SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C.  20549





FORM
10-K





[X]   Annual
Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
for the fiscal year ended December 31, 2009.





[   ]   Transition
Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
for 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 W. 22nd
      Street, Suite 320, Oak Brook, Illinois
            60523(Address of
      principal executive offices)
            (Zip
      Code)Registrant’s
      telephone number, including area code: 630-573-7200Securities
      registered pursuant to Section 12(b) of the Exchange Act:Title of each
      class
            Name of each
      exchange on which registeredCommon Stock, Par
      Value $0.01 Per Share
            The NASDAQ
      Stock Market




Securities
registered pursuant to Section 12(g) of the Exchange
Act:  None





Indicate
by check mark if the Registrant is a well-known seasoned issuer, as defined by
Rule 405 of the Securities Act.


Yes       No  X





Indicate
by check mark if the Registrant is not required to file reports pursuant to
Section 13 of 15(d) of the Exchange Act.


Yes      
No  X





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


Yes  X  
 No





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


Yes       No





Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best
of the Registrant’s knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]





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






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









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


Yes          No   X





Aggregate
market value of the Registrant’s common stock held by non-affiliates as of June
30, 2009 (the last business day of the Registrant’s most recently completed
second quarter): $222,614,012.  Shares of common stock held by any
executive officer or director of the Registrant have been excluded from this
computation because such persons may be deemed affiliates.  This
determination of affiliate status is not a conclusive determination for other
purposes.





Number of
shares of the Registrant’s common stock outstanding as of February 22, 2010:
21,386,970





DOCUMENTS
INCORPORATED BY REFERENCE





Portions
of the Proxy Statement for the 2010 Annual Meeting of the Stockholders of the
Registrant are incorporated by reference into Part III of this
report.





As used
in this report, the terms “we,” “us,” “our,” “RC2 Corporation,” “RC2” and the
“Company” mean RC2 Corporation and its subsidiaries, unless the context
indicates another meaning, and the term “common stock” means our common stock,
par value $0.01 per share.





Special
Note Regarding 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,” “hope,” “plan,” “potential,” “should,” “estimate,”
“predict,” “continue,” “future,” “will,” “would” or the negative of these terms
or other words of similar meaning.  Such forward-looking statements
are inherently subject to known and unknown risks and
uncertainties.  Our 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, those described under the caption
“Risk Factors” in Item 1A of this report.  We undertake no obligation
to make any revisions to the forward-looking statements contained in this filing
or to update them to reflect events or circumstances occurring after the date of
this filing.


Part
  I


Item
1.  Business





Overview





We are a
leading designer, producer and marketer of a broad range of innovative,
high-quality products for mothers, infants and toddlers, as well as
toys and collectible products sold to preschoolers, youths and
adults.  Our leadership position is measured by sales and brand
recognition.  Our mother, infant, toddler and preschool products are
primarily marketed under our Learning Curve® family of brands, which includes
The First Years® and Lamaze brands, as well as popular and classic licensed
properties such as Thomas
& Friends, Bob the
Builder, Super WHY!, Chuggington, Dinosaur Train, John Deere,
Disney’sWinnie the Pooh,
Princesses, Cars, Fairies andToy
Story, and other well known properties.  We market our youth
and adult products primarily under the Johnny Lightning® and Ertl®
brands.  We reach our target consumers through multiple channels of
distribution supporting more than 25,000 retail outlets throughout North
America, Europe, Australia, Asia Pacific and South America.





Business
Segments





The
Company’s reportable segments are North America and
International.  The North America segment includes the United States,
Canada and Mexico.  The International segment includes non-North
America markets.  The discussion in this Form 10-K applies to all
segments except where otherwise stated.  For additional information on
the Company’s segment reporting, including net sales, operating income (loss)
and total assets, see Note 4 to our consolidated financial statements included
elsewhere herein.





Products





North
America.  In the North America segment, our products are
organized into the following categories: (i) mother, infant and toddler products
and (ii) preschool, youth and adult products.


2


Our
mother, infant and toddler products category includes a wide-range of products
related to infant and toddler feeding, gear, care and play, which are marketed
under such brands as The First Years and Lamaze.  Some of the key
product lines in this category include reusable toddler feeding products, the
Take & Toss® toddler self-feeding system, Lamaze infant development products
and The First Years safety gates.  In 2009, we introduced several new
products under The First Years brand, including a line of MiPump® breast pumps and
the True FitTM
Premier Convertible Car Seat.  In late 2009, we also introduced a
new line of True ChoiceTM digital monitors
that offer two and three way communication.  In 2010, we plan to
introduce additional new products under both The First Years and Lamaze
brands.





Our
preschool, youth and adult products category includes our Learning Curve, Johnny
Lightning and Ertl brands and features products with such licensed properties as
Thomas & Friends
and John Deere.  In 2009, we introduced a new product line featuring
the literacy-powered superhero stars from the popular PBS show Super WHY!  This
product line features plush toys, vehicles, play sets and electronic learning
aids.  In 2010, we plan to introduce the Thomas Wooden Railway Early
EngineersTM product line, which features larger engines, simple-to-use
destinations and tracktiles that provide secure layouts for children as young as
18 months.  Additionally in 2010, we plan to introduce a new product
line featuring the characters from the PBS television show Dinosaur
Train.  This product line will feature characterized dinosaurs,
train cars and plush toys.





International.  In
addition to our business in North America, in 2009, we operated in more than 50
countries, selling a representative range of our mother, infant and toddler and
preschool, youth and adult product lines.  The geographic regions in
the International segment include Europe, Australia, Asia Pacific and South
America.  Key international brands for 2009 include Learning
Curve, Thomas &
Friends Wooden Railway, Bob the Builder, The First
Years, Lamaze, Ertl and Britains®.  Significant
product introductions for 2010 include the Thomas Wooden Railway Early Engineers
product line and two new train play product lines based on the Chuggington television
show.





The
strength of the U.S. dollar relative to other currencies can significantly
affect the net sales and profitability of our international
operations.  See Item 7A. “Quantitative and Qualitative Disclosures
About Market Risk.”





Licenses





We market
a significant portion of our products with licenses from other
parties.  A significant element of our strategy depends on our ability
to identify and obtain licenses for recognizable and respected brands and
properties.  Our licenses reinforce our brands and establish our
products’ overall appeal with consumers, and in some cases, provide for new
product development opportunities and expanded distribution
channels.  Our licenses are generally limited in scope and duration
and authorize the sale of specific licensed products, generally on a
nonexclusive basis.





We have
entered into agreements to license such properties from, among others, Disney
Consumer Products, Inc., HIT Entertainment (relating to its Thomas & Friends and
Bob the Builder
properties), John Deere Shared Services, Inc., Ludorum plc (relating to the
Chuggington property),
The Jim Henson Company, Inc. (related to its Dinosaur Train property), Out
of the Blue Worldwide LLC (relating to its Super WHY! property) and
Lamaze International, Inc.  In addition to our Chuggington master toy
licensing rights, we hold a 50.0% interest in Chuggington’s intellectual
property rights.





We are a
party to more than 250 license agreements with terms generally of two to three
years.  Any termination of or failure to renew our significant
licenses, or inability to develop and enter into new licenses, could limit our
ability to market our products or develop new products and reduce our net sales
and profitability.  For the year ended December 31, 2009, net sales of
the Company’s products with licensed properties Thomas & Friends and John
Deere each accounted for more than 10.0% of total net sales.  No other
licensed property accounted for more than 10.0% of our total net sales for the
year ended December 31, 2009.  Our license agreement with HIT
Entertainment for the Take Along Thomas & Friends die-cast
product line, which represented approximately 12% of total net sales for
the year ended December 31, 2009, terminated at the end of
2009.  This license agreement provides for a six month sell-off period
following the license termination date.  Our license with HIT
Entertainment for the Thomas
& Friends Wooden Railway product line and our license agreements for
our John Deere product lines have multiple years remaining.





Competition
for licenses could require us to pay licensors higher royalties and higher
minimum guaranteed payments in order to obtain or retain attractive licenses,
which could increase our expenses.  As of December 31, 2009, 38.3% of
our licenses require us to make minimum guaranteed royalty payments, whether or
not we meet specific sales targets.  Aggregate future minimum
guaranteed royalty payments as of December 31, 2009, are $25.5 million, with
individual minimum guarantees ranging up to $12.6 million.  Royalty
expense related to licenses with minimum guarantees for the year ended December
31, 2009, was $24.8 million.





3


Channels
of Distribution





Our
products are available through more than 25,000 retail outlets located in North
America, Europe, Australia, Asia Pacific and South America.  We market
our products through multiple channels of distribution in order to maximize our
sales opportunities for our broad product offering.  Products with
lower price points are generally sold in chain retailer channels and
higher-priced products are typically sold in hobby, collector and independent
toy stores, and through wholesalers and original equipment manufacturers
(OEMs).  We believe we have a leading position in multiple
distribution channels, and that this position extends the reach of our products
to consumers and mitigates the risk of concentration by channel or
customer.





Chain
retailers.  Our products marketed through this channel are
targeted predominately at value conscious consumers.  As a result, the
majority of our products marketed through this channel are designed to span
lower price points.  Customers included in this channel have more than
ten retail locations and include a wide range of retailers, such as book, farm
and ranch, craft/hobby and juvenile products stores, as well as the national toy
and discount retailers.  Key customers in our chain retailer channel
include Toys “R” Us/Babies “R” Us, Target, Wal-Mart and Tractor Supply
Company.  Sales in 2009 to chain retailers were 73.5% of our net
sales.





