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, 2007ORo
            TRANSITION
                REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
                OF 1934For
                the transition period from _______ to
                _________





Commission
      file
      number:  0-22635





RC2
                Corporation(Exact
                Name of Registrant as Specified in Its
                Charter)





Delaware
            
            36-4088307(State
                or other jurisdiction of incorporation or organization)
            
            (IRS
                Employer Identification No.)





1111
                West 22nd
                Street, Suite 320, Oak Brook, Illinois, 60523(Address
                of principal executive offices)





Registrant's
      telephone number, including area code: 630-573-7200





Indicate
      by check mark whether the Registrant (1) has filed all reports required to
      be filed by 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
        31, 2007, there were outstanding 21,247,696 shares of the Registrant's $0.01
        par
        value common stock.








RC2
      CORPORATION





FORM
      10-Q





JUNE
      30,
      2007





INDEX





PART
      I -
      FINANCIAL INFORMATION




PageItem
                1.
            Condensed
                Consolidated Balance Sheets as of June 30,
              2007
                and December 31, 2006
            3Condensed
                Consolidated Statements of Earnings for the Three
              Months
                and Six Months Ended June 30, 2007 and 2006
            4Condensed
                Consolidated Statements of Cash Flows for the
              Six
                Months Ended June 30, 2007 and 2006
            5Notes
                to Condensed Consolidated Financial Statements
            6Item
                2.
            Management's
                Discussion and Analysis of Financial Condition
              and
                Results of Operations
            19Item
                3.
            Quantitative
                and Qualitative Disclosures about Market Risk
            30Item
                4.
            Controls
                and Procedures
            30




PART
      II -
      OTHER INFORMATION




Item
                1.
            Legal
                Proceedings
            30Item
                1A.
            Risk
                Factors
            31Item
                2.
            Unregistered
                Sales of Equity Securities and Use of Proceeds
            32Item
                3.
            Defaults
                Upon Senior Securities
            33Item
                4.
            Submission
                of Matters to a Vote of Security Holders
            33Item
                5.
            Other
                Information
            33Item
                6.
            Exhibits
            33Signatures
            35





2




PART
      I.                     FINANCIAL
      INFORMATION







**Item
      1.  Financial Statements**





**RC2
      Corporation and Subsidiaries**


**Condensed
      Consolidated Balance Sheets**


**(Unaudited
      and in thousands)**


**June
                30,**
              **2007**
            
            **December
                31,****2006****Assets**Cash
                and cash equivalents
            
            $
            32,256
            
            
            $
            25,365Accounts
                receivable, net
            
            
            76,609
            
            
            
            112,937Inventory
            
            
            91,956
            
            
            
            83,650Other
                current assets
            
            
            14,753
            
            
            
            15,016Total
                current assets
            
            
            215,574
            
            
            
            236,968Property
                and equipment, net
            
            
            38,497
            
            
            
            38,991Goodwill
            
            
            244,495
            
            
            
            239,067Intangible
                assets, net
            
            
            96,089
            
            
            
            96,400Other
                non-current assets
            
            
            3,295
            
            
            
            3,214Total
                assets
            
            $
            597,950
            
            
            $
            614,640**Liabilities
                and stockholders’ equity**Accounts
                payable and accrued expenses
            
            $
            70,882
            
            
            $
            84,159Current
                maturities of bank term loans
            
            
            ---
            
            
            
            22,438Other
                current liabilities
            
            
            2,540
            
            
            
            768Total
                current liabilities
            
            
            73,422
            
            
            
            107,365Other
                non-current liabilities
            
            
            54,920
            
            
            
            55,349Total
                liabilities
            
            
            128,342
            
            
            
            162,714Stockholders’
                equity
            
            
            469,608
            
            
            
            451,926Total
                liabilities and stockholders' equity
            
            $
            597,950
            
            
            $
            614,640





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,****2007**
            
            
            **2006**
            
            
            **2007**
            
            
            **2006**Net
                sales
            
            $
            92,152
            
            
            $
            106,586
            
            
            $
            204,745
            
            
            $
            208,258Cost
                of sales
            
            
            54,409
            
            
            
            56,146
            
            
            
            116,540
            
            
            
            110,541Gross
                profit
            
            
            37,743
            
            
            
            50,440
            
            
            
            88,205
            
            
            
            97,717Selling,
                general and administrative expenses
            
            
            34,955
            
            
            
            36,646
            
            
            
            72,723
            
            
            
            70,762Amortization
                of intangible assets
            
            
            213
            
            
            
            315
            
            
            
            426
            
            
            
            630Operating
                income
            
            
            2,575
            
            
            
            13,479
            
            
            
            15,056
            
            
            
            26,325Interest
                (income) expense, net
            
            
            (150
            )
            
            
            856
            
            
            
            152
            
            
            
            1,871Other
                (income) expense
            
            
            (110
            )
            
            
            37
            
            
            
            (576
            )
            
            
            (118
            )Income
                from continuing operations
              before
                income taxes
            
            
            2,835
            
            
            
            12,586
            
            
            
            15,480
            
            
            
            24,572Income
                tax expense
            
            
            485
            
            
            
            4,538
            
            
            
            5,071
            
            
            
            8,958Income
                from continuing operations
            
            
            2,350
            
            
            
            8,048
            
            
            
            10,409
            
            
            
            15,614Income
                from discontinued operations, net of tax
            
            
            110
            
            
            
            1,087
            
            
            
            110
            
            
            
            1,011Net
                income
            
            $
            2,460
            
            
            $
            9,135
            
            
            $
            10,519
            
            
            $
            16,625Basic
                earnings per common share:Income
                from continuing
                operations
            
            $
            0.11
            
            
            $
            0.39
            
            
            $
            0.49
            
            
            $
            0.75Income
                from discontinued
                operations
            
            
            0.01
            
            
            
            0.05
            
            
            
            0.01
            
            
            
            0.05Net
                income
            
            $
            0.12
            
            
            $
            0.44
            
            
            $
            0.50
            
            
            $
            0.80Diluted
                earnings per common share:Income
                from continuing operations
            
            $
            0.11
            
            
            $
            0.38
            
            
            $
            0.48
            
            
            $
            0.73Income
                from discontinued operations
            
            
            ---
            
            
            
            0.05
            
            
            
            0.01
            
            
            
            0.05Net
                income per share
            
            $
            0.11
            
            
            $
            0.43
            
            
            $
            0.49
            
            
            $
            0.78Weighted
                average shares outstanding:Basic
            
            
            21,225
            
            
            
            20,863
            
            
            
            21,170
            
            
            
            20,807Diluted
            
            
            21,611
            
            
            
            21,347
            
            
            
            21,565
            
            
            
            21,313





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,****2007**
            
            
            **2006****Cash
                flows from operating activities**Net
                income
            
            $
            10,519
            
            
            $
            16,625Income
                from discontinued operations
            
            
            (110
            )
            
            
            (1,011
            )Depreciation
                and amortization
            
            
            7,665
            
            
            
            7,762Amortization
                and write-off of deferred financing costs
            
            
            382
            
            
            
            242Stock-based
                compensation
            
            
            2,349
            
            
            
            2,055Excess
                tax benefit on stock option exercises
            
            
            (953
            )
            
            
            (1,104
            )Gain
                on disposition of
                assets
            
            
            (85
            )
            
            
            (6
            )Changes
                in operating assets and liabilities
            
            
            18,324
            
            
            
            (44
            )Net
                cash provided by continuing operations
            
            
            38,091
            
            
            
            24,519Net
                cash provided by (used in) discontinued operations
            
            
            110
            
            
            
            (681
            )Net
                cash provided by operating activities
            
            
            38,201
            
            
            
            23,838**Cash
                flows from investing activities**Purchase
                of property and equipment
            
            
            (5,883
            )
            
            
            (7,597
            )Proceeds from disposition of property and equipment
            
            
            12
            
            
            
            18Decrease (increase) in other non-current assets
            
            
            16
            
            
            
            (56
            )Purchase
                of the Compass Business, net of cash acquired
            
            
            (6,761
            )
            
            
            ---Proceeds
                from sale of discontinued operations
            
            
            110
            
            
            
            ---Investments
            
            
            47
            
            
            
            (1,214
            )Net
                cash used in
                continuing operations
            
            
            (12,459
            )
            
            
            (8,849
            )Net
                cash used in discontinued operations
            
            
            ---
            
            
            
