enterprise. Information by segment and a reconciliation
        to
        reported amounts for the three months and six months ended June 30, 2006
        and
        2005 are as follows:
 
 **Three
                  Months Ended June 30,**(in
                  thousands)
              
              
              **2006**
              
              
              
              **2005****Net
                  sales:**North
                  America
              
              $
              90,775
              
              
              $
              93,868International
              
              
              22,129
              
              
              
              15,188Sales
                  and transfers between segments
              
              
              (197
              )
              
              
              (245
              )Combined
                  total
              
              $
              112,707
              
              
              $
              108,811**Operating
                  income:**North
                  America
              
              $
              10,108
              
              
              $
              12,822International
              
              
              5,093
              
              
              
              3,353Combined
                  total
              
              $
              15,201
              
              
              $
              16,175
 
 (in
                  thousands)
              
              
              **June
                  30, 2006**
              
              
              **December
                  31, 2005****Total
                  assets:**North
                  America
              
              $
              536,030
              
              $
              558,452International
              
              
              82,123
              
              
              71,284Combined
                  total
              
              $
              618,153
              
              $
              629,736
  
  11
  
 **Six
                  Months Ended June 30,**(in
                  thousands)
              
              
              **2006**
              
              
              
              **2005****Net
                  sales:**North
                  America
              
              $
              180,548
              
              
              $
              178,043International
              
              
              35,966
              
              
              
              27,886Sales
                  and transfers between segments
              
              
              (298
              )
              
              
              (629
              )Combined
                  total
              
              $
              216,216
              
              
              $
              205,300**Operating
                  income:**North
                  America
              
              $
              20,857
              
              
              $
              24,455International
              
              
              7,069
              
              
              
              5,187Combined
                  total
              
              $
              27,926
              
              
              $
              29,642
 
 Certain
        assets and resources are jointly used between the North America and
        International segments. Intercompany allocations of such uses are not
        made.
 
 Under
        the
        enterprise-wide disclosure requirements of SFAS No. 131, the Company reports
        net
        sales by product category and by distribution channel. The Company groups
        its
        products into three product categories: infant products, children’s toys and
        collectible products. The presentation is consistent with how the Company
        views
        its business. The following tables present consolidated net sales by product
        category and by distribution channel for the three months and six months
        ended
        June 30, 2006 and 2005:
 
 **Three
                  Months Ended June 30,**(in
                  thousands)
              
              
              **2006**
              
              
              **2005**Infant
                  products
              
              $
              42,450
              
              $
              38,586Children’s
                  toys
              
              
              47,368
              
              
              39,598Collectible
                  products
              
              
              22,889
              
              
              30,627Net
                  sales
              
              $
              112,707
              
              $
              108,811Chain
                  retailers
              
              $
              68,527
              
              $
              65,166Specialty
                  and hobby wholesalers
                and
                  retailers
              
              
              34,129
              
              
              31,319OEM
                  dealers
              
              
              6,493
              
              
              7,444Corporate
                  promotional
              
              
              3,211
              
              
              4,385Direct
                  to consumers
              
              
              347
              
              
              497Net
                  sales
              
              $
              112,707
              
              $
              108,811
  
  12
  
 **Six
                  Months Ended June 30,**(in
                  thousands)
              
              
              **2006**
              
              
              **2005**Infant
                  products
              
              $
              86,240
              
              $
              76,383Children’s
                  toys
              
              
              90,473
              
              
              73,578Collectible
                  products
              
              
              39,503
              
              
              55,339Net
                  sales
              
              $
              216,216
              
              $
              205,300Chain
                  retailers
              
              $
              141,076
              
              $
              125,311Specialty
                  and hobby wholesalers
                and
                  retailers
              
              
              58,343
              
              
              58,038OEM
                  dealers
              
              
              10,635
              
              
              13,816Corporate
                  promotional
              
              
              5,497
              
              
              6,932Direct
                  to consumers
              
              
              665
              
              
              1,203Net
                  sales
              
              $
              216,216
              
              $
              205,300
 
 **Note
        5 - Comprehensive Income**
 
 The
        Company reports comprehensive income in accordance with SFAS No. 130, "Reporting
        Comprehensive Income." SFAS No. 130 requires companies to report all changes
        in
        equity during a period, except those resulting from investment by owners
        and
        distributions to owners, in a financial statement for the period in which
        they
        are recognized. Comprehensive income for the six months ended June 30, 2006
        and 2005 is calculated as follows:
 
 (in
                  thousands)
              
              
              **2006**
              
              
              **2005**Net
                  income
              
              $
              16,625
              
              $
              17,591Other
                  comprehensive income (loss) - foreign currencytranslation
                  adjustments
              
              
              1,951
              
              
              (2,826
              )Comprehensive
                  income
              
              $
              18,576
              
              $
              14,765
 
 **Note
        6 - Common Stock**
 
 Authorized
        and outstanding shares and the par value of the Company's voting common stock
        are as follows:
 
 **Authorized**
              **Par**
              **Shares
                  Outstanding at**
              **Shares
                  Outstanding at****Shares**
              **Value**
              **June
                  30, 2006**
              **December
                  31, 2005**Voting
                  Common Stock
              28,000,000
              $0.01
              20,897,618
              20,717,954
 
 At
        December 31, 2005, the Company held 1,830,830 shares of its common stock
        in
        treasury. During the first half of 2006 and 2005, the Company sold a total
        of
        3,214 shares and 2,883 shares, respectively, out of treasury to Company
        employees under the ESPP for $101,755 and $82,486, respectively.
    13
  **Note
        7 - Debt**
 