Specialty
retailers, wholesalers, OEM dealers and other.  We sell many of
the products available at chain retailers, as well as higher-priced products
with special features, to specialty retailers, wholesalers and OEM dealers,
which comprised 26.5% of our net sales in 2009.  Additionally, we
often sell licensed products to the licensing OEM’s dealer
network.  OEM licensing partners benefit from our OEM dealer sales
through the opportunity to receive royalties from additional product sales
through the OEM’s dealer network.  We often provide OEM dealers with a
short-term exclusivity period in which the OEM dealers have the opportunity to
purchase new products for a short period (usually 90 to 360 days) before the
products become available through other distribution channels.  We
reach these customers directly through our internal telesales group, our
business-to-business website located at www.myRC2.com and through specialty
sales representatives.  We also make certain products available to
consumers through a company store and our website located at
www.learningcurveshop.com.  Key customers in our specialty retailers,
wholesalers, OEM dealers and other channel include John Deere, Case New Holland,
All Aboard Toys and Amazon.com LLC.





Trademarks





We have
registered several trademarks with the U.S. Patent and Trademark Office,
including the trademarks RC2®, Learning Curve®, The First Years®, Johnny
Lightning®, Ertl®, Take & Toss® and Caring Corners®.  A number of
these trademarks are also registered in foreign countries.  We believe
our trademarks hold significant value, and we plan to build additional value
through increased consumer awareness of our many other trade names and
trademarks.





Sales
and Marketing





Our sales
organization consists of an internal sales force and external sales
representative organizations.  Our internal sales force provides
direct customer contact with nearly all of our chain retail and wholesale
accounts.  A number of accounts are designated as “house accounts” and
are handled exclusively by our internal sales staff.  Our inside sales
and customer service groups use telephone calls, mailings, faxes and e-mails to
directly contact OEM dealers and smaller volume customers, such as collector,
hobby, specialty and independent toy stores.





Our
internal sales force is supplemented by external sales representative
organizations.  These external sales representative organizations
provide more frequent customer contact and solicitation of the specialty,
regional and national retailers and supported 32.6% of our net sales in
2009.  External sales representatives earn commissions of up to 12.5%
of the net sales price from their accounts.  Their commissions are
unaffected by the involvement of our internal sales force with a customer or
sale.





The
Company maintains a business-to-business website under the name
www.myRC2.com.  The website, targeted at smaller volume accounts,
allows qualified customers to view new product offerings, place orders, check
open order shipping status and review past orders.  We believe that
www.myRC2.com leverages our internal sales force and customer service group by
providing customers with greater information access and more convenient ordering
capability.





4


We
support our product lines with various advertising and marketing
promotions.  Advertising takes place at varying levels throughout the
year and peaks during the traditional holiday season.  Advertising
includes television commercials and print advertisements in magazines and other
publications.  Marketing includes, but is not limited to, digital
media, including our websites at www.learningcurve.com, www.johnnylightning.com
and www.ertl.com, in-store displays, merchandising material and public
relations.  We also work closely with retail chains to plan and
execute ongoing retailer-driven promotions and advertising.  These
programs usually involve promotion of our products in retail customers’ print
circulars, mailings and catalogs, and sometimes include placing our products in
high-traffic locations within retail stores.





Competition





We
compete with several large domestic and foreign companies, such as Mattel, Inc.
and Hasbro, Inc., with private label products sold by many of our retail
customers, and with other producers of products for mothers, infants
and toddlers, as well as toys and collectible products.  Competition
in the distribution of our products is intense, and the principal methods of
competition consist of product appeal, ability to capture shelf space,
timely distribution, price and quality.  Competition is also based on
the ability to obtain license agreements for existing and new products to be
sold through specific distribution channels or retail outlets.  We
believe that our competitive strengths include our knowledge of the markets we
serve, our ability to bring products to market rapidly and efficiently, our
dedicated and integrated suppliers, our multiple channels of distribution, our
well-known brands supported by respected licenses, our diversified product
categories, and our established and loyal customer base.  Many of our
competitors have longer operating histories, greater brand recognition, and
greater financial, technical, marketing and other resources than we
have.





Production





We
believe we are an industry leader in bringing new products to market rapidly and
efficiently.  Our integrated design and engineering expertise,
extensive library of product designs, molds and tools, and dedicated suppliers
enable us to be the first to market with many innovative products.





Far east product
sourcing.  We have operations in Kowloon, Hong Kong, and in the
RC2 and LC Industrial Zones in China, and employ 266 people in Hong Kong and
China who oversee the sourcing of the majority of our products.  This
group assists our suppliers in sourcing raw materials and packaging, performs
engineering, graphic art and finance support functions, executes the production
schedule, provides on-site quality control, facilitates third-party safety
testing and coordinates the delivery of shipments for export from
China.





Far east
production.  Most of our products are manufactured in
China.  Our China-based product sourcing accounted for 87.4% of our
product purchases in 2009.  During 2009, we primarily used eight
third-party, dedicated suppliers who manufactured only our products in eight
factories, three of which were located in the RC2 Industrial Zone and two of
which were located in the LC Industrial Zone.  The RC2 Industrial Zone
is the name of a factory complex developed in 1997 and located in Dongguan City,
China, (approximately 50 miles from Hong Kong) where three of our third-party,
dedicated suppliers operated freestanding factory facilities during
2009.  The LC Industrial Zone is the name of a factory complex
developed in 2007 and located in Shaoguan City, China, (approximately 200 miles
from Hong Kong) where two of our third-party, dedicated suppliers operated
freestanding factory facilities during 2009.  Most of our third-party,
dedicated suppliers have been supplying us for more than ten
years.  Third-party, dedicated suppliers produced 47.9% of our
China-based product purchases in 2009.  In order to supplement our
third-party, dedicated suppliers, we use several other suppliers in
China.  All products are manufactured to our specifications using
molds and tooling that we own.  These suppliers own the manufacturing
equipment and machinery, purchase raw materials, hire workers and plan
production.  We purchase fully assembled and packaged finished goods
in master cartons for distribution to our customers.  We enter into
purchase orders with our foreign suppliers and generally do not enter into
long-term contracts.





Die-casting.  All
of our die-cast products are manufactured in China.  Die-casting for
our products involves the use of custom molds to shape melted zinc alloy into
our die-cast products.  Our suppliers purchase zinc alloy and conduct
the die-cast manufacturing process at their facilities.





Domestic
production.  The production of certain products, such as
ride-ons, safety gates and certain plastic infant and toddler products, is
completed primarily by U.S.-based suppliers.  We create the product
design and specifications and coordinate the manufacturing
activities.  We generally prefer to coordinate the production of these
products through a limited number of suppliers and believe that a number of
alternate suppliers are available.





5


Tooling.  To
create new products, we continuously invest in new tooling.  Tooling
represents the majority of our capital expenditures.  Depending on the
size and complexity of the product, the cost of tooling a product generally
ranges from $3,000 to $250,000.  We own all of our tools and provide
them to our suppliers during production.  Tools are returned to us
when a product is no longer in production and are stored for future
use.





Product
safety.  Our products are designed, manufactured, packaged and
labeled to conform with all safety requirements under U.S. federal and other
applicable laws and regulations, industry-developed voluntary standards and
product-specific standards.  Additionally, we have safeguards through
our Multi-Check Safety System which includes:






●
            Increased scope and
      frequency of testing for both incoming material and finished products,
      including testing of finished products from every production
  run.●
            A certification
      program for contract manufacturers and paint suppliers, including evidence
      that toy safety standards and quality control procedures are in place and
      operating effectively.●
            Mandatory paint
      control procedures for contract manufacturers, including certified
      independent lab test results of every batch of wet paint before the paint
      is released for production.●
            Increased random
      inspections and audits of both manufacturers and their suppliers,
      including semi-annual audits and quarterly random inspections for key
      suppliers.●
            Zero tolerance for
      compromise on RC2 specifications reinforced by mandatory vendor compliance
      seminars and signed agreements.




We carry
various product liability insurance policies with coverage in aggregate of over
$75.0 million per occurrence.  Certain policies have coverage
exclusions including, but not limited to, some policies that exclude claims
related to lead.





Logistics.  We
own a distribution facility in Dyersville, Iowa, lease distribution facilities
in Rochelle, Illinois, and Australia, and use independent warehouses in
California, Canada, the United Kingdom, Belgium and Germany.





Seasonality





We have
experienced, and expect to continue to experience, substantial fluctuations in
our quarterly net sales and operating results, which is typical of many
companies in our industry.  Our business is highly seasonal primarily
due to high consumer demand for our toy products during the year-end holiday
season.  Approximately 58.3% of our net sales for the three years
ended December 31, 2009, were generated in the second half of the year, with
September and October being the largest shipping months.  As a result,
consistent with industry practice, our working capital, mainly inventory and
accounts receivable, is typically highest during the third and fourth quarters
and lowest during the first and second quarters.