            (5
            )Net
                cash used in investing activities
            
            
            (12,459
            )
            
            
            (8,854
            )**Cash
                flows from financing activities**Payments
                to bank on lines of credit
            
            
            ---
            
            
            
            (18,270
            )Payments
                to bank on term loans
            
            
            (22,438
            )
            
            
            (10,625
            )Issuance
                of common stock upon option exercises
            
            
            1,924
            
            
            
            2,067Excess
                tax benefit on stock option exercises
            
            
            953
            
            
            
            1,104Purchase
                of treasury stock
            
            
            (140
            )
            
            
            ---Issuance
                of common stock for ESPP
            
            
            95
            
            
            
            102Net
                cash used in continuing
                operations
            
            
            (19,606
            )
            
            
            (25,622
            )Net
                cash used in discontinued operations
            
            
            ---
            
            
            
            ---Net
                cash used in financing activities
            
            
            (19,606
            )
            
            
            (25,622
            )Effect
                of exchange rate changes on cash
            
            
            755
            
            
            
            313Net
                increase (decrease) in cash and cash equivalents
            
            
            6,891
            
            
            
            (10,325
            )Cash
                and cash equivalents, beginning of year
            
            
            25,365
            
            
            
            25,262Cash
                and cash equivalents, end of period
            
            $
            32,256
            
            
            $
            14,937Supplemental
                information:Cash
                flows during the period for:Interest
                paid
            
            $
            248
            
            
            $
            2,096Income
                taxes paid
            
            $
            8,131
            
            
            $
            14,752Income tax refunds received
            
            $
            838
            
            
            $
            384


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, 2007, the results
      of
      its operations for the three-month and six-month periods ended June 30, 2007
      and
      2006, and its cash flows for the six-month periods ended June 30, 2007 and
      2006.





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, 2006.  The condensed consolidated balance sheet
      information as of December 31, 2006 appearing herein is derived from the
      consolidated balance sheet in the Form 10-K.





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





**Note
      2 – Business Combination**





On
      May
      24, 2007, we acquired substantially all of the assets of Angels Landing, Inc.
      (Angels Landing), a privately-held, start-up developer and marketer of infant
      and toddler travel gear under the Compass brand name (the Compass Business)
      based in Kings Mills, Ohio.  Closing consideration consisted of $6.9
      million of cash, excluding transaction expenses, and includes $0.3 million
      which
      may be earned in the transaction by Angels Landing if gross sales relating
      to
      the Compass Business in 2008 exceed a certain target.  The transaction
      has been accounted for under the purchase method of accounting, and accordingly,
      the operating results of the Compass Business have been included in our
      condensed consolidated financial statements since the effective date of the
      acquisition.  The excess of the aggregate purchase price over the fair
      market value of net assets acquired of $5.0 million has been recorded as
      goodwill in the accompanying condensed consolidated balance sheet at June 30,
      2007.





6


The
      purchase price was allocated to the net assets of Angels Landing based on their
      estimated relative fair values on May 24, 2007, as follows:





(in
      thousands)





Total
                purchase price, including expenses, net of cash acquired
            
            
            
            
            $
            6,761Less:Current
                assets
            
            $
            1,399Property,
                plant and equipment
            
            
            838Liabilities
            
            
            (484
            )
            
            
            (1,753
            )Excess
                of purchase price over net assets acquired
            
            
            
            
            
            $
            5,008





The
      allocation of purchase price is subject to final adjustment based on valuations
      and other determinations that will be completed as soon as practical but no
      later than by the end of the second quarter of 2008 including performing
      valuations to finalize the fair value of any acquired identifiable intangible
      assets.  To the extent such assets are amortizable, amortization
      expense will be increased.  The unaudited pro forma condensed
      consolidated results of operations for the Compass Business are not presented
      due to the immateriality of the results of operations.





**Note
      3 – Business Segments**





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





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





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





7


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, 2007 and 2006 are as follows:





**Three
                Months Ended June 30,**(in
                thousands)
            
            **2007**
            
            
            **2006****Net
                sales:**North
                America
            
            $
            70,847
            
            
            $
            84,655International
            
            
            21,476
            
            
            
            22,129Sales
                and transfers between segments
            
            
            (171
            )
            
            
            (198
            )Combined
                total
            
            $
            92,152
            
            
            $
            106,586**Operating
                income:**North
                America
            
            $
            184
            
            
            $
            8,602International
            
            
            2,386
            
            
            
            4,877Sales
                and transfers between segments
            
            
            5
            
            
            
            ---Combined
                total
            
            $
            2,575
            
            
            $
            13,479






(in
                thousands)
            
            **June
                30,**
              **2007**
            
            **December
                31,****2006****Total
                assets:**North
                America
            
            $
            493,848
            
            
            $
            517,158International
            
            
            104,102
            
            
            
            97,482Combined
                total
            
            $
            597,950
            
            
            $
            614,640






**Six
                Months Ended June 30,**(in
                thousands)
            
            **2007**
            
            
            **2006****Net
                sales:**North
                America
            
            $
            161,437
            
            
            $
            172,592International
            
            
            43,644
            
            
            
            35,965Sales
                and transfers between segments
            
            
            (336
            )
            
            
            (299
            )Combined
                total
            
            $
            204,745
            
            
            $
            208,258**Operating
                income:**North
                America
            
            $
            9,470
            
            
            $
            19,596International
            
            
            5,575
            
            
            
            6,729Sales
                and transfers between segments
            
            
            11
            
            
            
            ---Combined
                total
            
            $
            15,056
            
            
            $
            26,325





8


Under
      the
      enterprise-wide disclosure requirements of SFAS No. 131, the Company reports
      net
      sales by product category and by distribution channel.  During the
      fourth quarter of 2006, the Company reclassified its product categories and
      distribution channels to be more closely aligned with its strategic direction
      and organization structure.  This presentation is consistent with how
      the Company views its business.  The Company groups its products into
      three product categories: infant and toddler products, preschool products and
      youth and adult products.  The following tables present consolidated
      net sales by product category and by distribution channel for the three months
      and six months ended June 30, 2007 and 2006:





**Three
                Months Ended June 30,**(in
                thousands)
            
            **2007**
            
            
            **2006**Infant
                and toddler products
            
            $
            44,080
            
            
            $
            42,579Preschool
                products
            
            
            30,801
            
            
            
            42,176Youth
                and adult products
            
            
            17,271
            
            
            
            21,831Net
                sales
            
            $
            92,152
            
            
            $
            106,586Chain
                retailers
            
            $
            62,149
            
            
            $
            68,708Specialty
                retailers, wholesales and OEM dealers
            
            
            25,587
            
            
            
            34,322Corporate
                promotional, direct to consumers and other
            
            
            4,416
            
            
            
            3,556Net
                sales
            
            $
            92,152
            
            
            $
            106,586





**Six
                Months Ended June 30,**(in
                thousands)
            
            **2007**
            
            
            **2006**Infant
                and toddler products
            
            $
            95,480
            
            
            $
            86,318Preschool
                products
            
            
            71,494
            
            
            
            80,007Youth
                and adult products
            
            
            37,771
            
            
            
            41,933Net
                sales
            
            $
            204,745
            
            
            $
            208,258Chain
                retailers
            
            $
            142,492
            
            
            $
            141,149Specialty
                retailers, wholesalers and OEM dealers
            
            
            55,625
            
            
            
            61,009Corporate
                promotional, direct to consumers and other
            
            
            6,628
            
            
            
            6,100Net
                sales
            
            $
            204,745
            
            
            $
            208,258





9


**Note
      4 – Goodwill and Intangible Assets**





The
      change in carrying value of goodwill by reporting unit for the six months ended
      June 30, 2007 is shown below:




(in
              thousands)
            
            **North
                America**
            
            
            **International**
            
            
            **Total**Balance
                at January 1, 2007
            
            $
            223,836
            
            
            $
            15,231
            
            
            $
            239,067Compass
                Business acquisition
            
            
            5,008
            
            
            
            ---
            
            
            
            5,008Other
                adjustments
            
            
            45
            
            
            
            375
            
            
            
            420Balance
                at June 30, 2007
            
            $
            228,889
            
            
            $
            15,606
            
            
            $
            244,495





Other
      adjustments made during the six months ended June 30, 2007 primarily relate
      to
      the adoption of FASB Interpretation (FIN) 48 (see Note 5 - Income Taxes) and
      currency exchange rate changes.