 Upon
        the
        closing of the acquisition of The First Years Inc. (TFY) on September 15,
        2004,
        the Company entered into a new credit facility to replace its previous credit
        facility. The credit facility is comprised of an $85.0 million term loan
        and a
        $100.0 million revolving line of credit, both of which mature on September
        14,
        2008, 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
        facility. The remaining term loan and revolving line of credit bear interest,
        at
        the Company’s option, at a base rate or at a LIBOR rate plus applicable margin.
        The applicable margin is based on the Company’s ratio of consolidated debt to
        consolidated EBITDA (earnings before interest, taxes, depreciation and
        amortization) and varies between 1.00% and 1.75%. 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 line of credit. At June 30, 2006, the
        margin in effect was 1.00% for LIBOR loans, and the commitment fee in effect
        was
        0.30% per annum. Under the terms of this credit facility, the Company is
        required to comply with certain financial and non-financial covenants. Among
        other restrictions, the Company is restricted in its ability to pay dividends,
        incur additional debt and make acquisitions above certain amounts. The key
        financial covenants include minimum EBITDA and interest coverage and leverage
        ratios. The credit facility is secured by working capital assets and certain
        intangible assets. On June 30, 2006, the Company had $54.1 million outstanding
        on this credit facility and was in compliance with all covenants. ****
 
 During
        2005, the Company’s United Kingdom subsidiary entered into a line of credit with
        a bank for $8.0 million that was to expire on September 14, 2008. The line
        of
        credit bore interest at 1.15% over the LIBOR rate, and the total amount was
        secured by a guarantee of the Company. During the first half of 2006, all
        borrowings under the line of credit were repaid and the Company cancelled
        the
        availability thereunder.
 
 **Note
        8 - Net Income Per Share**
 
 The
        Company computes net income per share in accordance with SFAS No. 128, "Earnings
        Per Share." Under the provisions of SFAS No. 128, basic net income per share
        is
        computed by dividing net income for the period by the weighted average number
        of
        common shares outstanding during the period. Diluted net income per share
        is
        computed by dividing the net income for the period by the weighted average
        number of common and common equivalent shares outstanding during the period.
        Options to purchase 538,775 shares of common stock at prices between $29.94
        and
        $35.72 per share were outstanding during the three months and six months
        ended
        June 30, 2006, but were not included in the computation of diluted earnings
        per
        share because the options’ total assumed proceeds under the treasury stock
        method were anti-dilutive. Options to purchase 2,752 shares of common stock
        at
        prices between $33.84 and $34.65 per share were outstanding during the six
        months ended June 30, 2005, but were not included in the computation of diluted
        earnings per share because the options’ exercise price was greater than the
        average market price of common shares. ****
 
 **Note
        9 - Legal Proceedings**
 
 The
        Company has certain contingent liabilities resulting from litigation and
        claims
        incident to the ordinary course of business. Management believes that the
        probable resolution of such contingencies will not materially affect the
        financial position or the results of the Company's operations.
    14
  **Note
        10 - Use of Estimates**
 
 The
        preparation of the financial statements in conformity with U.S. generally
        accepted accounting principles requires management to make estimates and
        assumptions that affect the amounts reported in the financial statements
        and
        accompanying notes. Actual results could differ from those
        estimates.
 
 **Note
        11 - Reclassifications**
 
 Certain
        prior year amounts have been reclassified to conform to the current year
        presentation.
 
 **Note
        12 - Related Party Transactions**
 
 The
        Company purchased some of its finished goods during the first half of 2006
        and
        2005 from two companies in which a relative of a Company stockholder/director
        has ownership interests.
 
 **Note
        13 - Commitments and Contingencies**
 
 The
        Company leases office and warehouse/distribution space under various
        non-cancelable operating lease agreements, which expire through November
        30,
        2019.
 
 The
        Company markets a significant portion of its products under licenses from
        other
        parties. These licenses are limited in scope and duration and authorize the
        sale
        of specific licensed products generally on a nonexclusive basis. The Company
        has
        license agreements with entertainment publishing and media companies; automotive
        and truck manufacturers; agricultural, construction and outdoor sports vehicle
        and equipment manufacturers; major race sanctioning bodies; and race team
        owners, sponsors and drivers. The Company has more than 700 license agreements,
        with terms generally of two to three years. Many of the license agreements
        include minimum guaranteed royalty payments that the Company must pay whether
        or
        not it meets specified sales targets. The Company believes it either achieved
        its minimum guarantees or has accrued for the costs related to these guarantees
        for the six months ended June 30, 2006 and 2005.
 
 Effective
        January 1, 2006, the Company entered into a five-year supply agreement with
        one
        of its third-party, dedicated suppliers (the Supplier). Under this agreement,
        the Supplier agrees to manufacture the Company’s products exclusively, and the
        Company agrees to purchase a minimum of $20.4 million of product from the
        Supplier each year. The annual minimum purchase guarantee is subject to annual
        decreases based upon the Company’s overall annual purchases from all of its
        suppliers.
 
 In
        conjunction with the acquisition of TFY during the third quarter of 2004,
        the
        Company acquired purchase commitments with certain vendors relating to product
        and product components which are kept on hand to shorten lead times. In the
        event the Company chooses to discontinue the product, the Company would be
        required to reimburse the applicable vendor for the cost of the products
        and
        product components on hand. At June 30, 2006, the total commitment to these
        vendors was approximately $0.5 million.
    15
  **Note
        14 - Employee Benefit Plans**
 
 The
        Company maintains a funded, noncontributory defined benefit pension plan
        (the
        Plan) that covers a select group of the Company’s workforce covered by a
        collective bargaining agreement who were hired prior to January 1, 2002.
        The
        Plan provides defined retirement benefits based on the employees’ years of
        service.
 