Customers





We derive
a significant portion of our sales from some of the world’s largest
retailers.  Our top three customers, Toys “R” Us/Babies “R” Us, Target
and Wal-Mart, combined accounted for 43.5% of our net sales in
2009.  Other than Toys “R” Us/Babies “R” Us, Target and Wal-Mart, no
customer accounted for more than 10.0% of our net sales in 2009.  Many
of our retail customers generally purchase large quantities of our product on
credit, which may cause a concentration of accounts receivable among some of our
largest customers.





Employees





As of
December 31, 2009, we had 713 employees, 36 of whom were employed
part-time.  We emphasize the recruiting and training of high-quality
personnel, and to the extent possible, promote people from within
RC2.  Collective bargaining agreements cover 94 of our employees who
work in the Company’s distribution facilities.  We consider our
employee relations to be good.  Our continued success will depend, in
part, on our ability to attract, train and retain qualified personnel at all of
our locations.


6


Available
Information





We
maintain our corporate website at www.rc2.com and we make available, free of
charge, through this website our annual report on Form 10-K, quarterly reports
on Form 10-Q, current reports on Form 8-K, and amendments to those reports that
we file with or furnish to the Securities and Exchange Commission (the
Commission), as soon as reasonably practicable after we electronically file such
material with, or furnish it to, the Commission.  Information on our
website is not part of this report.  This report includes all material
information about the Company that is included on the Company’s website and is
otherwise required to be included in this report.





Item
1A.  Risk Factors





The risks
described below are not the only risks we face.  Additional risks that
we do not yet know of or that we currently think are immaterial may also impair
our business operations.  If any of the events or circumstances
described in the following risks actually occur, our business, financial
condition or results of operations could be materially adversely
affected.  In such cases, the trading price of our common stock could
decline.





Competition
for licenses could increase our licensing costs or limit our ability to market
products.





We market
a significant portion of our products with licenses from other
parties.  These licenses are limited in scope and duration, and
generally authorize the sale of specific licensed products on a nonexclusive
basis.  Our license agreements often require us to make minimum
guaranteed royalty payments that may exceed the amount we are able to generate
from actual sales of the licensed products.





Our
license agreement with HIT Entertainment for the license of the Take Along Thomas & Friends die-cast
product line terminated at the end of 2009.  This license agreement
provides for a six month sell-off period following the license
term.  For the year ended December 31, 2009, net sales of our products
under this license agreement accounted for approximately 12% of our total net
sales.





Our
license agreements have terms generally of two to three
years.  Competition for licenses could require us to pay licensors
higher royalties and higher minimum guaranteed payments in order to obtain or
retain attractive licenses, which could increase our expenses.  In
addition, licenses granted to other parties, whether or not exclusive, could
limit our ability to market products, including products we currently market,
which could cause our net sales and profitability to decline.  Any
termination of or failure to renew our significant licenses, or inability to
develop and enter into new licenses, could limit our ability to market our
products or develop new products and reduce our net sales and
profitability.





Product
recalls or claims relating to the use of our products could increase our costs
and harm our reputation and our relationship with retailers and
licensors.





Because
we sell products for mothers, infants and toddlers, as well as toys and
collectible products, we face product liability risks relating to the use of our
products.  We also must comply with a variety of product safety and
product testing regulations.  During 2008, the Consumer Product Safety
Improvement Act was enacted.  As a result, the Consumer Product Safety
Commission is in the process of adopting new regulations for safety and product
testing that apply to substantially all of our products.  These new
regulations significantly tighten the regulatory requirements governing the
manufacture and sale of children’s products and also increase the potential
penalties for noncompliance with applicable regulations.  If we fail
to comply with these regulations or applicable product safety regulations in
other jurisdictions where our products are sold or if we face product liability
claims, we may be subject to damage awards or settlement costs that exceed our
insurance coverage, and we may incur significant costs in complying with recall
requirements.  Product recalls may 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 recalls may also 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.  In
addition, substantially all of our licenses give the licensor the right to
terminate, under certain circumstances, if any products marketed under the
license are subject to a product liability claim, recall or similar violations
of product safety regulations, or if we breach covenants relating to the safety
of the products or their compliance with product safety
regulations.  A termination of a license would likely adversely affect
our net sales.  Even if a product liability claim is without merit,
the claim could harm our reputation and divert management’s attention and
resources from our business.





7


Our
net sales and profitability depend on our ability to continue to conceive,
design and market products that appeal to consumers.





The
introduction of new products is critical in our industry and to our growth
strategy.  Our business depends on our ability to continue to
conceive, design and market new products and upon continuing market acceptance
of our product offerings.  Rapidly changing consumer preferences and
trends make it difficult to predict how long consumer demand for our existing
products will continue or what new products will be successful.  In
addition, the trend of children “getting older younger,” where children are
losing interest in traditional toys and games at younger ages, may increase the
pace of change of consumer preferences that affect the demand for our preschool
and youth products.  As a result of this trend, at younger and younger
ages, our toys compete with the offerings of video game suppliers, consumer
electronics companies and other businesses outside of the traditional toy
industry.  Our current products may not continue to be popular or new
products that we introduce may not achieve adequate consumer acceptance for us
to recover development, manufacturing, marketing and other costs.  A
decline in consumer demand for our products, our failure to develop new products
on a timely basis in anticipation of changing consumer preferences or the
failure of our new products to achieve and sustain consumer acceptance could
reduce our net sales and profitability.





Increases
in the cost of raw materials, labor and other costs used to manufacture our
products could increase our cost of sales and reduce our gross
margins.





Since our
products are manufactured by third-party suppliers, we do not directly purchase
the raw materials used to manufacture our products.  However, the
prices we pay our suppliers may increase if their raw materials, labor or other
costs increase.  We may not be able to pass along such price increases
to our customers.  As a result, an increase in the cost of raw
materials, labor or other costs associated with the manufacturing of our
products could increase our costs of sales and reduce our gross
margins.  For example, an increase in the price of zinc and resins,
key raw materials in many of our products, and increased costs in China,
primarily for labor, reduced our gross margins in 2007 and 2008.





Uncertainty
and adverse changes in the general economic conditions may negatively affect our
business.





Adverse
changes in general economic conditions in the United States and other global
markets in which we operate, or consumer fears of adverse changes in economic
conditions, may cause consumers to reduce expenditures for products such as our
products.  Adverse changes may occur as a result of adverse global or
regional economic conditions, fluctuating oil prices, declining consumer
confidence, unemployment, fluctuations in stock markets, contraction of credit
availability, bankruptcy or liquidity problems with our customers or other
factors affecting economic conditions generally.  These changes may
negatively affect the sales of our products, increase exposure to losses from
bad debts, increase the cost and decrease the availability of financing,
increase the risk of loss on investments, or increase costs associated with
producing and distributing our products.





Currency
exchange rate fluctuations could increase our expenses.





Our net
sales are primarily denominated in U.S. dollars, with 21.9% of our net sales in
2009 denominated in British pounds sterling, Australian dollars, Euros or
Canadian dollars.  Our purchases of finished goods from Chinese
manufacturers are primarily denominated in Hong Kong
dollars.  Expenses for these manufacturers are primarily denominated
in Chinese renminbi.  Any material increase in the value of the Chinese
renminbi relative to the U.S. dollar would increase our suppliers’ expenses, and
therefore, the cost of our products, which could adversely affect the Company’s
profitability.  A material increase in the value of the Hong Kong
dollar relative to the U.S. dollar would increase the Company’s expenses, and
therefore, could adversely affect the Company’s profitability.  We are
also subject to exchange rate risk relating to transfers of funds or other
transactions denominated in British pounds sterling, Australian dollars,
Canadian dollars or Euros from our foreign subsidiaries to the United States,
such as for purchases of inventory by certain of our foreign subsidiaries in
U.S. dollars.  As a result, any increase in the U.S. dollar relative
to our foreign subsidiaries’ local currencies would increase our expenses and,
therefore, could adversely affect our profitability.  We are not
currently using and have not historically used hedges or other derivative
financial instruments to manage or reduce exchange rate risk.





8


Competition
in our markets could reduce our net sales and profitability.





We
operate in highly competitive markets.  We compete with several large
domestic and foreign companies such as Mattel, Inc. and Hasbro, Inc., with
private label products sold by many of our retail customers and with other
producers of products for mothers, infants and toddlers, as well as
toys and collectible products.  Many of our competitors have longer
operating histories, greater brand recognition, and greater financial,
technical, marketing and other resources than we have.  In addition,
we may face competition from new participants in our markets because
the infant and toddler, toy and collectible product industries have
limited barriers to entry.  We experience price competition for our
products, competition for shelf space at retailers and competition for licenses,
all of which may increase in the future.  If we cannot compete
successfully in the future, our net sales and profitability will likely
decline.





An
inability to identify or complete future acquisitions could adversely affect our
future growth.





As part
of our growth strategy, we intend to pursue acquisitions that are consistent
with our mission and enable us to leverage our competitive
strengths.  While we continue to evaluate potential acquisitions, we
may not be able to identify and successfully negotiate suitable acquisitions,
obtain financing for future acquisitions on satisfactory terms, obtain
regulatory approval for certain acquisitions or otherwise complete acquisitions
in the future.  An inability to identify or complete future
acquisitions could limit our future growth.





We
may experience difficulties in integrating strategic acquisitions.