The
      components of intangible assets, net are as follows:







(in
              thousands)
            
            **June
                30,**
              **2007**
            
            **December
                31, 2006****Gross
                amount of amortizable intangible assets:**Customer
                relationships
            
            $
            8,363
            
            
            $
            8,363Other
            
            
            3,471
            
            
            
            3,47111,834
            
            
            
            11,834**Accumulated
                amortization of amortizable intangible assets:**Customer
                relationships
            
            
            586
            
            
            
            485Other
            
            
            2,468
            
            
            
            2,1433,054
            
            
            
            2,628**Intangible
                assets not subject to amortization:**Licenses
                and trademarks
            
            
            87,309
            
            
            
            87,194**Total
                intangible assets, net**
            
            $
            96,089
            
            
            $
            96,400





Other
      amortizable intangible assets consist primarily of patents, non-compete
      agreements and trademarks.  Amortization expense related to
      amortizable intangible assets for the year 2007 is estimated to be $0.8
      million.





10


**Note
      5 – Income Taxes**





Effective
      January 1, 2007, the Company adopted FIN 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 approach 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.  As a result of the Company’s
      adoption of FIN 48, the Company recognized a $0.7 million increase to reserves
      for uncertain tax positions.  This increase was accounted for as a
      $0.7 million adjustment to the beginning balance of retained earnings which
      is
      included in stockholders’ equity and an increase to goodwill on the accompanying
      condensed consolidated balance sheet at June 30, 2007 of less than $0.1
      million.  As of the date of the adoption, the Company had
      approximately $5.0 million of total gross unrecognized tax benefits of which
      $1.0 million is included in other current liabilities and $4.0 million is
      included in other non-current liabilities on the accompanying condensed
      consolidated balance sheet at June 30, 2007.  Approximately $4.1
      million of the total gross unrecognized tax benefits represents the amount
      that,
      if recognized, would affect the effective income tax rate in future
      periods.  The Company and its subsidiaries are subject to U.S. federal
      income tax as well as income tax of multiple state and foreign
      jurisdictions.  The Company has substantially concluded all U.S.
      federal income tax matters for years through 2002.  Substantially all
      material state and local and foreign income tax matters have been concluded
      for
      years through 2002.  U.S. federal income tax returns for 2003 through
      2006 are currently open for examination.  In the next twelve months,
      the Company expects to reduce the unrecognized tax positions reserve by
      approximately $1.3 million primarily due to the settlement of various state
      and
      international income tax audits and court cases.  The Company’s
      continuing practice is to recognize interest and/or penalties related to income
      tax matters in income tax expense.  The Company had $1.7 million
      accrued for interest and $0.9 million accrued for penalties as of January 1,
      2007.  As of June 30, 2007, the Company reversed $0.5 million of
      interest and penalties recorded at adoption due to the settlement of a tax
      position with a foreign taxing jurisdiction.





11


**Note
      6 – Debt**





Upon
      the
      closing of the acquisition of The First Years Inc. (TFY) on September 15, 2004,
      the Company entered into a new credit facility, which has subsequently been
      amended, to replace its previous credit facility.  The credit facility
      is comprised of an $85.0 million term loan and a $100.0 million revolving line
      of credit.  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 the
      first quarter of 2007, the term loan was repaid and the term loan is no longer
      available for borrowing.  The revolving line of credit is available
      until its maturity on September 14, 2008.   A portion of the term
      loan had an interest rate of 3.45% plus applicable margin through the first
      three years of the facility.  The remaining term loan bore and
      revolving line of credit bears interest, at the Company’s option, at a base rate
      or at a LIBOR rate plus applicable margin.  The applicable margin is
      based on the Company’s ratio of consolidated debt to consolidated EBITDA
      (earnings before interest, taxes, depreciation amortization and non-cash expense
      related to equity awards) and varies between 0.75% and 1.625%.  At
      June 30, 2007, the margin in effect was 0.75% for LIBOR loans.  The
      Company is also required to pay a commitment fee of 0.20% to 0.35% per annum
      on
      the average daily unused portion of the revolving line of credit.  At
      June 30, 2007, the commitment fee in effect was 0.20% per
      annum.  Under the terms of this credit facility, the Company is
      required to comply with certain financial and non-financial
      covenants.  Among other restrictions, the Company is restricted in its
      ability to pay dividends, incur additional debt and make acquisitions above
      certain amounts.  The key financial covenants include minimum EBITDA
      and interest coverage and leverage ratios.  The credit facility is
      secured by working capital assets and certain intangible assets.  On
      June 30, 2007, the Company had no outstanding borrowings on the revolving line
      of credit, and was in compliance with all covenants.





During
      the first half of 2007, the Company expensed $0.2 million of deferred financing
      fees in conjunction with the Company’s voluntary payment of the remaining
      balance of its term loan.  Write-offs of deferred financing fees are
      included in interest (income) expense, net in the accompanying condensed
      consolidated statement of earnings.





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
      7 – Commitments and Contingencies**





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





12


The
      Company markets a significant portion of its products under licenses from other
      parties. These licenses are limited in scope and duration and authorize the
      sale
      of specific licensed products generally on a nonexclusive basis. The Company
      has
      license agreements with, among others, entertainment, publishing and media
      companies, automotive and truck manufacturers, and agricultural and construction
      vehicle and equipment manufacturers.  The Company is a party to more
      than 500 license agreements, approximately 400 of which are actively used in
      the
      Company’s current product lines, 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, 2007
      and
      2006.





During
      the first quarter of 2007, the Company entered into a multi-year digital media
      agreement which requires monthly payments beginning June 1, 2007 through May
      31,
      2009.  The aggregate commitment under this agreement is $2.8
      million.





**Note
      8 – Legal Proceedings**





See
      Note
      18 – Recall of Certain *Thomas & Friends* Wooden Railway Toys for a
      description of certain putative class action lawsuits against the Company with
      respect to the products subject to the Recall.





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





**Note
      9 - Common Stock**





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





**Authorized**
            **Par**
            **Shares
                Outstanding**
            **Shares
                Outstanding at****Shares**
            **Value**
            **at
                June 30, 2007**
            **December
                31, 2006**Voting
                Common Stock
            28,000,000
            $0.01
            21,240,106
            21,052,038





At
      December 31, 2006, the Company held 1,824,221 shares of its common stock in
      treasury. During the first half of 2007 and 2006, the Company sold a total
      of
      2,831 shares and 3,214 shares, respectively, out of treasury to Company
      employees under the employee stock purchase plan (ESPP) for $0.1 million and
      $0.1 million, respectively.





13


In
      February 2007, the Company’s Board of Directors authorized the adoption of a
      program to repurchase up to $75.0 million of the Company’s common
      stock.  Shares may be repurchased from time to time in open market
      transactions or privately negotiated transactions at the Company’s discretion,
      subject to market conditions and other factors.  Shares repurchased by
      the Company will be held as treasury shares.  The program has
      initially been authorized for a period of one year, but may be extended beyond
      that period or may be suspended at any time.  During the second
      quarter of 2007, the Company repurchased 3,500 shares for $0.1 million under
      this program.





**Note
      10 – Stock-Based Payment Arrangements**





Effective
      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 Accounting Principles Board 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.





At
      June
      30, 2007, the Company has three stock incentive plans, two of which are dormant,
      and an ESPP.  Amounts recognized in the financial statements with
      respect to these stock-based payment arrangements for the three months and
      six
      months ended June 30, 2007 and 2006, are as follows:




**For
                the three months ended June 30,**(in
                thousands)
            
            **2007**
            
            
            **2006**Total
                expense recognized for stock-based payment plans
            
            $
            1,303
            
            
            $
            1,049Amount
                of related income tax benefit recognized in determining net
                income
            
            $
            483
            
            
            $
            389






**For
                the six months ended June 30,**(in
                thousands)
            
            **2007**
            
            
            **2006**Total
                expense recognized for stock-based payment plans
            
            $
            2,349
            
            
            $
            2,055Amount
                of related income tax benefit recognized in determining net
                income
            
            $
            872
            
            
            $
            762





Stock-based
      compensation expense is included in cost of sales and selling, general and
      administrative expenses in the accompanying condensed consolidated statements
      of
      earnings for the three months and six months ended June 30,
      2007.  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.