 The
        components of net periodic benefit cost for the three months ended June 30,
        2006
        and 2005 are as follows:
 
 (in
                  thousands)
              
              
              **2006**
              
              
              
              **2005**Service
                  cost
              
              $
              26
              
              
              $
              27Interest
                  cost
              
              
              197
              
              
              
              192Expected
                  return on plan assets
              
              
              (245
              )
              
              
              (245
              )Amortization
                  of prior service costs
              
              
              5
              
              
              
              5Amortization
                  of net loss
              
              
              110
              
              
              
              93Net
                  periodic benefit cost
              
              $
              93
              
              
              $
              72
 
 The
        components of net periodic benefit cost for the six months ended June 30,
        2006
        and 2005 are as follows:
 
 (in
                  thousands)
              
              
              **2006**
              
              
              
              **2005**Service
                  cost
              
              $
              52
              
              
              $
              54Interest
                  cost
              
              
              394
              
              
              
              384Expected
                  return on plan assets
              
              
              (490
              )
              
              
              (490
              )Amortization
                  of prior service costs
              
              
              10
              
              
              
              10Amortization
                  of net loss
              
              
              220
              
              
              
              186Net
                  periodic benefit cost
              
              $
              186
              
              
              $
              144
 
 The
        Company did not make any contributions to the pension benefit plan during
        the
        six months ended June 30, 2006 and does not expect to make any contributions
        during the fiscal 2006 year.
 
 **Note
        15 - Meteor The Monster Truck Company, LLC**
 
 In
        July
        2005, the Company invested in Meteor The Monster Truck Company, LLC (Meteor).
        The Company initially contributed $0.8 million to Meteor, and after recovery
        of
        its capital contributions and preferred returns, the Company was to share
        in
        7.5% of the profits and losses of Meteor. In April 2006, an event occurred
        under
        the Company’s agreement with Meteor which triggered the Company’s obligation to
        make an additional investment in Meteor. During the second quarter of 2006,
        the
        Company contributed an additional $1.2 million which adjusted the Company’s
        share in the profits and losses of Meteor to 17.5%.
 
 The
        Company accounts for the investment in Meteor using the equity method of
        accounting. This determination was made based on the Company’s ability to
        exercise significant influence over the operating and financial policies
        of
        Meteor as a result of its representation on the board of directors. The
        investment in Meteor of $1.9 million and $0.7 million is included in other
        non-current assets on the accompanying condensed consolidated balance sheets
        at
        June 30, 2006 and December 31, 2005, respectively.
  
  16
  **Note
        16 - Subsequent Event**
 
 In
        July
        2006, the Company amended its credit facility. This amendment lowers the
        range
        of the applicable margin to 0.75% to 1.625% and the range of the commitment
        fee
        to 0.20% to 0.35%. Upon execution of the amendment, the applicable margin
        and
        commitment fee will be reduced to 0.75% and 0.20%, respectively. Additionally,
        EBITDA will be calculated as earnings before interest, taxes, depreciation,
        amortization and non-cash expense related to equity awards. The amendment
        to the
        credit facility also provides an additional $75.0 million of capacity under
        the
        revolving line of credit. This additional capacity is currently uncommitted
        by
        the lenders and must be approved by the lenders upon the Company’s request for
        borrowing.
 
 **Item
        2.    Management's
        Discussion and
        Analysisof Financial**
 **Condition
        and Results of Operations**
 
 The
        following is a discussion and analysis of the Company's financial condition,
        results of operations, liquidity and capital resources. The discussion and
        analysis should be read in conjunction with the Company's unaudited condensed
        consolidated financial statements and notes thereto included elsewhere
        herein.
 
 RESULTS
        OF OPERATIONS
  **Operating
        Highlights**
 
 Net
        sales
        for the quarter ended June 30, 2006 increased 3.6% primarily due to our *Bob
        the Builder, Thomas & Friends* and John
        Deere toy product lines, our John Deere and *Thomas
        & Friends* ride-on’s and our licensed Take & Toss toddler self-feeding system. Gross
        margin decreased to 47.9% for the second quarter of 2006 from 48.4% for the
        second quarter of 2005 primarily due to a less favorable product mix and
        higher
        product costs than that experienced in the second quarter of 2005. Selling,
        general and administrative expenses as a percentage of net sales increased
        to
        34.1% for the second quarter of 2006 from 33.5% for the second quarter of
        2005
        due to the inclusion of $1.1 million of compensation expense for stock options
        and $0.8 million of legal and settlement expenses for litigation involving
        The
        First Years Inc. (TFY) which preceded its acquisition by RC2. Operating income
        decreased to $15.2 million for the second quarter of 2006 compared to $16.2
        million for the second quarter of 2005. As a percentage of net sales, operating
        income decreased to 13.5% for the second quarter of 2006 from 14.9% for the
        second quarter of 2005.
 
 Net
        sales
        for the first half of 2006 increased 5.3% primarily due to our *Bob
        the Builder, Thomas & Friends* and John
        Deere toy product lines, our John Deere and *Thomas
        & Friends* ride-on’s and our new infant and toddler feeding products, including our new
        licensed Take & Toss toddler self-feeding system, our Lamaze infant play and
        certain other infant care and safety product lines. Gross margin decreased
        to
        47.2% for the first half of 2006 from 49.6% for the first half of 2005 primarily
        due to a more favorable product mix in 2005 and higher product costs and
        increased sales promotions in 2006. Selling, general and administrative expenses
        as a percentage of net sales decreased to 34.0% for the first half of 2006
        from
        35.1% for the first half of 2005. Operating income decreased to $27.9 million
        for the first half of 2006 compared to $29.6 million for the first half of
        2005
        due to the inclusion of $2.1 million of compensation expense for stock options
        and $1.0 million of legal and settlement expenses for litigation involving
        TFY
        which preceded its acquisition by RC2. As a percentage of net sales, operating
        income decreased to 12.9% for the first half of 2006 from 14.4% for the first
        half of 2005.
  