The
integration of acquired companies and their operations into our operations
involves a number of risks, including:






●
            the acquired
      business may experience losses that could adversely affect our
      profitability;●
            unanticipated costs
      relating to the integration of acquired businesses may increase our
      expenses;●
            possible failure to
      obtain any necessary consents to the transfer of licenses or other
      agreements of the acquired company may decrease our net
sales;●
            possible failure to
      maintain customer, licensor and other relationships after the closing of
      the transaction of the acquired company may decrease our net
    sales;●
            difficulties in
      achieving planned cost-savings and synergies may increase our expenses or
      decrease our net sales;●
            diversion of
      management’s attention could impair their ability to effectively manage
      our business operations;●
            we may record
      goodwill and nonamortizable intangible assets that are subject to
      impairment testing on a regular basis and potential impairment charges and
      we may also incur amortization expenses related to intangible assets;
      and●
            unanticipated
      management or operational problems or liabilities may adversely affect our
      profitability and financial condition.





Additionally,
to finance our strategic acquisitions, we have borrowed funds under our credit
facility, and we may borrow additional funds to complete future
acquisitions.  Our credit agreement may limit our ability to make
acquisitions.  Debt leverage resulting from future acquisitions could
adversely affect our profit margins and limit our ability to capitalize on
future business opportunities.  All of our borrowing capacity is also
subject to fluctuations in interest rates.





We
depend on the continuing willingness of chain retailers to purchase and provide
shelf space for our products.





In
2009, 73.5% of our net sales were to chain retailers.  Our
success depends upon the continuing willingness of these retailers to purchase
and provide shelf space for our products.  We do not have long-term
contracts with our customers.  In addition, our access to shelf space
at retailers may be reduced by store closings, stricter requirements for
children’s products by retailers that we may not be able to meet, consolidation
among these retailers and competition from other products.  An adverse
change in our relationship with or the financial viability of one or more of our
customers could reduce our net sales and profitability.  In addition,
increased concentration of our sales to our largest chain retailer customers may
adversely affect our ability to negotiate sales prices for our products and
could result in increased pressure on our gross margins.


9


We
may not be able to collect outstanding accounts receivable from our major retail
customers.





Many of
our retail customers generally purchase large quantities of our products on
credit, which may cause a concentration of accounts receivable among some of our
largest customers.  Our profitability or liquidity may be harmed if
one or more of our largest customers were unable or unwilling to pay these
accounts receivable when due or demand credits or other concessions for products
they are unable to sell.  We maintain credit insurance for some of our
major domestic customers, and the amount of this insurance covers a limited
portion of the total amount of our accounts receivable.  At December
31, 2008 and 2009, our credit insurance covered 9.8% and 5.8%, respectively, of
our gross accounts receivable.  Insurance coverage for future sales is
subject to reduction or cancellation.





We
rely on a limited number of foreign suppliers in China to manufacture a majority
of our products.





During
2009, we relied on eight third-party, dedicated suppliers in China to
manufacture a significant portion of our products in eight factories, three of
which were located in close proximity to each other in the RC2 Industrial Zone
manufacturing complex and two of which were located in close proximity to each
other in the LC Industrial Zone, both of which are located in
China.  Our China-based product sourcing accounted for 87.4% of
our product purchases in 2009.  Third-party, dedicated suppliers who
manufacture only our products accounted for 47.9% of our China-based product
purchases in 2009.  We enter into purchase orders with our foreign
suppliers and generally do not enter into long-term
contracts.  Because we rely on these suppliers for flexible production
and have integrated these suppliers with our development and engineering teams,
if these suppliers do not continue to manufacture our products exclusively, our
product sourcing could be adversely affected.  Difficulties
encountered by these suppliers, such as fire, accident, natural disaster or an
outbreak of a contagious disease at one or more of their facilities, could halt
or disrupt production at the affected facilities, delay the completion of
orders, cause the cancellation of orders, delay the introduction of new products
or cause us to miss a selling season applicable to some of our
products.  Any of these risks could increase our expenses or reduce
our net sales.





Because
we rely on foreign suppliers and we sell products in foreign markets, we are
susceptible to numerous international business risks that could increase our
costs or disrupt the supply of our products.





Our
international operations subject us to risks, including:






●
            economic and
      political instability;●
            restrictive actions
      by foreign governments;●
            greater difficulty
      enforcing intellectual property rights and weaker laws protecting
      intellectual property rights;●
            changes in import
      duties or import or export restrictions;●
            timely shipping of
      product and unloading of product through West Coast ports, as well as
      timely rail/truck delivery to our warehouses and/or a customer’s
      warehouse;●
            complications in
      complying with the laws and policies of the United States affecting the
      importation of goods, including duties, quotas and taxes; and●
            complications in
      complying with trade and foreign tax
laws.




Any of
these risks could disrupt the supply of our products or increase our
expenses.  The cost of compliance with trade and foreign tax laws
increases our expenses, and actual or alleged violations of such laws could
result in enforcement actions or financial penalties that could result in
substantial costs.





10


Impairment
charges could reduce our profitability.





In
accordance with the provisions of the Intangibles – Goodwill and Other Topic of
the FASB Accounting Standards Codification, we test goodwill and our other
intangible assets with indefinite useful lives for impairment on an annual basis
or on an interim basis if an event occurs that might reduce the fair value of
the reporting unit below its carrying value.  We conduct testing for
impairment annually during the fourth quarter.  In the fourth quarter
of 2008, we recorded impairment charges of $244.0 million of our goodwill, which
was a 100.0% reduction of our goodwill, and $11.9 million for certain of our
indefinite lived intangible assets, as a result of our annual impairment
test.  An amendment to our credit facility was obtained to
exclude the effect of these impairment charges on our financial
covenants.  In the fourth quarter of 2009, we recorded impairment
charges of $2.4 million for certain of our indefinite lived
intangibles.  At December 31, 2009, we had other intangible assets of
$80.3 million, or 21.4% of our total assets, and
no goodwill.  Various uncertainties, including changes in
consumer preferences, ability to renew licenses, deterioration in the political
environment, continued adverse conditions in the capital markets or changes in
general economic conditions, could impact the expected cash flows to be
generated by an intangible asset or group of intangible assets, and may result
in an impairment of those assets.  Although such an impairment charge
would be a non-cash expense, any impairment or change in the useful lives of the
intangible assets could materially increase our expenses and reduce our
profitability.  If we are required to record an impairment charge, the
charge could affect our compliance with the debt covenants in our credit
agreement.  Additionally, should we violate a covenant under our
credit agreement, the cost of obtaining an amendment or waiver could be
significant, or the lenders could be unwilling to provide a waiver or agree to
an amendment.





Our
credit agreement contains debt covenants which restrict our current and future
operations, including our ability to take certain actions.





Our
credit agreement contains provisions that place limitations on a number of our
activities, including our ability to:






●
            incur additional
      debt;●
            create liens on our
      assets or make guarantees;●
            make acquisitions
      above certain amounts;●
            pay
    dividends;●
            buy back shares of
      our common stock; or●
            dispose of
      our assets outside the ordinary course of business or enter into a
      merger or similar transaction.





Our
credit agreement also contains a number of financial covenants, including a
clean down provision.  The clean down provision will limit the maximum
amount of borrowings under the revolving line of credit for a period of 60
consecutive days in the first four calendar months of 2011 to $25.0
million.





The
restrictive covenants in our credit agreement may limit our ability to engage in
acts that may be in our best long-term interests.  A breach of any of
the restrictive covenants in our credit agreement could result in a default
under our credit agreement.  If a default occurs, the lenders under
our credit agreement may elect to declare all outstanding borrowings, together
with accrued interest, to be immediately due and payable, to terminate any
commitments they have to provide further borrowers, and to exercise any other
rights they have under the credit agreement or applicable law.





Trademark
infringement or other intellectual property claims relating to our products
could increase our costs.





Our
industry is characterized by frequent litigation regarding trademark and patent
infringement and other intellectual property rights.  We are and have
been a defendant in trademark and patent infringement claims and claims of
breach of license from time to time, and we may continue to be subject to such
claims in the future.  The defense of intellectual property litigation
is both costly and disruptive of the time and resources of our management even
if the claim is without merit.  We also may be required to pay
substantial damages or settlement costs to resolve intellectual property
litigation.





Sales
of our products are seasonal, which causes our operating results to vary from
quarter to quarter.





Our
business is highly seasonal primarily due to high consumer demand for our toy
products during the year-end holiday season.  Historically, our net
sales and profitability have peaked in the third and fourth quarters due to the
holiday season buying patterns.  Seasonal variations in operating
results may cause us to increase our debt levels and interest expense primarily
in the third quarter.





11


The
trading price of our common stock has been volatile, and investors in our common
stock may experience substantial losses.





The
trading price of our common stock has been volatile and may become volatile
again in the future.  The trading price of our common stock could
decline or fluctuate in response to a variety of factors,
including:






●
            our failure to meet
      the performance estimates of securities analysts;●
            changes in financial
      estimates of our net sales and operating results or buy/sell
      recommendations by securities analysts;●
            the timing of
      announcements by us or our competitors concerning significant product
      developments, acquisitions or financial performance;●
            fluctuations in our
      quarterly operating results;●
            substantial sales of
      our common stock;●
            general stock market
      conditions; or●
            other economic or
      external factors.





Our
stockholders may be unable to sell their stock at or above their purchase
price.