14


Restricted
      stock awards or options to purchase stock may be granted under the current
      stock
      incentive plan.  A summary of stock option activity for the Company’s
      stock incentive plans for the six months ended June 30, 2007 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
            
            
            1,412,201
            
            
            $
            20.15Changes
                during the period:Granted
            
            
            257,009
            
            
            
            39.12Exercised
            
            
            148,900
            
            
            
            12.92Cancelled
            
            
            800
            
            
            
            31.27Expired
            
            
            16,320
            
            
            
            9.84Outstanding
                at end of period
            
            
            1,503,190
            
            
            $
            24.22
            
            
            
            6.8
            
            
            $
            23,745Exercisable
                at end of period
            
            
            785,809
            
            
            $
            15.59
            
            
            
            5.3
            
            
            $
            19,199





The
      total
      fair value of options vested during the six months ended June 30, 2007 was
      $3.2
      million.  As of June 30, 2007, there was $12.7 million of total
      unrecognized compensation cost related to nonvested stock-based compensation
      arrangements granted under the Company’s stock incentive plans for stock
      options.  That cost is expected to be recognized over a weighted
      average period of 3.6 years.





Restricted
      stock awards require no payment from the grantee.  The related
      compensation cost of each award is calculated using the market price on the
      grant date or the market price on the last day of the reported period and is
      expensed equally over the vesting period which is generally over two to three
      years.  A summary of restricted stock awards for the Company’s stock
      incentive plan for the six months ended June 30, 2007 is as
      follows:





**Number
                of Shares**
            **Weighted
                Average**
              **Grant
                Date**
              **Fair
                Value**
            **Weighted
                Average Remaining**
              **Contractual
                Life**Unvested
                restricted stock awards at beginning of year
            ---
            $      ---Changes
                during the period:Granted
            39,837
            41.31Vested
            4,195
            40.57Unvested
                restricted stock awards at end of period
            35,642
            $
                41.40
            2.6





As
      of
      June 30, 2007, there was $1.4 million of total unrecognized compensation cost
      related to nonvested stock-based compensation arrangements granted under the
      Company’s stock incentive plans for restricted stock awards.  That
      cost is expected to be recognized over a weighted average period of 2.6
      years.





15


**Note
      11 – Related Party Transactions**





The
      Company purchased some of its finished goods during the first half of 2007
      and
      2006 from two companies in which relatives of a Company stockholder/director
      have ownership interests.





**Note
      12 – Employee Benefit Plans**





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





The
      components of net periodic benefit cost for the three months and six months
      ended June 30, 2007 and 2006 are as follows:





**For
                the three months ended June 30,**(in
                thousands)
            
            **2007**
            
            
            **2006**Service
                cost
            
            $
            27
            
            
            $
            26Interest
                cost
            
            
            205
            
            
            
            197Expected
                return on plan assets
            
            
            (253
            )
            
            
            (245
            )Amortization
                of prior service costs
            
            
            5
            
            
            
            5Amortization
                of net loss
            
            
            96
            
            
            
            110Net
                periodic benefit cost
            
            $
            80
            
            
            $
            93





**For
                the six months ended June 30,**(in
                thousands)
            
            **2007**
            
            
            **2006**Service
                cost
            
            $
            54
            
            
            $
            52Interest
                cost
            
            
            410
            
            
            
            394Expected
                return on plan assets
            
            
            (506
            )
            
            
            (490
            )Amortization
                of prior service costs
            
            
            10
            
            
            
            10Amortization
                of net loss
            
            
            192
            
            
            
            220Net
                periodic benefit cost
            
            $
            160
            
            
            $
            186





The
      Company did not make any contributions to the pension benefit plan during the
      six months ended June 30, 2007 and currently does not expect to make any
      contributions during the fiscal 2007 year.





**Note
      13 – Discontinued Operations**





On
      November 3, 2006, the Company announced the completion of the sale of RC2 South,
      Inc., its collectible trading card business, and substantially all of the assets
      related to its die-cast sports collectibles product line.  The sale of
      the Company’s trading card business and sports collectibles product line is
      consistent with the Company’s strategic focus to achieve sustainable organic
      growth and to concentrate its efforts on its higher growth infant and toddler
      products and preschool products categories.  The transaction was
      effective November 1, 2006, and the results of this sold business are presented
      as discontinued operations in the accompanying condensed consolidated statements
      of earnings and condensed consolidated statements of cash flows.  The
      sold business was primarily reported under the North America
      segment.


16


Net
      sales
      and income before income taxes generated by the sold business for the three
      months and six months ended June 30, 2006, were as follows:





(in
                thousands)
            
            **For
                the three months ended June 30, 2006**
            
            
            **For
                the six months ended June 30, 2006**Net
                sales
            
            $
            6,121
            
            
            $
            7,958Income
                before income taxes
            
            $
            1,722
            
            
            $
            1,603





A
      gain on
      the sale of $0.1 million, net of income tax benefit, was recognized on this
      transaction during the second quarter of 2007.  The gain is presented
      in income from discontinued operations, net of tax, on the accompanying
      condensed consolidated statements of earnings for the three months and the
      six
      months ended June 30, 2007.  This gain represents the final escrow
      payout which was received during the second quarter of 2007.  For tax
      purposes, this sale generated a pre-tax capital loss and a valuation allowance
      was established during the fourth quarter of 2006 because the Company does
      not
      believe recoverability of this amount is more likely than not.  The
      valuation allowance was reduced by less than $0.1 million during the second
      quarter of 2007 as a result of the gain recorded.





**Note
      14 – 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
      15 – Earnings Per Share**





The
      Company computes earnings per share in accordance with SFAS No. 128, "Earnings
      Per Share."  Under the provisions of SFAS No. 128, basic earnings 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 net income for the period by the
      weighted average number of common and common equivalent shares outstanding
      during the period.  Options to purchase 513,609 shares and 538,775
      shares of common stock were outstanding during the three months ended June
      30,
      2007 and 2006, respectively, but were not included in the computation of diluted
      earnings per share because the options were anti-dilutive.  Options to
      purchase 476,544 shares and 538,775 shares of common stock were outstanding
      during the six months ended June 30, 2007 and 2006, respectively, but were
      not
      included in the computation of diluted earnings per share because the options
      were anti-dilutive.





17


**Note
      16 – 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, 2007 and 2006 is calculated as follows:





(in
                thousands)
            
            **2007**
            
            
            **2006**Net
                income
            
            $
            10,519
            
            
            $
            16,625Other
                comprehensive income – foreign currencytranslation
                adjustments
            
            
            2,314
            
            
            
            1,951Comprehensive
                income
            
            $
            12,833
            
            
            $
            18,576





**Note
      17 – Reclassifications**





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





**Note
      18 – Recall of Certain *Thomas & Friends* Wooden Railway
      Toys**





On
      June
      13, 2007, the Company announced the voluntary recall (the Recall) of 26
      individual wooden railway vehicles and set components from the *Thomas &
Friends* Wooden Railway product line, after an internal investigation linked
      apparent excess levels of lead with a limited number of paint colors used at
      a
      single contract manufacturing facility which purchased paint from an independent
      supplier.  The Company recorded a charge of $4.0 million, net of tax,
      or $0.19 per diluted share, in the three months and six months ended June 30,
      2007 related to the Recall.  This charge is based on the latest
      estimates of retailer inventory returns and consumer product replacement costs
      as of the date of this filing.  The Company currently anticipates
      incremental professional service fees, air freight, returns and replacement
      processing, marketing and promotional costs related to the Recall totaling
      between $3.0 and $4.0 million, net of tax, in the second half of
      2007.  These charges include estimated defense costs relating to the
      class action lawsuits that have been filed against the Company described in
      the
      next paragraph.





Following
      the announcement of the Recall, twelve putative class action lawsuits have
      been
      filed against the Company in various U.S. District Courts with respect to the
      products subject to the Recall.  These lawsuits make various claims
      and seek (i) medical monitoring as a result of alleged exposure to lead in
      the
      products subject to the Recall, (ii) disgorgement of certain profits under
      common law unjust enrichment theories, and/or (iii) various remedies under
      claims of product liability, breach of warranty, negligence, unfair and
      deceptive trade practices under state law and violation of the federal Consumer
      Product Safety Act.  The Company intends to vigorously defend against
      these lawsuits, although no assurances can be given as to the outcome of these
      matters.  In view of the inherent difficulty of predicting the outcome
      of litigation, the Company cannot predict the outcome of these lawsuits and
      has
      not established any reserves for any potential liability relating to the
      lawsuits.  As described above, the Company does anticipate
      incurring estimated defense costs relating to these lawsuits in the second
      half of 2007.