  17
  On
            January 1, 2006, the Company adopted SFAS No. 123R, “Share-Based Payment,” using
            the modified prospective method. This Statement is a revision of SFAS
            No. 123,
“Accounting for Stock-Based Compensation” and supersedes APB Opinion No. 25,
“Accounting for Stock Issued to Employees.” For periods ended prior to January
            1, 2006, pursuant to APB Opinion No. 25, no stock-based employee compensation
            expense was recognized by the Company and, under the modified prospective
            method
            pursuant to SFAS No. 123R, results for prior periods have not been restated.
            Selling, general and administrative expenses for the three months and
            the six
            months ended June 30, 2006 includes $1.1 million and $2.1 million, respectively,
            in compensation expense for stock options as a result of the Company’s adoption
            of SFAS No. 123R which negatively impacted diluted earnings per share
            by $0.03
            and $0.06, respectively. Results for the three months and six months
            ended June
            30, 2005 do not include compensation expense for stock
            options.
 
 As
        of
        June 30, 2006, there was $12.1 million of total unrecognized compensation
        cost
        related to nonvested stock-based compensation arrangements granted under
        the
        Company’s stock incentive plans. The cost is expected to be recognized over a
        weighted average period of 2.8 years. The total fair value of options vested
        during the six months ended June 30, 2006 was $2.8 million.
 
 **Three
        Months Ended June 30, 2006 Compared to Three Months Ended June 30,
        2005**
 
 *Net
        sales.* Net
        sales
        for the second quarter of 2006 increased $3.9 million, or 3.6%, to $112.7
        million from $108.8 million for the second quarter of 2005. Net sales increases
        occurred in our children’s toys and infant products categories, but these
        increases were partially offset by a decrease in our collectible products
        category.
 
 Net
        sales
        in our children’s toys category increased 19.6% primarily driven by *Bob
        the Builder* , *Thomas
        & Friends* and
        John
        Deere toy product lines as well as our John Deere and *Thomas
        & Friends* ride-on
        product lines. Net sales in our infant products category increased 10.0%
        primarily due to our new licensed Take & Toss toddler self-feeding system.
        Net sales in our collectible products category decreased 25.3% primarily
        due to
        continued softness in the collectibles market.
 
 *Gross
        profit.* Gross
        profit increased $1.3 million, or 2.5%, to $54.0 million for the second quarter
        of 2006 from $52.7 million for the second quarter of 2005. However, as a
        percentage of net sales, gross profit margin decreased to 47.9% in the second
        quarter of 2006 compared to 48.4% in the second quarter of 2005 primarily
        due to
        a less favorable product mix and higher product costs than that experienced
        in
        the second quarter of 2005. Our quarterly gross margins can be affected by
        the
        mix of product that is shipped during each quarter. Our infant products category
        has higher sales of non-licensed products that carry lower selling prices
        and
        gross margins than our children’s toys and collectible products categories.
        Additionally, individual product lines within a category carry gross margins
        that vary significantly and cause quarterly fluctuations, based on the timing
        of
        these individual shipments throughout the year. There were no major changes
        in
        the components of cost of sales.
 
 *Selling,
        general and administrative expenses.* Selling,
        general and administrative expenses increased $2.0 million, or 5.5%, to $38.4
        million for the second quarter of 2006 from $36.4 million for the second
        quarter
        of 2005. As a percentage of net sales, selling, general and administrative
        expenses increased to 34.1% for the second quarter of 2006 from 33.5% for
        the
        second quarter of 2005. Selling, general and administrative expenses for
        the
        second quarter of 2006 include $1.1 million of compensation expense for stock
        options and $0.8 million in expenses related to litigation involving TFY
        which
        preceded its acquisition by RC2. Results for the second quarter of 2005 do
        not
        include compensation expense for stock options.
 
 *Operating
        income.* Operating
        income decreased to $15.2 million for the second quarter of 2006 from $16.2
        million for the second quarter of 2005. As a percentage of net sales, operating
        income decreased to 13.5% in the second quarter of 2006 from 14.9% in the
        prior
        year second quarter.
    18
 
 *Net
        interest expense* .
        Net
        interest expense of $0.9 million for the second quarter of 2006 and $1.7
        million
        for the second quarter of 2005 relates primarily to bank term loans and lines
        of
        credit. The decrease in net interest expense was primarily due to the decrease
        in average outstanding debt balances offset slightly by higher interest rates.
 
 *Income
        tax.* Income
        tax expense for the second quarter of 2006 and 2005 includes provisions for
        federal, state and foreign income taxes at an effective rate of 36.9% and
        37.4%,
        respectively. The actual tax rate, including discrete items, for the second
        quarter of 2006 and 2005 is 36.2% and 33.7%, respectively. During the second
        quarter of 2005, the Company reduced its income tax accruals by approximately
        $0.7 million, or $0.03 per diluted share, due to the resolution of specific
        outstanding state and foreign tax issues.
 
 **Six
        Months Ended June 30, 2006 Compared to Six Months Ended June 30,
        2005**
 
 *Net
        sales.* Net
        sales
        for the first half of 2006 increased $10.9 million, or 5.3%, to $216.2 million
        from $205.3 million for the first half of 2005. Net sales increases occurred
        in
        our children’s toys and infant products categories, but these increases were
        partially offset by a decrease in our collectible products
        category.
 
 Net
        sales
        in our children’s toys category increased 23.0% primarily driven by *Bob
        the Builder* , *Thomas
        & Friends* and John
        Deere toy vehicle product lines as well as John Deere and *Thomas
        & Friends* ride-on
        product lines. Net sales in our infant products category increased 12.9%
        primarily due to our new feeding products including our new licensed Take
&
Toss toddler self-feeding system, our Lamaze infant play and certain infant
        care
        and safety product lines. Net sales in our collectible products category
        decreased 28.6% primarily due to continued softness in the collectibles
        market.
 
 *Gross
        profit.* Gross
        profit increased $0.2 million, or 0.2%, to $102.1 million for the first half
        of
        2006 from $101.9 million for the first half of 2005. However, as a percentage
        of
        net sales, the gross profit margin decreased to 47.2% in the first half of
        2006
        compared to 49.6% in the first half of 2005 primarily due to a more favorable
        product and sales mix in 2005 and higher product costs and increased sales
        promotions in 2006. There were no major changes in the components of cost
        of
        sales.
 