We
may face future securities class action lawsuits that could require us to pay
damages or settlement costs and otherwise harm our business.





Future
volatility in the price of our common stock may result in securities class
action lawsuits against us, which may require that we pay substantial damages or
settlement costs in excess of our insurance coverage and incur substantial legal
costs, and which may divert management’s attention and resources from our
business.





Various
restrictions in our charter documents, Delaware law and our credit agreement
could prevent or delay a change in control of us that is not supported by our
board of directors.





We are
subject to a number of provisions in our charter documents, Delaware law and our
credit agreement that may discourage, delay or prevent a merger, acquisition or
change of control that a stockholder may consider favorable.  These
anti-takeover provisions include:






●
            advance notice
      procedures for nominations of candidates for election as directors and for
      stockholder proposals to be considered at stockholders’
  meetings;●
            covenants in our
      credit agreement restricting mergers, asset sales and similar transactions
      and a provision in our credit agreement that triggers an event of default
      upon the acquisition by a person or a group of persons of beneficial
      ownership of 33 1/3% or more of our outstanding common stock;
  and●
            the Delaware
      anti-takeover statute contained in Section 203 of the Delaware General
      Corporation Law.





Section
203 of the Delaware General Corporation Law prohibits a merger, consolidation,
asset sale or other similar business combination between RC2 and any stockholder
of 15.0% or more of our voting stock for a period of three years after the
stockholder acquires 15.0% or more of our voting stock, unless (1) the
transaction is approved by our board of directors before the stockholder
acquires 15.0% or more of our voting stock, (2) upon completing the transaction
the stockholder owns at least 85.0% of our voting stock outstanding at the
commencement of the transaction, or (3) the transaction is approved by our board
of directors and the holders of 66 2/3% of our voting stock, excluding shares of
our voting stock owned by the stockholder.





Item
1B. Unresolved Staff Comments





Not
applicable.








12


Item
2.  Properties




As of
December 31, 2009, our facilities were as follows:





Description
            Square
      Feet
            Location
            Lease
      ExpirationCorporate
      headquarters
            27,050
            Oak
      Brook, IL
            April
      2013Learning
      Curve Brands, Inc. warehouse
            400,000
            Rochelle,
      IL
            November
      2019Learning
      Curve Brands, Inc. office and warehouse
            534,000
            Dyersville,
      IA
            OwnedLearning
      Curve Brands, Inc. office
            21,650
            Stoughton,
      MA
            August
      2010Learning
      Curve Brands, Inc. office
            3,300
            Bentonville,
      AR
            October
      2013Learning
      Curve Brands, Inc. office
            1,986
            Walnut
      Creek, CA
            May
      2010Learning
      Curve Brands, Inc. storage
            1,875
            Stoughton,
      MA
            June
      2010Learning
      Curve Brands, Inc. office
            1,263
            Kettering,
      OH
            Month-to-monthLearning
      Curve Brands, Inc. office
            659
            Mission
      Viejo, CA
            November
      2010Learning
      Curve Brands, Inc. office
            294
            Danbury,
      CT
            Month-to-monthRC2
      (H.K.) Limited RC2 Industrial Zone quarters (1)
            68,230
            Dongguan
      City, China
            March
      2010RC2
      (H.K.) Limited RC2 Industrial Zone office,
              warehouse and storage (1)
            66,365
            Dongguan
      City, China
            March
      2010RC2
      (H.K.) Limited warehouse and storage (1)
            8,238
            Dongguan
      City, China
            April
      2010RC2
      (H.K.) Limited office (1)
            10,296
            Kowloon,
      Hong Kong
            July
      2010RC2
      (H.K.) Limited quarters (1)
            2,173
            Weng
      Yuan, Shao Guan, China
            March
      2010RC2
      (H.K.) Limited office (1)
            1,124
            Weng
      Yuan, Shao Guan, China
            March
      2010Racing
      Champions International Limited office
            8,419
            Exeter,
      United Kingdom
            October
      2013Racing
      Champions International Limited office and showroom
            2,035
            Thatcham,
      United Kingdom
            August
      2011Racing
      Champions International Limited office
            699
            Barcelona,
      Spain
            May
      2013Racing
      Champions International Limited office
            603
            Lauren,
      Holland
            December
      2010Racing
      Champions International Limited office
            559
            Marcq-En-Baroeul,
      France
            September
      2014RC2
      Canada Corporation warehouse (2)
            47,000
            Concord,
      Ontario
            May
      2010RC2
      Deutschland GmbH office
            2,570
            Marsdof,
      Germany
            December
      2010RC2
      Australia, Pty. Ltd. office and warehouse
            174,376
            Dandenong
      South, Victoria,
      Australia
            September
      2019






(2)  As
of January 1, 2004, the Canadian warehouse was no longer being used in our
operations and has been subsequently sublet.





Item
3.  Legal Proceedings





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





During
2008, the Company received an inquiry from the CPSC for information regarding
the recalls of certain Thomas
& Friends Wooden Railway toys in 2007 for the purpose of
asserting whether the CPSC may impose a fine on the Company.  In the
fourth quarter of 2009, the Company agreed to a settlement with the CPSC
resolving this matter, which included a $1.3 million civil
penalty.  This penalty was included in accrued expenses in the
accompanying consolidated balance sheets at both December 31, 2008 and 2009, and
was paid subsequent to the end of 2009.





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




Item 4. 
[Reserved]


13










Part
  II




Item
5.  Market for Registrant’s Common Equity, Related Stockholder Matters
and Issuer Purchases of Equity Securities





Stock
Price Information





Our
common stock trades on the NASDAQ Global Select Market under the symbol
“RCRC.”  The following table sets forth the high and low closing sales
prices for our common stock as reported by NASDAQ for the periods
indicated.





2008:
            
            High
            
            
            LowFirst
      Quarter
            
            $
            26.89
            
            
            $
            18.55Second
      Quarter
            
            
            22.01
            
            
            
            17.30Third
      Quarter
            
            
            26.83
            
            
            
            16.35Fourth
      Quarter
            
            $
            19.60
            
            
            $
            6.452009:
            
            High
            
            
            LowFirst
      Quarter
            
            $
            10.73
            
            
            $
            3.40Second
      Quarter
            
            
            15.07
            
            
            
            5.40Third
      Quarter
            
            
            16.92
            
            
            
            12.67Fourth
      Quarter
            
            $
            16.16
            
            
            $
            12.46





As of
December 31, 2009, there were 136 holders of record of our common
stock.  We believe the number of beneficial owners of our common stock
on that date was substantially greater.





Dividend
Policy





We have
not paid any cash dividends on our common stock.  We intend to retain
any earnings for use in operations to repay indebtedness and for expenses of our
business, and therefore, we do not anticipate paying any cash dividends in the
foreseeable future.  Our credit agreement prohibits the Company from
declaring or paying any dividends on any class or series of our capital
stock.  This prohibition will apply as long as any credit is available
or outstanding under the credit agreement that currently has a maturity date of
November 1, 2011.





Item
6.  Selected Financial Data





The
following table presents selected consolidated financial data, which should be
read along with our consolidated financial statements, the notes to those
statements and “Item 7. Management’s Discussion and Analysis of Financial
Condition and Results of Operations.”  The consolidated statements of
operations for the years ended December 31, 2007, 2008 and 2009, and the
consolidated balance sheet data as of December 31, 2008 and 2009, are derived
from our audited consolidated financial statements included elsewhere
herein.  The consolidated statements of operations for the years ended
December 31, 2005 and 2006, and the consolidated balance sheet data as of
December 31, 2005, 2006 and 2007, are derived from our audited consolidated
financial statements, as adjusted for discontinued operations, that are not
included herein.


14








Year Ended December 31,2005
            
            
            2006
            
            
            2007
            
            
            2008
            
            
            2009Consolidated
      Statement of Operations:
            
            (in
      thousands, except per share data)Net
      sales (1)
            
            $
            492,766
            
            
            $
            518,829
            
            
            $
            488,999
            
            
            $
            437,029
            
            
            $
            421,139Cost
      of sales (2)
            
            
            252,935
            
            
            
            275,754
            
            
            
            270,059
            
            
            
            246,301
            
            
            
            236,243Restructuring
      charge related to discontinuedautomotive
    collectibles
            
            
            —
            
            
            
            1,872
            
            
            
            —
            
            
            
            —
            
            
            
            —Recall-related
      items
            
            
            —
            
            
            
            —
            
            
            
            4,624
            
            
            
            (1,114
            )
            
            
            (298
            )Gross
      profit
            
            
            239,831
            
            
            
            241,203
            
            
            
            214,316
            
            
            
            191,842
            
            
            
            185,194Selling,
      general and administrative expenses (2)
            
            
            150,381
            
            
            
            155,180
            
            
            
            161,560
            
            
            
            155,903
            
            
            
            136,869Amortization
      of intangible assets
            
            
            1,385
            
            
            
            1,149
            
            
            
            893
            
            
            
            889
            
            
            
            608Impairment
      of goodwill and other intangible assets
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            255,853
            
            
            
            2,432Gain
      on sale of W. Britain product line
            
            
            (1,953
            )
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —Restructuring
      charge related to discontinued automotive
      collectibles
            
            
            —
            
            
            
            12,631
            
            
            
            —
            
            
            
            —
            
            
            