18


**Item
      2.      Management's Discussion and Analysis of
      Financial**


**Condition
      and Results of Operations**





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





RESULTS
      OF OPERATIONS





**Operating
      Highlights**





Net
      sales
      for the three months ended June 30, 2007, decreased 13.5% primarily due to
      lower
      sales in our preschool and youth and adult products categories and include
      $3.3
      million of recall-related returns and allowances.  Gross margin
      decreased to 40.9% for the three months ended June 30, 2007, from 47.3% for
      the
      three months ended June 30, 2006, primarily due to a less favorable product
      mix
      and higher product costs than that experienced in the prior year and $4.1
      million of recall-related costs.  Selling, general and administrative
      expenses as a percentage of net sales increased to 38.0% for the three months
      ended June 30, 2007, from 34.3% for the three months ended June 30,
      2006.  Selling, general and administrative expenses for the three
      months ended June 30, 2007, include $2.2 million of recall-related
      costs.  Operating income decreased to $2.6 million for the three
      months ended June 30, 2007, compared with $13.5 million for the three months
      ended June 30, 2006.  Operating income for the three months ended June
      30, 2007, includes $6.4 million of recall-related costs.  As a
      percentage of net sales, operating income decreased to 2.8% for the three months
      ended June 30, 2007, from 12.7% for the three months ended June 30,
      2006.





Net
      sales
      for the six months ended June 30, 2007, decreased 1.7% primarily due to lower
      sales in our preschool and youth and adult products categories and include
      $3.3
      million of recall-related returns and allowances.  Gross margin
      decreased to 43.1% for the six months ended June 30, 2007, from 46.9% for the
      six months ended June 30, 2006, primarily due to a less favorable product mix
      and higher product costs than that experienced in the prior year and $4.1
      million of recall-related costs.  Selling, general and administrative
      expenses as a percentage of net sales increased to 35.5% for the six months
      ended June 30, 2007, from 34.0% for the six months ended June 30,
      2006.  Selling, general and administrative expenses for the six months
      ended June 30, 2007, include $2.2 million of recall-related
      costs.  Operating income decreased to $15.1 million for the six months
      ended June 30, 2007, compared with $26.3 million for the six months ended June
      30, 2006.  Operating income for the six months ended June 30, 2007,
      includes $6.4 million of recall-related costs.  As a percentage of net
      sales, operating income decreased to 7.4% for the six months ended June 30,
      2007, from 12.6% for the six months ended June 30, 2006.





19


On
      June
      13, 2007, the Company announced the voluntary recall (the Recall) of 26
      individual wooden railway vehicles and set components from the *Thomas &
Friends* Wooden Railway product line.  The Company recorded a
      charge of $4.0 million, net of tax, or $0.19 per diluted share, in the three
      months and six months ended June 30, 2007 related to the Recall.  The
      portion of this charge included in the North America and International segments
      is $3.1 million and $0.9 million, respectively.  This charge is based on
      the latest estimates of retailer inventory returns and consumer product
      replacement costs as of the date of this filing.  The Company
      currently anticipates incremental professional service fees, air freight,
      returns and replacement processing, marketing and promotional costs related
      to
      the Recall totaling between $3.0 and $4.0 million, net of tax, in the second
      half of 2007.  These charges include estimated defense costs relating
      to the class action lawsuits that have been filed against the
      Company.  The Recall may have a material adverse effect on our
      business and reputation, and may reduce our net sales and increase our costs
      in
      excess of the amounts currently anticipated.  See Part II, Item 1A,
“Risk Factors” for additional information.





On
      May
      24, 2007, the Company acquired substantially all of the assets of Angels
      Landing, Inc. (Angels Landing), a privately-held, start-up developer and
      marketer of infant and toddler travel gear under the Compass brand name (the
      Compass Business) based in Kings Mills, Ohio.  Closing consideration
      consisted of $6.9 million of cash, excluding transaction expenses, and
      includes $0.3 million which may be earned in the transaction by Angels Landing
      if gross sales relating to the Compass Business in 2008 exceed a certain
      target. The transaction has been accounted for under the purchase method of
      accounting, and accordingly, the operating results of the Compass Business
      have
      been included in our condensed consolidated financial statements since the
      effective date of the acquisition.  These results did not have a
      material impact on the three months or six months ended June 30,
      2007.





**Three
      Months Ended June 30, 2007, Compared to Three Months Ended June 30,
      2006**





*Net
      sales.*Net sales for the three months ended June 30, 2007,
      decreased $14.4 million, or 13.5%, to $92.2 million from $106.6 million for
      the
      three months ended June 30, 2006.





Net
      sales
      for the three months ended June 30, 2007, excluding $4.5 million in net sales
      of
      discontinued product lines and the $3.3 million of recall-related returns and
      allowances, were $91.0 million, a decrease of 6.9% when compared with net sales
      for the three months ended June 30, 2006, excluding $8.9 million in net sales
      of
      discontinued product lines, of $97.7 million.  Management believes
      that the presentation of these non-GAAP financial measures provides useful
      information to investors because this information may allow investors to better
      evaluate ongoing business performance and certain components of the Company's
      results.  A reconciliation to the nearest GAAP financial measure
      follows:




(in
                millions)
            
            **Net
                Sales**2007
                actual
            
            $
            92.2Deduct:
                discontinued product lines
            
            
            4.5Add:
                recall-related returns and allowances
            
            
            3.3$
            91.02006
                actual
            
            $
            106.6Deduct:
                discontinued product lines
            
            
            8.9$
            97.7





Net
      sales
      decreases occurred in our preschool products and youth and adult products
      categories, but these decreases were partially offset by an increase in our
      infant and toddler products category.







20


Net
      sales
      in our preschool products category decreased 27.0% primarily due to lower sales
      of our *Bob the Builder*, John Deere and *Thomas & Friends*
      toy product lines and ride-ons.  We expect the negative trends in
      ride-ons to continue during the remainder of 2007.  In addition,
      recall-related returns and allowances of $3.3 million negatively impacted the
      net sales in the preschool products category.  Excluding the $3.3
      million of recall-related returns and allowances, our preschool products
      category decreased 19.2%.  Net sales in our youth and adult products
      category decreased 20.6% primarily due to lower sales of discontinued
      products.  Excluding net sales related to the discontinued product
      lines, net sales in our youth and adult product category decreased
      1.5%.  Net sales in our infant and toddler category increased 3.5%
      primarily driven by our SoothieTM bottle
      feeding
      system, our American Red Cross health and wellness products marketed under
      our
      The First Years brand and the newly re-launched Lamaze infant development
      products.  Information in this paragraph regarding net sales in our
      preschool products category excluding recall-related returns and allowances
      and
      in our youth and adult products category excluding net sales related to
      discontinued product lines constitutes non-GAAP financial
      information.   Management believes that the presentation of these
      non-GAAP financial measures provides useful information to investors because
      this information may allow investors to better evaluate ongoing business
      performance and certain components of the Company's results.  A
      reconciliation to the nearest GAAP financial measure follows:





**Net
                Sales**(in
                millions)
            
            **2007**
            
            
            **2006**
            
            
            **Difference**
            
            
            **%
                Change**Preschool
                products actual
            
            $
            30.8
            
            
            $
            42.2
            
            
            $
            (11.4
            )
            
            
            (27.0
            )%Add:
                recall-related returns and allowances
            
            
            3.3
            
            
            
            ---
            
            
            
            (3.3
            )
            
            
            ---$
            34.1
            
            
            $
            42.2
            
            
            $
            (8.1
            )
            
            
            (19.2
            )%Youth
                and adult products actual
            
            $
            17.3
            
            
            $
            21.8
            
            
            $
            (4.5
            )
            
            
            (20.6
            )%Deduct:
                discontinued product lines
            
            
            4.5
            
            
            
            8.8
            
            
            
            (4.3
            )
            
            
            (48.9
            )$
            12.8
            
            
            $
            13.0
            
            
            $
            (0.2
            )
            
            
            (1.5
            )%





*Gross
      profit.*Gross profit decreased $12.7 million, or 25.2%, to $37.7
      million for the three months ended June 30, 2007, from $50.4 million for the
      three months ended June 30, 2006.  As a percentage of net sales, gross
      profit margin decreased to 40.9% in the three months ended June 30, 2007,
      compared with 47.3% in the three months ended June 30, 2006, primarily due
      to a
      less favorable product mix and higher product costs, especially the effect
      of
      increased China and raw material costs, particularly zinc, than that experienced
      in the prior year and $4.1 million of recall-related costs.  Our
      quarterly gross margins can be affected by the mix of product that is shipped
      during each quarter.  Our infant and toddler products category has
      higher sales of non-licensed products that carry lower selling prices and gross
      margins that vary significantly and cause quarterly fluctuations, based on
      the
      timing of these individual shipments throughout the year.  There were
      no major changes in the components of cost of sales.