 *Selling,
        general and administrative expenses.* Selling,
        general and administrative expenses increased $1.5 million, or 2.1%, to $73.5
        million for the first half of 2006 from $72.0 million for the first half
        of
        2005. As a percentage of net sales, selling, general and administrative expenses
        decreased to 34.0% for the first half of 2006 from 35.1% for the first half
        of
        2005. Selling, general and administrative expenses for the first half of
        2006
        include $2.1 million of compensation expense for stock options and $1.0 million
        in expenses related to litigation involving TFY which preceded its acquisition
        by RC2. Results for the first half of 2005 do not include compensation expense
        for stock options.
 
 *Operating
        income.* Operating
        income decreased to $27.9 million for the first half of 2006 from $29.6 million
        for the first half of 2005. As a percentage of net sales, operating income
        decreased to 12.9% in the first half of 2006 from 14.4% in the first half
        of
        2005.
 
 *Net
        interest expense* .
        Net
        interest expense of $1.9 million for the first half of 2006 and $3.0 million
        for
        the first half of 2005 relates primarily to bank term loans and lines of
        credit.
        The decrease in net interest expense was primarily due to the decrease in
        average outstanding debt balances offset slightly by higher interest rates.
    19
  *Income
        tax.* Income
        tax expense for the first half of 2006 and 2005 includes provisions for federal,
        state and foreign income taxes at an effective rate of 36.9% and 37.4%,
        respectively. The actual tax rate, including discrete items, for the first
        half
        of 2006 and 2005 is 36.5% and 34.7%, respectively. During the second quarter
        of
        2005, the Company reduced its income tax accruals by approximately $0.7 million,
        or $0.03 per diluted share, due to the resolution of specific outstanding
        state
        and foreign tax issues.
 
 **Related
        Party Transactions**
 
 The
        Company purchased some of its finished goods during the first half of 2006
        and
        2005 from two companies in which a relative of a Company stockholder/director
        has ownership interests.
 
 LIQUIDITY
        AND CAPITAL RESOURCES
 
 The
        Company’s operations provided net cash of $23.3 million during the first half of
        2006. Accounts receivable decreased $31.7 million during the first half of
        2006
        and was the primary source of cash from operations. Inventory increased $27.1
        million and was the primary use of cash from operations. Capital expenditures
        for the first half of 2006 were $7.6 million, of which $5.3 million was for
        molds and tooling. Payments of outstanding debt under the Company’s credit
        facilities were $28.9 million for the first six months of 2006. Cash and
        cash
        equivalents decreased by $10.3 million during the first half of
        2006.
 
 Upon
        the
        closing of the acquisition of TFY on September 15, 2004, the Company entered
        into a new credit facility to replace its previous credit facility. The credit
        facility is comprised of an $85.0 million term loan and a $100.0 million
        revolving line of credit, both of which mature on September 14, 2008 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 facility. The
        remaining term loan and revolving line of credit bear interest, at the Company’s
        option, at a base rate or at a LIBOR rate plus applicable margin. The applicable
        margin is based on the Company’s ratio of consolidated debt to consolidated
        EBITDA (earnings before interest, taxes, depreciation and amortization) and
        varies between 1.00% and 1.75%. 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 line of credit. At June 30, 2006, the margin in effect was
        1.00% for LIBOR loans, and the commitment fee in effect was 0.30% per
        annum. Under the terms of this credit facility, the Company is required to
        comply with certain financial and non-financial covenants. Among other
        restrictions, the Company is restricted in its ability to pay dividends,
        incur
        additional debt and make acquisitions above certain amounts. The key financial
        covenants include minimum EBITDA and interest coverage and leverage ratios.
        The
        credit facility is secured by working capital assets and certain intangible
        assets. On June 30, 2006, the Company had $54.1 million outstanding on this
        credit facility and was in compliance with all covenants.
   
  20
  In
        July
        2006, the Company amended its credit facility. This amendment lowers the
        range
        of the applicable margin to 0.75% to 1.625% and the range of the commitment
        fee
        to 0.20% to 0.35%. Upon execution of the amendment, the applicable margin
        and
        commitment fee will be reduced to 0.75% and 0.20%, respectively. Additionally,
        EBITDA will be calculated as earnings before interest, taxes, depreciation,
        amortization and non-cash expense related to equity awards. The amendment
        to the
        credit facility also provides an additional $75.0 million of capacity under
        the
        revolving line of credit. This additional capacity is currently uncommitted
        by
        the lenders and must be approved by the lenders upon the Company’s request for
        borrowing.
 
 During
        2005, the Company’s United Kingdom subsidiary entered into a line of credit with
        a bank for $8.0 million that was to expire on September 14, 2008. The line
        of
        credit bore interest at 1.15% over the LIBOR rate, and the total amount was
        secured by a guarantee of the Company. During the first half of 2006, all
        borrowings under the line of credit were repaid and the Company cancelled
        the
        availability thereunder.
 
 During
        the first half of 2006, the Company made total payments of $18.3 million
        on its
        lines of credit and $10.6 million on its term loan. At June 30, 2006, the
        Company had $99.5 million available on its line of credit.
 
 The
        Company has met its working capital needs through funds generated from
        operations and available borrowings under our lines of credit. The Company’s
        working capital requirements fluctuate during the year based on the seasonality
        related to sales. Due to seasonal increases in demand for the Company’s
        products, working capital financing requirements are usually highest during
        the
        third and fourth quarters. The Company expects that capital expenditures
        during
        2006, principally for molds and tooling, will be approximately $16.0
        million.
 