            —Recall-related
      items
            
            
            —
            
            
            
            —
            
            
            
            18,068
            
            
            
            15,782
            
            
            
            576Terminated
      acquisition costs
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            1,399
            
            
            
            —Operating
      income (loss)
            
            
            90,018
            
            
            
            72,243
            
            
            
            33,795
            
            
            
            (237,984
            )
            
            
            44,709Interest
      expense
            
            
            6,634
            
            
            
            4,375
            
            
            
            2,712
            
            
            
            6,584
            
            
            
            3,923Interest
      income
            
            
            (651
            )
            
            
            (910
            )
            
            
            (1,197
            )
            
            
            (1,579
            )
            
            
            (546
            )Write-off
      of investment
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            2,057
            
            
            
            —Other
      expense (income), net
            
            
            146
            
            
            
            530
            
            
            
            (1,768
            )
            
            
            (3,553
            )
            
            
            780Income
      (loss) from continuing operations before income
taxes
            
            
            83,889
            
            
            
            68,248
            
            
            
            34,048
            
            
            
            (241,493
            )
            
            
            40,552Income
      tax expense (benefit)
            
            
            31,153
            
            
            
            24,478
            
            
            
            12,472
            
            
            
            (35,741
            )
            
            
            13,590Income
      (loss) from continuing operations
            
            
            52,736
            
            
            
            43,770
            
            
            
            21,576
            
            
            
            (205,752
            )
            
            
            26,962Income
      (loss) from discontinued operations, net of tax
            
            
            394
            
            
            
            (9,676
            )
            
            
            110
            
            
            
            —
            
            
            
            —Net
      income (loss)
            
            $
            53,130
            
            
            $
            34,094
            
            
            $
            21,686
            
            
            $
            (205,752
            )
            
            $
            26,962Basic
      earnings (loss) per common share:Income
      (loss) from continuing operations
            
            $
            2.56
            
            
            $
            2.09
            
            
            $
            1.05
            
            
            $
            (11.82
            )
            
            $
            1.42Income
      (loss) from discontinued operations
            
            
            0.02
            
            
            
            (0.46
            )
            
            
            0.01
            
            
            
            —
            
            
            
            —Net
      income (loss)
            
            $
            2.58
            
            
            $
            1.63
            
            
            $
            1.06
            
            
            $
            (11.82
            )
            
            $
            1.42Diluted
      earnings (loss) per common share:Income
      (loss) from continuing operations
            
            $
            2.45
            
            
            $
            2.04
            
            
            $
            1.04
            
            
            $
            (11.82
            )
            
            $
            1.39Income
      (loss) from discontinued operations
            
            
            0.02
            
            
            
            (0.45
            )
            
            
            0.01
            
            
            
            —
            
            
            
            —Net
      income (loss)
            
            $
            2.47
            
            
            $
            1.59
            
            
            $
            1.05
            
            
            $
            (11.82
            )
            
            $
            1.39Weighted
      average shares outstanding:Basic
            
            
            20,613
            
            
            
            20,884
            
            
            
            20,395
            
            
            
            17,406
            
            
            
            19,014Diluted
            
            
            21,532
            
            
            
            21,377
            
            
            
            20,748
            
            
            
            17,406
            
            
            
            19,362





15





As of December 31,Consolidated
      Balance Sheet Data: (in thousands)
            
            2005
            
            
            2006
            
            
            2007
            
            
            2008
            
            
            2009Working
      capital
            
            $
            113,286
            
            
            $
            129,603
            
            
            $
            67,128
            
            
            $
            125,799
            
            
            $
            188,433Total
      assets
            
            
            629,736
            
            
            
            614,640
            
            
            
            650,245
            
            
            
            336,650
            
            
            
            375,785Total
      debt
            
            
            82,647
            
            
            
            22,438
            
            
            
            95,000
            
            
            
            95,120
            
            
            
            41,250Total
      stockholders’ equity
            
            $
            398,951
            
            
            $
            451,926
            
            
            $
            397,378
            
            
            $
            148,689
            
            
            $
            244,733





(1)  Net
sales for the years ended December 31, 2007, 2008 and 2009, include $(5.6)
million, $0.3 million and $0.4 million, respectively, in recall-related
items.


(2)  Depreciation
expense was $14.4 million, $14.1 million, $13.9 million, $15.4 million and $11.5
million for the years ended December 31, 2005, 2006, 2007, 2008 and 2009,
respectively.





General
Note:  Results for 2007 include the results of Angels Landing, Inc.
from May 24, 2007, and Mother's Intuition Inc. from November 30,
2007.  As these acquisitions were accounted for using the purchase
method of accounting, periods prior to the acquisition effective dates do not
include any results for Angels Landing, Inc. or Mother's Intuition
Inc.  Discontinued operations include the results from our collectible
trading card business and die-cast sports collectibles product line, which were
disposed of in connection with the sale of RC2 South, Inc., effective November
1, 2006.





Item
7.  Management’s Discussion and Analysis of Financial Condition and
Results of Operations





Overview





We are a
leading designer, producer and marketer of a broad range of innovative,
high-quality products for mothers, infants and toddlers, as well as toys and
collectible products sold to preschoolers, youths and adults.  We
reach our target consumers through multiple channels of distribution supporting
more than 25,000 retail outlets throughout North America, Europe, Australia,
Asia Pacific and South America.  Our product categories include (i)
mother, infant and toddler products and (ii) preschool, youth and adult
products.  We market a significant portion of our products with
licenses from other parties, and we are currently a party to more than 250
license agreements.





Sales.  Our
sales are primarily derived from the sale of mother, infant and toddler products
and preschool, youth and adult products, and are recognized upon transfer of
title of product to our customers.  We market our products through a
variety of distribution channels, including chain retailers, specialty
retailers, wholesalers and OEM dealers.  For the years ended December
31, 2007, 2008 and 2009, sales to chain retailers comprised 68.3%, 70.3% and
73.5%, respectively, of our net sales.





Our
products are marketed and distributed primarily in North America, Europe,
Australia, Asia Pacific and South America.  International sales,
defined as sales outside of North America, constituted 22.1%, 25.3% and 23.9%,
of our net sales for the years ended December 31, 2007, 2008 and 2009,
respectively.  We expect international sales to continue to increase
in local currencies as we expand our geographic reach.  Net sales in
our international segment decreased 8.9% for the year ended December 31, 2009,
which includes a negative impact of 9.0% related to changes from currency
exchange rates.





We derive
a significant portion of our sales from some of the world’s largest
retailers.  Our top three customers, Toys “R” Us/Babies “R” Us, Target
and Wal-Mart, combined accounted for 42.6%, 40.1% and 43.5% of our net sales in
2007, 2008 and 2009, respectively.  Over the last three years, each of
these three customers accounted for between 11.9% and 16.6% of our net
sales.  No other customers accounted for more than 10.0% of the
Company’s net sales in any of the years ended December 31, 2007, 2008 or
2009.





We
provide certain customers the option to take delivery of our products in the
United States, United Kingdom, Australia, Canada, Belgium or Germany, with
credit terms generally ranging from 30 to 90 days, or directly in China with
payment made by irrevocable letter of credit or wire transfer.  We
generally grant price discounts on direct sales from China resulting in lower
gross margins.  However, shipments direct from China lower our
distribution and administrative costs, so we believe that our operating income
margin is comparable for products delivered in China versus products shipped in
the United States, United Kingdom, Australia, Canada, Belgium or
Germany.  For the years ended December 31, 2007, 2008 and 2009, direct
sales from China constituted 15.6%, 14.1% and 15.2%, respectively, of our net
sales.





16


We do not
ordinarily sell our products on consignment, and we ordinarily accept returns
only for defective merchandise.  In certain instances, where retailers
are unable to resell the quantity of products that they have purchased from us,
we may, in accordance with industry practice, assist retailers in selling such
excess inventory by offering credits and other price concessions, which are
typically evaluated and issued annually.  Returns and allowances on an
annual basis have ranged from 7.1% to 8.6% of our net sales over the last three
years.  Returns and allowances for the years ended December 31, 2007,
2008 and 2009, include $5.6 million, $(0.3) million and $(0.4) million,
respectively, of items related to the 2007 recalls, causing returns and
allowances to be at a higher end of the annual range in 2007.





Expenses.  Our
products are manufactured by third-parties, principally located in
China.  Cost of sales primarily consists of purchases of finished
products, which accounted for 82.3%, 80.0% and 82.6% of our cost of sales in
2007, 2008 and 2009, respectively.  The remainder of our cost of sales
primarily includes tooling depreciation, freight-in from suppliers, inventory
reserves, concept and design expenses, employee compensation, expense related to
stock-based payment arrangements and certain recall-related
items.  Our purchases of finished products from Chinese manufacturers
are primarily denominated in Hong Kong dollars.  Expenses for these
manufacturers are primarily denominated in Chinese renminbi.  Any
material increase in the value of the Chinese renminbi relative to the U.S.
dollar would increase our suppliers’ expenses, and therefore, the cost of our
products, which could adversely affect our profitability.  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.  Additionally, as certain of our foreign subsidiaries
purchase inventory, effectively in U.S. dollars, any material increase in the
U.S. dollar relative to our foreign subsidiaries’ local currencies would
increase our expenses, and therefore, could adversely affect our
profitability.