*Selling,
      general and administrative expenses.*Selling, general and
      administrative expenses decreased $1.6 million, or 4.4%, to $35.0 million for
      the three months ended June 30, 2007, from $36.6 million for the three months
      ended June 30, 2006.  As a percentage of net sales, selling, general
      and administrative expenses increased to 38.0% for the three months ended June
      30, 2007, from 34.3% for the three months ended June 30,
      2006.  Selling, general and administrative expenses for the three
      months ended June 30, 2007, include $2.2 million of recall-related
      costs.





21


*Operating
      income.*Operating income decreased to $2.6 million for the three
      months ended June 30, 2007, from $13.5 million for the three months ended June
      30, 2006.  As a percentage of net sales, operating income decreased to
      2.8% in the three months ended June 30, 2007, from 12.7% in the three months
      ended June 30, 2006.  Operating income for the three months ended June
      30, 2007, were negatively impacted by $6.4 million of recall-related
      costs.





*Net
      interest expense*.  Net interest income of $0.2 million for the
      three months ended June 30, 2007, relates primarily to earnings on cash
      balances.  Net interest expense of $0.9 million for the three months
      ended June 30, 2006, relates primarily to bank term loans and lines of
      credit.  The favorable change in net interest (income) expense is
      primarily due to the absence of outstanding debt during the three months ended
      June 30, 2007.





*Income
      tax.*Income tax expense for the three months ended June 30, 2007
      and 2006, includes provisions for federal, state and foreign income taxes at
      an
      effective rate of 36.5% and 36.9%, respectively.  However, the tax
      rate, including discrete items, for the three months ended June 30, 2007 and
      2006 is 17.1% and 36.1%, respectively.  Additionally, during the three
      months ended June 30, 2007, the Company reversed $0.5 million, or $0.02 per
      diluted share, of interest and penalties recorded at the adoption of FASB
      Interpretation (FIN) 48 due to the settlement of a tax position with a foreign
      taxing jurisdiction.





**Six
      Months Ended June 30, 2007, Compared to Six Months Ended June 30,
      2006**





*Net
      sales.*Net sales for the six months ended June 30, 2007,
      decreased $3.6 million, or 1.7%, to $204.7 million from $208.3 million for
      the
      six months ended June 30, 2006.





Net
      sales
      for the six months ended June 30, 2007, excluding $10.4 million in net sales
      of
      discontinued product lines and the $3.3 million of recall-related returns and
      allowances, were $197.6 million, an increase of 2.9% when compared with net
      sales for the six months ended June 30, 2006, excluding $16.3 million in net
      sales of discontinued product lines, of $192.0 million.  Management
      believes that the presentation of these non-GAAP financial measures provides
      useful information to investors because this information may allow investors
      to
      better evaluate ongoing business performance and certain components of the
      Company's results.  A reconciliation to the nearest GAAP financial measure
      follows:





(in
                millions)
            
            **Net
                Sales**2007
                actual
            
            $
            204.7Deduct:
                discontinued product lines
            
            
            10.4Add:
                recall-related returns and allowances
            
            
            3.3$
            197.62006
                actual
            
            $
            208.3Deduct:
                discontinued product lines
            
            
            16.3$
            192.0





Net
      sales
      decreases occurred in our preschool products and youth and adult products
      categories, but these decreases were partially offset by an increase in our
      infant and toddler products category.





22


Net
      sales
      in our preschool products category decreased 10.6% primarily due to lower sales
      of our John Deere and *Thomas & Friends* toy product lines and
      ride-ons.  We expect the negative trends in ride-ons to continue
      during the remainder of 2007.  In addition, recall-related returns and
      allowances of $3.3 million negatively impacted the net sales in the preschool
      products category.  Excluding the $3.3 million of recall-related
      returns and allowances, our preschool products category decreased
      6.5%.  Net sales in our youth and adult products category decreased
      9.8% primarily due to lower sales of discontinued products.  Excluding
      net sales related to the discontinued product lines, net sales in our youth
      and
      adult products category increased 6.2%.  Net sales in our infant and
      toddler products category increased 10.6% primarily driven by our Take &
Toss® toddler self-feeding system, our Soothie bottle feeding system, our
      American Red Cross health and wellness products marketed under our The First
      Years brand and the newly re-launched Lamaze infant development
      products.  Information in this paragraph regarding net sales in our
      preschool products category excluding recall-related returns and allowances
      and
      in our youth and adult products category excluding net sales related to
      discontinued product lines constitutes non-GAAP financial
      information.  Management believes that the presentation of these
      non-GAAP financial measures provides useful information to investors because
      this information may allow investors to better evaluate ongoing business
      performance and certain components of the Company's results.  A
      reconciliation to the nearest GAAP financial measure follows:





**Net
                Sales**(in
                millions)
            
            **2007**
            
            
            **2006**
            
            
            **Difference**
            
            
            **%
                Change**Preschool
                products actual
            
            $
            71.5
            
            
            $
            80.0
            
            
            $
            (8.5
            )
            
            
            (10.6
            )%Add:
                recall-related returns and allowances
            
            
            3.3
            
            
            
            ---
            
            
            
            (3.3
            )
            
            
            ---$
            74.8
            
            
            $
            80.0
            
            
            $
            (5.2
            )
            
            
            (6.5
            )%Youth
                and adult products actual
            
            $
            37.8
            
            
            $
            41.9
            
            
            $
            (4.1
            )
            
            
            (9.8
            )%Deduct:
                discontinued product lines
            
            
            10.4
            
            
            
            16.1
            
            
            
            (5.7
            )
            
            
            (35.4
            )$
            27.4
            
            
            $
            25.8
            
            
            $
            1.6
            
            
            
            6.2
            %





*Gross
      profit.*Gross profit decreased $9.5 million, or 9.7%, to $88.2
      million for the six months ended June 30, 2007, from $97.7 million for the
      six
      months ended June 30, 2006.  As a percentage of net sales, the gross
      profit margin decreased to 43.1% in the six months ended June 30, 2007, compared
      with 46.9% in the six months ended June 30, 2006, primarily due to a less
      favorable product mix and higher product costs, especially the effect of
      increased China and raw material costs, particularly zinc, than that experienced
      in the prior year and $4.1 million of recall-related costs.  There
      were no major changes in the components of cost of sales.





*Selling,
      general and administrative expenses.*Selling, general and
      administrative expenses increased $1.9 million, or 2.7%, to $72.7 million for
      the six months ended June 30, 2007, from $70.8 million for the six months ended
      June 30, 2006.  As a percentage of net sales, selling, general and
      administrative expenses increased to 35.5% for the six months ended June 30,
      2007, from 34.0% for the six months ended June 30, 2006.  Selling,
      general and administrative expenses for the six months ended June 30, 2007,
      include $2.2 million of recall-related costs.





23


*Operating
      income.*Operating income decreased to $15.1 million for the six
      months ended June 30, 2007, from $26.3 million for the six months ended June
      30,
      2006.  As a percentage of net sales, operating income decreased to
      7.4% in the six months ended June 30, 2007, from 12.6% in the six months ended
      June 30, 2006.  Operating income for the six months ended June 30,
      2007, were negatively impacted by $6.4 million of recall-related
      costs.





*Net
      interest expense*.  Net interest expense of $0.2 million for the
      six months ended June 30, 2007, and $1.9 million for the six months ended June
      30, 2006, 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 partially offset by the write-off
      of $0.2 million of deferred financing fees related to the Company’s voluntary
      payment of the remaining balance of its term loan.