 The
        Company believes that its cash flows from operations, cash on hand and available
        borrowings will be sufficient to meet its working capital and capital
        expenditure requirements and provide the Company with adequate liquidity
        to meet
        anticipated operating needs for 2006. However, if the Company’s capital
        requirements vary materially from those currently planned, the Company may
        require additional debt or equity financing. There can be no assurance that
        financing, if needed, would be available on terms acceptable to the Company,
        if
        at all.
 
 CRITICAL
        ACCOUNTING POLICIES AND ESTIMATES
 
 The
        Company makes certain estimates and assumptions that affect the reported
        amounts
        of assets and liabilities and the reported amounts of revenues and expenses.
        The
        accounting policies described below are those the Company considers critical
        in
        preparing its consolidated financial statements. These policies include
        significant estimates made by management using information available at the
        time
        the estimates are made. However, as described below, these estimates could
        change materially if different information or assumptions were used.
 
 *Allowance
        for Doubtful Accounts.* The
        allowance for doubtful accounts represents adjustments to customer trade
        accounts receivable for amounts deemed uncollectible. The allowance for doubtful
        accounts reduces gross trade receivables to their net realizable value. The
        Company's allowance is based on management's assessment of the business
        environment, customers' financial condition, historical trends, customer
        payment
        practices, receivable aging and customer disputes. The Company has purchased
        credit insurance that covers a portion of its receivables from major customers.
        The Company will continue to proactively review its credit risks and adjust
        its
        customer terms to reflect the current environment.
 
  21
  *Inventory.*
            Inventory, which consists of finished goods, has been written down for
            excess
            quantities and obsolescence, and is stated at lower of cost or market.
            Cost is
            determined by the first-in, first-out method and includes all costs necessary
            to
            bring inventory to its existing condition and location. Market represents
            the
            lower of replacement cost or estimated net realizable value. Inventory
            write-downs are recorded for damaged, obsolete, excess and slow-moving
            inventory. The Company's management uses estimates to record these write-downs
            based on its review of inventory by product category, length of time
            on hand and
            order bookings. Changes in public and consumer preferences and demand
            for
            product or changes in customer buying patterns and inventory management
            could
            impact the inventory valuation.
 
 *Impairment
        of Long-Lived Assets, Goodwill and Other Intangible Assets.* Long-lived assets have been reviewed for impairment based on Statement of
        Financial Accounting Standards (SFAS) No. 144, "Accounting for the Impairment
        of
        Long-Lived Assets and for Long-Lived Assets to be Disposed Of." This statement
        requires that an impairment loss be recognized whenever the carrying value
        of an
        asset exceeds the sum of the undiscounted cash flows expected to result from
        the
        use and eventual disposition of that asset, excluding future interest costs
        the
        entity would recognize as an expense when incurred. Goodwill and other
        intangible assets have been reviewed for impairment based on SFAS No. 142,
        "Goodwill and Other Intangible Assets." Under this Statement, goodwill and
        other
        intangible assets that have indefinite useful lives are not amortized, but
        rather tested at least annually for impairment. The Company's management
        reviews
        for indicators that might suggest an impairment loss could exist. Testing
        for
        impairment requires estimates of expected cash flows to be generated from
        the
        use of the assets. Various uncertainties, including changes in consumer
        preferences, deterioration in the political environment or changes in general
        economic conditions, could impact the expected cash flows to be generated
        by an
        asset or group of assets. Intangible assets that have finite useful lives
        are
        amortized over their useful lives.
 
 *Income
        Taxes.* The
        Company records current and deferred income tax assets and liabilities.
        Management considers all available evidence in evaluating the realizability
        of
        the deferred tax assets and records valuation allowances against its deferred
        tax assets as needed. Management believes it is more likely than not that
        the
        Company will generate sufficient taxable income in the appropriate carry-forward
        periods to realize the benefit of its deferred tax assets. In determining
        the
        required liability, management considers certain tax exposures and all available
        evidence. However, if the available evidence were to change in the future,
        an
        adjustment to the tax-related balances may be required. Estimates for such
        tax
        contingencies are classified in other non-current liabilities on the
        accompanying condensed consolidated balance sheets.
  
  22
  *Accrued
        Allowances.* The
        Company ordinarily accepts returns only for defective merchandise. In certain
        instances, where retailers are unable to resell the quantity of products
        that
        they have purchased from the Company, the Company may, in accordance with
        industry practice, assist retailers in selling excess inventory by offering
        credits and other price concessions, which are typically evaluated and issued
        annually. Other allowances can also be issued for defective merchandise,
        volume
        programs and co-op advertising. All allowances are accrued for throughout
        the
        year, as sales are recorded. The allowances are based on the terms of the
        various programs in effect; however, management also takes into consideration
        historical trends and specific customer and product information when making
        its
        estimates. For the volume programs, the Company generally sets a volume target
        for the year with each participating customer and issues the discount if
        the
        target is achieved. The allowance for the volume program is accrued throughout
        the year, and if it becomes clear to management that the target for the
        participating customer will not be reached, the Company will change the estimate
        for that customer as required. The Company’s products currently carry a limited
        warranty which guarantees the product to be free from defects in material
        and
        workmanship under normal and intended use for a period of 90 days from the
        date
        of consumer purchase. Historical results of these product warranties have
        shown
        that they have had an immaterial impact on the Company. Based upon the
        historical results, appropriate allowances for product warranty claims are
        accrued throughout the year.
 
 *Accrued
        Royalties.* Royalties
        are accrued based on the provisions in licensing agreements for amounts due
        on
        net sales during the period as well as management estimates for additional
        royalty exposures. Royalties vary by product category and are generally paid
        on
        a quarterly basis. Multiple royalties may be paid to various licensors on
        a
        single product. Royalty expense is included in selling, general and
        administrative expenses on the accompanying condensed consolidated statements
        of
        earnings.
 