If our
suppliers experience increased costs for raw materials, labor or other items,
and pass along such cost increases to us through higher prices for finished
goods, our cost of sales would increase, and to the extent we are unable to pass
such price increases along to our customers, our gross margins would
decrease.  For example, an increase in the price of zinc, a key
component in die-cast products, and increased costs in China, primarily for
labor, taxes and currency, reduced our gross margins in 2007 and
2008.  During 2009, we experienced raw material and freight cost
reductions.  In 2010, we expect our input costs to increase from 2009
levels.





Our
quarterly gross margins can also be affected by the mix of product that is
shipped during each quarter.  Our mother, infant and toddler products
category has higher sales of non-licensed products that carry lower selling
prices and gross margins than our preschool, youth and adult products
category.  Additionally, individual product lines within each category
carry gross margins that vary significantly and cause quarterly fluctuations,
based on the timing of these individual shipments throughout the
year.





Selling,
general and administrative expenses primarily consist of royalties, employee
compensation, advertising and marketing, freight-out and other distribution
costs, sales commissions, expense related to stock-based compensation
arrangements and certain recall-related items.  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.  In 2009, aggregate royalties by product ranged up to
17.0% of our net sales price.  Royalty expense was 7.1% of our net
sales for each of the years ended December 31, 2007, 2008 and
2009.  Sales commissions range up to 12.5% of the net sales price, and
are generally paid quarterly to our external sales representative
organizations.  Sales subject to commissions represented 29.5%, 30.9%
and 32.6% of our net sales for the years ended December 31, 2007, 2008 and 2009,
respectively.  Sales commission expense was 1.2%, 1.1% and 1.1% of our
net sales for the years ended December 31, 2007, 2008 and 2009,
respectively.





In the
fourth quarter of 2008, the Company implemented an operating cost reduction
plan.  Under this plan, the Company reduced approximately 15.0% of its
full-time, white-collar workforce.  In addition, the Company enacted
plans to reduce non-payroll operating expenses in 2009.  In connection
with this plan and other personnel changes, the Company incurred severance and
certain non-cash charges of $1.5 million, net of tax, in the fourth quarter of
2008.  Primarily as a result of this cost reduction plan, and to a
lesser extent, lower variable sales-related costs, selling, general and
administrative expenses decreased by $19.0 million in the year ended December
31, 2009, as compared with the year ended December 31, 2008.





Seasonality.  We
have experienced, and expect to continue to experience, substantial fluctuations
in our quarterly net sales and operating results, which is typical of many
companies in our industry.  Our business is highly seasonal primarily
due to the high consumer demand for our toy products during the year-end holiday
season.  Approximately 58.3% of our net sales for the three years
ended December 31, 2009, were generated in the second half of the
year.  As a result, our working capital, mainly inventory and accounts
receivable, is typically highest during the third and fourth quarters and lowest
during the first and second quarters.


17


Results
of Operations








Year Ended December
    31,2007
            
            
            2008
            
            
            2009(in
      thousands, except per share data)
            
            Amount
            
            
            Percent
            
            
            Amount
            
            
            Percent
            
            
            Amount
            
            
            PercentNet
      sales (1)
            
            $
            488,999
            
            
            
            100.0
            %
            
            $
            437,029
            
            
            
            100.0
            %
            
            $
            421,139
            
            
            
            100.0
            %Cost
      of sales
            
            
            270,059
            
            
            
            55.2
            
            
            
            246,301
            
            
            
            56.4
            
            
            
            236,243
            
            
            
            56.1Recall-related
      items
            
            
            4,624
            
            
            
            1.0
            
            
            
            (1,114
            )
            
            
            (0.3
            )
            
            
            (298
            )
            
            
            (0.1
            )Gross
      profit
            
            
            214,316
            
            
            
            43.8
            
            
            
            191,842
            
            
            
            43.9
            
            
            
            185,194
            
            
            
            44.0Selling,
      general and administrative expenses
            
            
            161,560
            
            
            
            33.0
            
            
            
            155,903
            
            
            
            35.7
            
            
            
            136,869
            
            
            
            32.5Amortization
      of intangible assets
            
            
            893
            
            
            
            0.2
            
            
            
            889
            
            
            
            0.2
            
            
            
            608
            
            
            
            0.2Impairment
      of goodwill and other intangible assets
            
            
            —
            
            
            
            —
            
            
            
            255,853
            
            
            
            58.6
            
            
            
            2,432
            
            
            
            0.6Recall-related
      items
            
            
            18,068
            
            
            
            3.7
            
            
            
            15,782
            
            
            
            3.6
            
            
            
            576
            
            
            
            0.1Terminated
      acquisition costs
            
            
            —
            
            
            
            —
            
            
            
            1,399
            
            
            
            0.3
            
            
            
            —
            
            
            
            —Operating
      income (loss)
            
            
            33,795
            
            
            
            6.9
            
            
            
            (237,984
            )
            
            
            (54.5
            )
            
            
            44,709
            
            
            
            10.6Interest
      expense
            
            
            2,712
            
            
            
            0.5
            
            
            
            6,584
            
            
            
            1.5
            
            
            
            3,923
            
            
            
            0.9Interest
      income
            
            
            (1,197
            )
            
            
            (0.2
            )
            
            
            (1,579
            )
            
            
            (0.4
            )
            
            
            (546
            )
            
            
            (0.1
            )Write-off
      of investment
            
            
            —
            
            
            
            —
            
            
            
            2,057
            
            
            
            0.5
            
            
            
            —
            
            
            
            —Other
      (income) expense, net
            
            
            (1,768
            )
            
            
            (0.4
            )
            
            
            (3,553
            )
            
            
            (0.8
            )
            
            
            780
            
            
            
            0.2Income
      (loss) from continuing operations
              before income taxes
            
            
            34,048
            
            
            
            7.0
            
            
            
            (241,493
            )
            
            
            (55.3
            )
            
            
            40,552
            
            
            
            9.6Income
      tax expense (benefit)
            
            
            12,472
            
            
            
            2.6
            
            
            
            (35,741
            )
            
            
            (8.2
            )
            
            
            13,590
            
            
            
            3.2Income
      (loss) from continuing operations
            
            
            21,576
            
            
            
            4.4
            
            
            
            (205,752
            )
            
            
            (47.1
            )
            
            
            26,962
            
            
            
            6.4Income
      from discontinued operations, net of tax
            
            
            110
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —Net
      income (loss)
            
            $
            21,686
            
            
            
            4.4
            %
            
            $
            (205,752
            )
            
            
            (47.1
            )%
            
            $
            26,962
            
            
            
            6.4
            %Basic
      earnings (loss) per common share:Income
      (loss) from continuing operations
            
            $
            1.05
            
            
            
            
            
            
            $
            (11.82
            )
            
            
            
            
            
            $
            1.42Income
      from discontinued operations
            
            
            0.01
            
            
            
            
            
            
            
            —
            
            
            
            
            
            
            
            —Net
      income (loss)
            
            $
            1.06
            
            
            
            
            
            
            $
            (11.82
            )
            
            
            
            
            
            $
            1.42Diluted
      earnings (loss) per common share:Income
      (loss) from continuing operations
            
            $
            1.04
            
            
            
            
            
            
            $
            (11.82
            )
            
            
            
            
            
            $
            1.39Income
      from discontinued operations
            
            
            0.01
            
            
            
            
            
            
            
            —
            
            
            
            
            
            
            
            —Net
      income (loss)
            
            $
            1.05
            
            
            
            
            
            
            $
            (11.82
            )
            
            
            
            
            
            $
            1.39Weighted
      average shares outstanding:Basic
            
            
            20,395
            
            
            
            
            
            
            
            17,406
            
            
            
            
            
            
            
            19,014Diluted
            
            
            20,748
            
            
            
            
            
            
            
            17,406
            
            
            
            
            
            
            
            19,362





(1)  Net
sales for the years ended December 31, 2007, 2008 and 2009, include $(5.6)
million, $0.3 million and $0.4 million, respectively, in recall-related
items.





18


Calculation
of Adjusted EBITDA (1)





Year Ended December 31,(in
      thousands)
            
            2007
            
            
            2008
            
            
            2009Income
      (loss) from continuing operations before income taxes
            
            $
            34,048
            
            
            $
            (241,493
            )
            
            $
            40,552Impairment
      of goodwill and other intangible assets
            
            
            —
            
            
            
            255,853
            
            
            
            2,432Depreciation
      and amortization
            
            
            14,843
            
            
            
            16,279
            
            
            
            12,058Compensation
      expense for equity awards
            
            
            4,705
            
            
            
            6,078
            
            
            
            6,298Cash-based
      severance charges
            
            
            —
            
            
            
            1,344
            
            
            
            —Recall-related
      items
            
            
            28,288
            
            
            
            14,327
            
            
            
            (160
            )Terminated
      acquisition costs
            
            
            —
            
            
            
            1,399
            
            
            
            —Write-off
      of investment
            
            
            —
            
            
            
            2,057
            
            
            
            —(Gain)
      loss on disposal of fixed assets
            
            
            (20
            )
            
            
            (51
            )
            
            
            141Interest
      expense
            
            
            2,712
            
            
            
            6,584
            
            
            
            3,923Adjusted
      EBITDA
            
            $
            84,576
            
            
            $
            62,377
            
            
            $
            65,244




(1)  Adjusted
EBITDA is presented as a supplemental measure of our performance and constitutes
non-GAAP financial information.  See “Non-GAAP Financial
Information”
and “Adjusted
EBITDA”
below.