*Income
      tax.*Income tax expense for the six months ended June 30, 2007
      and 2006, includes provisions for federal, state and foreign income taxes at
      an
      effective rate of 36.5% and 36.9%, respectively.  However, the tax
      rate, including discrete items, for the six months ended June 30, 2007 and
      2006,
      is 32.8% and 36.5%, respectively.  Additionally, during the three
      months ended June 30, 2007, the Company reversed $0.5 million, or $0.02 per
      diluted share, of interest and penalties recorded at the adoption of FIN 48
      due
      to the settlement of a tax position with a foreign taxing
      jurisdiction.





**Related
      Party Transactions**





The
      Company purchased some of its finished goods during the first half of 2007
      and
      2006 from two companies in which relatives of a Company stockholder/director
      have ownership interests.





LIQUIDITY
      AND CAPITAL RESOURCES





The
      Company’s operations provided net cash of $38.2 million during the six months
      ended June 30, 2007.  Accounts receivable decreased $38.9 million
      during the six months ended June 30, 2007, and was the primary source of cash
      from operations.  Inventory increased $6.7 million during the six
      months ended June 30, 2007.  Capital expenditures for the six months
      ended June 30, 2007, were $5.9 million, of which $4.2 million was for molds
      and
      tooling.  Payments of outstanding debt under the Company’s credit
      facilities were $22.4 million for the six months ended June 30, 2007, all of
      which were made on the Company’s term loan and resulted in the Company paying
      off its outstanding debt during the first quarter of 2007.  The
      Company also used $6.8 million of cash to purchase the Compass Business during
      the second quarter of 2007.  Cash and cash equivalents increased by $6.9
      million during the six months ended June 30, 2007.





24


Upon
      the
      closing of the acquisition of The First Years Inc. (TFY) on September 15, 2004,
      the Company entered into a new credit facility, which has subsequently been
      amended, to replace its previous credit facility.  The credit facility
      is comprised of an $85.0 million term loan and a $100.0 million revolving line
      of credit.  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 the
      first quarter of 2007, the term loan was repaid and the term loan is no longer
      available for borrowing.  The revolving line of credit is available
      until its maturity on September 14, 2008.  A portion of the term loan
      had an interest rate of 3.45% plus applicable margin through the first three
      years of the facility.  The remaining term loan bore and revolving
      line of credit bears interest, at the Company’s option, at a base rate or at a
      LIBOR rate plus applicable margin.  The applicable margin is based on
      the Company’s ratio of consolidated debt to consolidated EBITDA (earnings before
      interest, taxes, depreciation, amortization and non-cash expense related to
      equity awards) and varies between 0.75% and 1.625%.  At June 30, 2007,
      the margin in effect was 0.75% for LIBOR loans.  The Company is also
      required to pay a commitment fee of 0.20% to 0.35% per annum on the average
      daily unused portion of the revolving line of credit.  At June 30,
      2007, the commitment fee in effect was 0.20% per annum.  Under the
      terms of this credit facility, the Company is required to comply with certain
      financial and non-financial covenants.  Among other restrictions, the
      Company is restricted in its ability to pay dividends, incur additional debt
      and
      make acquisitions above certain amounts.  The key financial covenants
      include minimum EBITDA and interest coverage and leverage ratios.  The
      credit facility is secured by working capital assets and certain intangible
      assets.  On June 30, 2007, the Company had no outstanding borrowings
      on the revolving line of credit, and was in compliance with all
      covenants.  At June 30, 2007, the Company had $99.8 million available
      on its revolving line of credit due to letters of credit
      outstanding.





During
      the six months ended June 30, 2007, the Company expensed $0.2 million of
      deferred financing fees in conjunction with the Company’s voluntary payment of
      the remaining balance of its term loan.  Write-offs of deferred
      financing fees are included in interest (income) expense, net in the
      accompanying condensed consolidated statements of earnings.





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.





On
      February 22, 2007, the Company announced that its Board of Directors authorized
      a stock repurchase program to repurchase up to $75.0 million of the Company’s
      common stock.  The program has initially been authorized for a period
      of one year, but may be extended beyond that period or may be suspended at
      any
      time.  Repurchases may occur from time to time and are expected to be
      funded by cash flow from operations as well as borrowings on the Company's
      revolving line of credit.  During the six months ended June 30, 2007,
      the Company repurchased 3,500 shares for $0.1 million under this
      program.





In
      order
      to support its new product launches and to build consumer awareness of its
      owned
      brands, the Company is planning new investment spending of approximately $9.0
      million in 2007.  The Company estimates that $5.0 million to $7.0
      million of this amount will be expensed in 2007.  During the six
      months ended June 30, 2007, the Company spent $1.9 million, of which $0.8
      million has been expensed.  This spending will be focused on key
      strategic plan initiatives including on-line, digital and traditional consumer
      marketing and building and launching owned brands.


25





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 2007, principally for molds and tooling, will
      be approximately $13.0 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 2007.  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.





*Inventory.*  Inventory
      is recognized at the time title is transferred to the Company.  Title
      is transferred to the Company FOB shipping point.  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.





26


*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, except for those deferred tax assets for which
      an
      allowance has been provided.





Effective
      January 1, 2007, the Company adopted FIN 48, “Accounting for Uncertainty in
      Income Taxes – an interpretation of FASB Statement No.
      109.”  Management considers certain tax exposures and all available
      evidence when evaluating and estimating our tax positions and tax benefits,
      which may require periodic adjustments and which may not accurately anticipate
      actual outcomes.  If the available evidence were to change in the
      future, an adjustment to the tax-related balances may be
      required.  Estimates for such tax contingencies are classified in
      other current liabilities and other non-current liabilities on the accompanying
      condensed consolidated balance sheets.





27


*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.  In addition
      to regular allowances for defective merchandise which are recorded throughout
      the year, as sales are recorded, based on historical results, the Company may
      also establish an allowance for returns relating to a specific product or
      issue.  In connection with the Recall, the Company has established an
      allowance for returns of the affected products in the three months and six
      months ended June 30, 2007, based on the latest estimates of retailer
      inventory returns as well as consumer product replacement costs as of the date
      of this filing.





*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.





*Stock-based
      compensation.*  On January 1, 2006, the Company adopted SFAS No.
      123R, “Share-Based Payments.”  The Company elected to use the modified
      prospective application of SFAS No. 123R for awards issued prior to January
      1,
      2006.  Income from continuing operations before income taxes for the
      three months and six months ended June 30, 2007 and 2006, includes total expense
      recognized for all of the Company’s stock-based payment plans.





The
      fair
      value of stock options granted under the stock incentive plans is estimated
      on
      the date of grant based on the Black-Scholes option pricing
      model.  Prior to 2007, the Company calculated 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.  The historical stock price movements of the Company’s common
      stock had not been considered a good indicator of expected future volatility
      because the Company’s business had changed significantly as a result of
      acquisitions completed.  However, the Company continued to monitor its
      actual volatility to assess whether its historical stock price movements over
      the expected option term were a good indicator of expected future result and
      began using Company specific volatility in 2007.





28


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 the share options granted represents the
      period in 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.








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 risk that the charges and expenses the Company expects
      relating to the Recall may increase based on the amount of inventory of affected
      products at retailers, the amount of affected products that may be returned
      by
      consumers and the cost of providing replacement products to consumers and
      retailers; the outcome of the class action lawsuits that have been filed against
      the Company related to the Recall and the possibility of potential new claims
      or
      litigation; 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, Nickelodeon and *Sesame
      Street*,  vehicle manufacturers, agricultural equipment
      manufacturers 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,
      2006 and Part II, Item 1A, “Risk Factors,” below in this report.  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.





29


**Item
      3.     Quantitative and Qualitative Disclosures about Market
      Risk**





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





The
      Company repaid the term loan under its credit facility during the first quarter
      of 2007, and had no borrowings outstanding under its revolving line of credit
      as
      of June 30, 2007.  To the extent that the Company has future
      borrowings under its revolving line of credit, the Company will be subject
      to
      interest rate risk with respect to such borrowings.