 **Recently
        Issued Accounting Pronouncements**
 
 In
        June
        2006, the FASB issued FASB Interpretation 48, “Accounting for Uncertainty in
        Income Taxes - an interpretation of FASB Statement No. 109.” This Interpretation
        clarifies the accounting for uncertainty in income taxes recognized in an
        enterprise’s financial statements in accordance with FASB Statement No. 109,
“Accounting for Income Taxes.” This Interpretation prescribes a recognition
        threshold and measurement attribute for the financial statement recognition
        and
        measurement of a tax position taken or expected to be taken in a tax return.
        This Interpretation also provides guidance on derecognition, classification,
        interest and penalties, accounting in interim periods, disclosure, and
        transition. This Interpretation is effective for fiscal years beginning after
        December 15, 2006. The Company is evaluating the effect that this Interpretation
        will have on the Company’s financial statements.
 
  23
  FORWARD-LOOKING
        STATEMENTS
 
 Certain
        statements contained in this report are considered "forward-looking statements"
        within the meaning of the Private Securities Litigation Reform Act of 1995.
        These statements may be identified by the use of forward-looking words or
        phrases such as "anticipate," "believe," "could," "expect," "intend," "may,"
        "planned," "potential," "should," "will," "would" or the negative of those
        terms
        or other words of similar meaning. Such forward-looking statements are
        inherently subject to known and unknown risks and uncertainties. The Company's
        actual results and future developments could differ materially from the results
        or developments expressed in, or implied by, these forward-looking
        statements *.* Factors
        that may cause actual results to differ materially from those contemplated
        by
        such forward-looking statements include, but are not limited to, the following:
        the Company may not be able to manufacture, source and ship new and continuing
        products on a timely basis; the Company is dependent upon timely shipping
        of
        product and unloading of product through West Coast ports as well as timely
        rail/truck delivery to the Company's warehouse and/or customers' warehouses;
        increases in the cost of raw materials used to manufacture the Company’s
        products and increases in freight costs could increase the Company’s cost of
        sales and reduce the Company’s gross margins; currency exchange rate
        fluctuations, particularly in the Chinese Renminbi or the Hong Kong dollar,
        could increase the Company’s expenses; customers and consumers may not accept
        the Company's products at prices sufficient for the Company to profitably
        recover development, manufacturing, marketing, royalty and other costs; the
        inventory policies of retailers, together with increased reliance by retailers
        on quick response inventory management techniques, may increase the risk
        of
        underproduction of popular items, overproduction of less popular items and
        failure to achieve tight shipping schedules; competition in the markets for
        the
        Company's products may increase significantly; the Company is dependent upon
        continuing licensing arrangements with owners of popular and classic licensed
        properties such as *Thomas
        & Friends, Bob the Builder, Winnie the Pooh,* John
        Deere and *Sesame
        Street* ,
        vehicle
        manufacturers, agricultural equipment manufacturers, major race sanctioning
        bodies, race team owners, drivers, sponsors, agents and other licensors;
        the
        Company may experience unanticipated negative results of litigation; the
        Company
        relies upon a limited number of independently owned factories located in
        China
        to manufacture a significant portion of its vehicle replicas and certain
        other
        products; the Company is dependent upon the continuing willingness of leading
        retailers to purchase and provide shelf space for the Company's products;
        and
        general economic conditions in the Company's markets *.* Such
        uncertainties and other risks that may affect the Company’s performance are
        discussed further in Part I, Item 1A, “Risk Factors,” in the Company’s Form 10-K
        for the year ended December 31, 2005. The Company undertakes no obligation
        to
        make any revisions to the forward-looking statements contained in this report
        or
        to update them to reflect events or circumstances occurring after the date
        of
        this report.
  
  24
  **Item
        3.** **Quantitative
        and Qualitative Disclosures about
        Market Risk**
 
 The
        Company's exposure to market risk is limited to interest rate risk associated
        with the Company’s credit facilities and foreign currency exchange rate risk
        associated with the Company’s foreign operations.
 
 Based
        on
        the Company's interest rate exposure on variable rate borrowings at
        June 30, 2006, a one percentage point increase in average interest rates on
        the Company's borrowings would increase future interest expense by $23,851
        per
        month and a five percentage point increase would increase future interest
        expense by $0.1 million per month. The Company determined these amounts based
        on
        approximately $28.6 million of variable rate borrowings at June 30, 2006,
        multiplied by 1.0% and 5.0%, respectively, and divided by twelve. The Company
        is
        currently not using any interest rate collars, hedges or other derivative
        financial instruments to manage or reduce interest rate risk. As a result,
        any
        increase in interest rates on the Company's variable rate borrowings would
        increase interest expense and reduce net income.
 
 During
        July 2005, China revalued the Chinese Renminbi, abandoning the former method
        of
        pegging the Chinese Renminbi to the U.S. dollar. As expenses for the Company’s
        Chinese manufacturers are primarily denominated in Chinese Renminbi, a material
        increase in the value of the Chinese Renminbi relative to the U.S. dollar
        would
        increase the Company’s expenses and therefore could adversely affect the
        Company’s profitability.
 
 **Item
        4.  Controls and
        Procedures**
 
 As
        of the
        end of the period covered by this report, the Company carried out an evaluation,
        under the supervision and with the participation of the Company's management,
        including the Company's Chief Executive Officer and Chief Financial Officer,
        of
        the Company's disclosure controls and procedures (as defined in
        Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as
        amended). Based on this evaluation, the Company's Chief Executive Officer
        and
        Chief Financial Officer concluded that, as of the end of such period, the
        Company's disclosure controls and procedures were effective in recording,
        processing, summarizing and reporting, on a timely basis, information required
        to be disclosed by the Company in reports that the Company files with or
        submits
        to the Securities and Exchange Commission. It should be noted that in designing
        and evaluating the disclosure controls and procedures, management recognized
        that any controls and procedures, no matter how well designed and operated,
        can
        provide only reasonable assurance of achieving the desired control objectives,
        and management necessarily was required to apply its judgment in evaluating
        the
        cost-benefit relationship of possible controls and procedures. The Company
        has
        designed its disclosure controls and procedures to reach a level of reasonable
        assurance of achieving the desired control objectives and based on the
        evaluation described above, the Company's Chief Executive Officer and Chief
        Financial Officer concluded that the Company's disclosure controls and
        procedures were effective at reaching that level of reasonable
        assurance.
 