The
        Company's net sales are primarily denominated in U.S. dollars, with
        approximately 20.0% of the Company's net sales during the six months ended
        June 30, 2007, denominated in British pounds sterling, Australian dollars,
        Euros or Canadian dollars.  The Company's purchases of finished
        goods from Chinese manufacturers are denominated in Hong Kong
        dollars.  The Hong Kong dollar is currently pegged to the U.S.
        dollar.  If the Hong Kong dollar ceased to be pegged to the U.S. dollar, a
        material increase in the value of the Hong Kong dollar relative to the U.S.
        dollar would increase our expenses, and therefore, could adversely affect
        our
        profitability.  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. 
The Company is also subject to exchange rate risk relating to transfers of
        funds
        denominated in British pounds sterling, Australian dollars, Canadian dollars
        or
        Euros from the Company's foreign subsidiaries to the United
        States.  Historically, the Company has not hedged its foreign currency
        risk.
  **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 Securitiesand 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.





PART II.     OTHER
      INFORMATION





**Item 1.      Legal
      Proceedings.**





On
      June
      13, 2007, the Company announced the voluntary recall (the Recall) of 26
      individual wooden railway vehicles and set components from the *Thomas &
Friends* Wooden Railway product line, after an internal investigation linked
      apparent excess levels of lead with a limited number of paint colors used at
      a
      single contract manufacturing facility which purchased paint from an independent
      supplier.


30


Following
      the announcement of the Recall, twelve putative class action lawsuits have
      been
      filed against the Company in various U.S. District Courts with respect to the
      products subject to the Recall.  These lawsuits make various claims
      and seek (i) medical monitoring as a result of alleged exposure to lead in
      the
      products subject to the Recall, (ii) disgorgement of certain profits under
      common law unjust enrichment theories, and/or (iii) various remedies under
      claims of product liability, breach of warranty, negligence, unfair and
      deceptive trade practices under state law and violating the federal Consumer
      Products Safety Act.  The Company intends to vigorously defend against
      these lawsuits, although no assurances can be given as to the outcome of these
      matters.





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





**Item
      1A.      Risk Factors**





Except
      as
      provided below, 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, 2006.  The information presented below
      updates and should be read in conjunction with the risk factors and information
      disclosed in that Form 10-K.





**The
      Recall relating to certain *Thomas & Friends* Wooden Railway products
      could increase our costs in excess of current estimates and could harm our
      reputation or otherwise reduce our net sales and
      profitability.**





The
      Company recorded a charge of $4.0 million, net of tax, or $0.19 per diluted
      share, in the three months and six months ended June 30, 2007, related
      to the Recall, based on the latest estimates of retailer inventory returns
      and
      consumer product replacement costs as of the date of this filing.  In
      addition, the Company currently anticipates incremental professional service
      fees, air freight, returns and replacement processing, marketing and promotional
      costs related to the Recall totaling between $3.0 million and $4.0 million,
      net
      of tax, in the second half of 2007.  Since these current and expected
      future charges are based on estimates, they may increase based on a number
      of
      factors, many of which are outside of the Company’s control, including the
      amount of inventory of affected products at retailers, the amount of affected
      products that may be returned by consumers and the cost of providing replacement
      products to consumers and retailers.  Any increase in the costs
      relating to the Recall would further reduce our net sales and
      profitability.  In addition, addressing the Recall and issues relating
      to the Recall will likely divert management’s attention and resources from our
      business.





The
      Recall may also harm our reputation and consumer acceptance of the affected
      products or our other products, which may have an adverse effect on our net
      sales.  The Recall may harm our relationships with our retail
      customers, including the willingness of those customers to purchase and provide
      shelf space for our products and to support retailer driven promotions and
      advertising for our products. The Recall may also harm our relationship with
      the
      licensor (the Licensor) who has granted the license under which we market the
      products affected by the Recall (the License).  The License, like most
      of our other licenses, gives the Licensor the right to terminate if we breach
      covenants relating to the safety of the products or their compliance with safety
      regulations.  Any termination of the License, or any adverse effect of
      the Recall on our relationship with the Licensor and the terms of our other
      licenses with the Licensor, may have a material adverse effect on our business
      and prospects and could reduce our profitability.





31


At
      June
      30, 2007, we have intangible assets not subject to amortization of $33.1 million
      relating to the License.  These intangible assets are not subject to
      amortization because they have indefinite useful lives.  As of the
      date of this report, we have determined that there is no impairment of these
      intangible assets or change to the indefinite useful lives.  However,
      we will continue to monitor these intangible assets for impairment or a change
      in the indefinite useful lives in light of the status of the Recall and related
      events, including the class action litigation.  Any impairment or
      change in the useful lives of the intangible assets would increase our expenses
      and reduce our profitability.





**We
      face class action lawsuits relating to the Recall that could require us to
      pay
      damages or settlement costs or otherwise harm our
      business.**





Following
      the announcement of the Recall, twelve putative class action lawsuits have
      been
      filed against the Company in various U.S. District Courts with respect to the
      products subject to the Recall.  These lawsuits make various claims
      and seek (i) medical monitoring as a result of alleged exposure to lead in
      the
      products subject to the Recall, (ii) disgorgement of certain profits under
      common law unjust enrichment theories, and/or (iii) various remedies under
      claims of product liability, breach of warranty, negligence, unfair and
      deceptive trade practices under state law and violating the federal Consumer
      Products Safety Act.  We are not currently able to estimate any amount
      of damages that we may be required to pay in connection with these
      lawsuits.  These lawsuits, which may be expected to continue for
      years, are currently in a very early stage and the Company has very little
      information as to the course they may take.  In view of the inherent
      difficulty of predicting the outcome of litigation, we cannot predict the
      outcome of these lawsuits and have not established any reserves for any
      potential liability relating to the lawsuits.  As described above, we
      do anticipate establishing a reserve for estimated defense costs relating to
      these lawsuits in the second half of 2007.  Any unfavorable outcomes
      in these lawsuits, resulting in the payment of substantial damages, could have
      a
      material adverse effect on our business and prospects and could reduce our
      profitability.  In addition, addressing these lawsuits will likely
      divert management’s attention and resources from our business.





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





(a)
            Not
                applicable.





(b)
            Not
                applicable.





(c)
            Issuer
                Purchases of Equity Securities





Period
            
            Total
                Number of Shares Purchased
            
            
            Average
                Price Paid Per Share
            
            
            Total
                Number of Shares Purchased As Part of Publicly Announced
                Program
            
            
            Maximum
                Dollar Value of Shares that May Yet be Purchased Under the Program
                (000s)April
                1, 2007 – April 30, 2007
            
            
            ---
            
            
            $
            ---
            
            
            
            ---
            
            
            $
            ---May
                1, 2007 – May 31, 2007
            
            
            ---
            
            
            
            ---
            
            
            
            ---
            
            
            
            ---June
                1, 2007 – June 30, 2007
            
            
            3,500
            
            
            
            40.03
            
            
            
            3,500
            
            
            
            74,860Total
            
            
            3,500
            
            
            $
            40.03
            
            
            
            3,500
            
            
            $
            74,860





32


On
      February 22, 2007, the Company
      announced that its Board of Directors authorized a stock repurchase program
      to
      repurchase up to $75.0 million of the Company’s common stock.  The
      program has initially been authorized for a period of one year, but may be
      extended beyond that period or may be suspended at any
      time.  Repurchases may occur from time to time and are expected to be
      funded by cash flow from operations as well as borrowings on the Company's
      revolving line of credit.





**Item
      3.    Defaults Upon Senior Securities.**





Not
      applicable.





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





Not
      applicable.





**Item
      5.    Other Information.**





Not
      applicable.





**Item
      6.    Exhibits.**




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





33


10.1
            Fourth
                Amendment and Waiver to Amended and Restated Credit Agreement, dated
                as of
                September
                29, 2006, among the Company, certain of its subsidiaries, Harris
                N.A., as
                lender and
                agent, and the other lenders named
                therein.




10.2
            Fifth
                Amendment to Amended and Restated Credit Agreement, dated as of June
                28,
                2007, among
                the Company, certain of its subsidiaries, Harris N.A., as lender
                and
                agent, and the other lenders named
                therein.




10.3
            Sixth
                Amendment to Amended and Restated Credit Agreement, effective as
                of June
                30, 2007, among the Company, certain of its subsidiaries, Harris
                N.A., as
                lender and agent, and the other agents named
                therein.




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.





34


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 7th day of August
      2007.





RC2
      CORPORATION





By  /s/
      Curtis W.
      Stoelting


Curtis W. Stoelting, Chi ef


Executive Officer








By
        /s/ Jody L.
      Taylor


Jody
      L.
      Taylor, Chief Financial


Officer
      and Secretary











35