 There
        was
        no change in the Company's internal control over financial reporting (as
        defined
        in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934,
        as amended) during the Company's most recently completed fiscal quarter that
        has
        materially affected, or is reasonably likely to materially affect, the Company's
        internal control over financial reporting.
    25
  
 PART II.  OTHER
        INFORMATION
 
 **Item 1.** **Legal
        Proceedings.**
 
 The
        Company has certain contingent liabilities resulting from litigation and
        claims
        incident to the ordinary course of business. Management believes that the
        probable resolution of such contingencies will not materially affect the
        financial position or the results of the Company's operations.
 
 **Item
        1A.** **Risk
        Factors.**
 
 There
        have been no material changes from the risk factors previously disclosed
        in Part
        I, Item 1A, “Risk Factors,” of our Form 10-K for the year ended December 31,
        2005. Please refer to that section for disclosures regarding the risks and
        uncertainties relating to our business.
 
 **Item
        2.** **Unregistered
        Sales of Equity Securities and
        Use of Proceeds.**
 
 (a)
              Not
                  applicable.
 
 (b)
              Not
                  applicable.
 
 (c)
              Not
                  applicable.
 
 **Item
        3.** **Defaults
        Upon Senior
        Securities.**
 
 Not
        applicable.
 
 **Item
        4.    S** **ubmission
        of Matters to a Vote of Security
        Holders.**
 
 The
        annual meeting of stockholders of the Company was held on May 5, 2006. The
        only
        matter voted upon was the election of directors for the ensuing year. The
        number
        of votes cast for and withheld as to such matter were as follows:
 
 **FOR**
              **WITHHELD**Robert
                  E. Dods
              15,700,696
              4,184,910Boyd
                  L. Meyer
              15,379,110
              4,506,496Peter
                  K.K. Chung
              15,365,560
              4,520,046Curtis
                  W. Stoelting
              15,736,019
              4,149,587John
                  S. Bakalar
              19,285,519
              600,087John
                  J. Vosicky
              18,960,267
              925,339Paul
                  E. Purcell
              15,365,585
              4,520,021Daniel
                  M. Wright
              19,285,269
              600,337Thomas
                  M. Collinger
              18,263,566
              1,622,040Richard
                  E. Rothkopf
              15,690,687
              4,194,919Michael
                  J. Merriman, Jr.
              19,550,370
              335,236
 
 
  26
  **Item
        5.****Other
        Information.**
  Not
          applicable
 
 **Item
        6.** **Exhibits.**
 
 3.1
              Amended
                  and Restated Certificate of Incorporation of the Company (incorporated
                  by
                  reference to Exhibit 3.1 of the Company's Quarterly Report on Form
                  10-Q
                  for the quarter ended March 31, 2002 (File No. 0-22635) filed by
                  the
                  Company with the Securities and Exchange Commission on May 14,
                  2002).3.2
              First
                  Amendment to the Amended and Restated Certificate of Incorporation
                  of the
                  Company (incorporated by reference to Exhibit 3.2 of the Company's
                  Quarterly Report on Form 10-Q for the quarter ended March 31, 2002
                  (File
                  No. 0-22635) filed by the Company with the Securities and Exchange
                  Commission on May 14, 2002).3.3
              Certificate
                  of Ownership and Merger changing the Company's name to Racing Champions
                  Ertl Corporation (incorporated by reference to Exhibit 3.3 of the
                  Company's Quarterly Report on Form 10-Q for the quarter ended March
                  31,
                  2002 (File No. 0-22635) filed by the Company with the Securities
                  and
                  Exchange Commission on May 14, 2002).3.4
              Certificate
                  of Ownership and Merger changing the Company's name to RC2 Corporation
                  (incorporated by reference to Exhibit 3.4 of the Company's Quarterly
                  Report on Form 10-Q for the quarter ended March 31, 2003 (File
                  No.
                  0-22635) filed by the Company with the Securities and Exchange
                  Commission
                  on May 14, 2003).3.5
              Amended
                  and Restated By-Laws of the Company (incorporated by reference
                  to Exhibit
                  3.5 of the Company’s Quarterly Report on Form 10-Q for the quarter ended
                  March 31, 2004 (File No. 0-22635) filed by the Company with the
                  Securities
                  and Exchange Commission on May 10, 2004).31.1
              Certification
                  of Chief Executive
                  Officer pursuant to Section 302 of the Sarbanes-Oxley Act of
                  2002.31.2
              Certification
                  of Chief Financial
                  Officer pursuant to Section 302 of the Sarbanes-Oxley Act of
                  2002.32.1*
              Certification
                  of Chief Executive
                  Officer and Chief Financial Officer pursuant to 18 U.S.C. Section
                  1350
                  (Section 906 of the Sarbanes-Oxley Act of
                  2002).
 _______________________
 
 *This
                  certification is not "filed" for purposes of Section 18 of the
                  Securities
                  Exchange Act of 1934, as amended, or incorporated by reference
                  into any
                  filing under the Securities Act of 1933, as amended, or the Securities
                  Exchange Act of 1934, as
                  amended.
  27
  SIGNATURES
  Pursuant to the requirements of the Securities Exchange Act of 1934, the
        registrant has duly caused this report to be signed on its behalf by the
        undersigned thereunto duly authorized.
  Dated this 2nd day of August, 2006.
 
 RC2
        CORPORATION
 
 By /s/
        Curtis W.
        Stoelting
 Curtis
        W.
        Stoelting, Chief Executive Officer
 
 By /s/
        Jody L.
        Taylor
 Jody
        L.
        Taylor, Chief Financial Officer and Secretary
  
  28