Reconciliation
of Diluted Earnings (Loss) Per Common Share (1)





Year
      Ended December 31,2007
            
            
            2008
      (2)
            
            
            2009As
      reported
            
            $
            1.04
            
            
            $
            (11.82
            )
            
            $
            1.39Impairment
      of goodwill and other intangible assets
            
            
            —
            
            
            
            12.39
            
            
            
            0.06Recall-related
      items
            
            
            0.84
            
            
            
            0.57
            
            
            
            0.02Write-off
      of tooling
            
            
            —
            
            
            
            0.10
            
            
            
            —Severance
      and other non-cash charges
            
            
            —
            
            
            
            0.08
            
            
            
            —Write-off
      of investment
            
            
            —
            
            
            
            0.08
            
            
            
            —Terminated
      acquisition costs
            
            
            —
            
            
            
            0.06
            
            
            
            —As
      adjusted
            
            $
            1.88
            
            
            $
            1.46
            
            
            $
            1.47





(1)  Diluted
earnings (loss) per common share as adjusted is presented as a supplemental
measure of our performance and constitutes non-GAAP financial
information.  See “Non-GAAP Financial
Information”
below.


(2)  Because
actual results for 2008 generated a loss from continuing operations, any
potential common shares would be anti-dilutive, and accordingly, were excluded
from the diluted earnings (loss) per common share, as reported.  Diluted
earnings per share, as adjusted, for the year ended December 31, 2008, is
calculated using weighted average shares outstanding of 17,649, which includes
the dilution effect of outstanding stock options and stock-settled stock
appreciation rights (SARs).





Operating
Highlights





Net sales
for the year ended December 31, 2009, decreased 3.6%.  Gross margins
increased to 44.0% for 2009, from 43.9% for 2008.  Selling, general
and administrative expenses, as a percentage of net sales, decreased to 32.5% in
2009, from 35.7% in 2008.  The Company recorded operating income of
$44.7 million in 2009, compared with an operating loss of $238.0 million in
2008.





The
Company recorded charges for non-cash impairment of intangible assets and
recall-related items of $1.5 million, net of tax, or $0.08 per diluted share,
for the year ended December 31, 2009, which related entirely to the North
American segment.





The
Company recorded charges in 2008 for non-cash impairment of goodwill and
other intangible assets of $215.8 million, net of tax, a non-cash write-off of
tooling of $1.7 million, net of tax, severance and certain non-cash related
charges of $1.5 million, net of tax, recall-related items of $10.1 million, net
of tax, terminated acquisition costs of $1.0 million, net of tax, and a
non-cash write-off of an investment of $1.4 million, net of tax.  The
results for 2008 were negatively impacted by $13.28 per diluted share for these
charges.  The portion of these charges, net of tax, included in the
North America and International segments for the year ended December 31, 2008,
is $216.4 million and $15.1 million, respectively.





The
results for 2007 were negatively impacted by $17.6 million, net of tax, or $0.84
per diluted share, of items related to the 2007 recalls.  The portion
of these charges, net of tax, included in the North America and International
segments for the year ended December 31, 2007, is $14.8 million and $2.8
million, respectively.





Adjusted
EBITDA for the years ended December 31, 2007, 2008 and 2009, was $84.6 million,
$62.4 million and $65.2 million, respectively.





19


We expect
2010 will be a transition year for our preschool, youth and adult products
category as our license of the Take Along Thomas & Friends die-cast
product line terminated at the end of 2009.  This license provides for
a six month sell-off period following the license term.  For the year
ended December 31, 2009, net sales of our products under the Take Along Thomas & Friends license agreement
accounted for approximately 12% of our total net sales.





Year
Ended December 31, 2009, Compared to Year Ended December 31, 2008





Net
sales.  Net sales decreased $15.9 million, or 3.6%, to $421.1
million for 2009, from $437.0 million for 2008.  Net sales were
negatively impacted by 3.0% due to unfavorable fluctuations in foreign currency
exchange rates.  Net sales in our North America segment decreased
1.8%, and net sales in our international segment decreased 8.9%, which was
negatively impacted by 9.0% due to unfavorable fluctuations in foreign currency
exchange rates.





Net sales
in our mother, infant and toddler products category increased 2.7%, primarily
driven by higher sales in our infant and toddler feeding product lines somewhat
offset by lower sales in our infant and toddler play product
lines.  Net sales in our preschool, youth and adult products category
decreased 8.0%, primarily driven by lower sales in our collectibles product
lines somewhat offset by higher sales in our Thomas & Friends Wooden
Railway product line and the launch of our new Super WHY! product line in
2009.





Gross
profit.  Gross profit decreased $6.6 million, or 3.4%, to
$185.2 million for 2009, from $191.8 million for 2008.  The gross
profit margin, as a percentage of net sales, increased slightly to 44.0% for
2009, from 43.9% for 2008, primarily due to cost reduction initiatives and the
impact from the 2008 non-cash tooling write-off and severance, offset by less
favorable product mix shifts and unfavorable foreign currency rate impact on our
international segment’s product costs.  Gross profit for the year
ended December 31, 2008, includes $2.7 million for a write-off of tooling and
$0.2 million of severance charges, partially offset by recall-related recoveries
of $1.5 million.  There were no major changes in the components of
cost of sales.





Selling, general
and administrative expenses.  Selling, general and
administrative expenses decreased $19.0 million, or 12.2%, to $136.9 million for
2009, from $155.9 million for 2008.  Selling, general and
administrative expenses for the year ended December 31, 2008, include $2.0
million of severance and other related charges.  In addition to the
severance and other related charges in 2008, the decrease in selling, general
and administrative expenses is primarily due to the net impact of the Company’s
operating cost reduction plan, and to a lesser extent, lower sales-related
variable costs.  As a percentage of net sales, selling, general and
administrative expenses decreased to 32.5% for 2009, from 35.7% for
2008.





Operating income
(loss).  The Company reported operating income of $44.7
million, or 10.6% of net sales, for 2009, as compared to an operating loss of
$238.0 million, or 54.5% of net sales, for 2008.  Operating income for
the year ended December 31, 2009, includes a $2.4 million impairment charge
on intangible assets.  The operating loss for the year ended
December 31, 2008, includes an impairment of goodwill and other intangible
assets of $255.9 million, recall-related items of $14.3 million, a $2.7 million
write-off of tooling, $2.2 million of severance and other related charges, a
$2.1 million write-off of investment and $1.4 million of terminated acquisition
costs.





Interest
expense.  Interest expense of $3.9 million for 2009 and $6.6
million for 2008 relates primarily to the bank term loan and line of
credit.  The decrease in interest expense for 2009 was due to
lower average outstanding debt, as well as lower average interest
rates.





Income
tax.  Income tax expense (benefit) for the years ended December
31, 2008 and 2009, includes a benefit for federal, state and foreign income
taxes at an effective rate of 14.8% and a provision of 33.5%, respectively,
including discrete items.  Discrete items include significant,
infrequent, unusual or non-recurring items.  The effective rate for
2008 was impacted by the goodwill impairment, the majority of which was non-tax
deductible.  Additionally, the variation in the effective tax rate was
impacted by differences in discrete items and the mix of taxable income across
various tax jurisdictions.





20


Year
Ended December 31, 2008, Compared to the Year Ended December 31,
2007





Net
Sales.  Net sales decreased $52.0 million, or 10.6%, to $437.0
million for 2008, from $489.0 million for 2007.  Net sales were
negatively impacted by 1.0% due to unfavorable fluctuations in foreign currency
exchange rates.  Net sales in our North America segment decreased
14.3%, and net sales in our international segment increased 2.2%, which was
negatively impacted by 4.7% due to unfavorable fluctuations in foreign currency
exchange rates.





Net sales
for the year ended December 31, 2008, excluding $2.3 million in net sales of
discontinued product lines and $(0.3) million of recall-related items, were
$434.4 million, a decrease of 8.0% when compared with net sales for the year
ended December 31, 2007, excluding $22.2 million in net sales of discontinued
product lines and $5.6 million of recall-related items, of $472.4
million.  Information in this paragraph regarding net sales, excluding
recall-related items and excluding discontinued product lines, constitutes
non-GAAP financial information.  See discussion of “Non-GAAP Financial
Information” below.  A reconciliation to the nearest GAAP financial
measure follows:





(in
      millions)
            
            Net
      Sales2008
      actual
            
            $
            437.0Add:
      recall-related items
            
            
            (0.3
            )Deduct:
      discontinued product lines
            
            
            2.3As
      adjusted
            
            $
            434.42007
      actual
            
            $
            489.0Add:
      recall-related items
            
            
            5.6Deduct:
      discontinued product lines
            
            
            22.2As
      adjusted
            
            $
            472.4





Net sales
decreases occurred in both our mother, infant and toddler products category and
our preschool, youth and adult products category.





Net sales
in our preschool, youth and adult products category decreased 15.0%, primarily
driven by declines in our licensed toy product lines and ride-ons and lower
sales of discontinued product lines, which offset the increase generated from
the initial launch of our Caring Corners® product
line.  Excluding net sales of discontinued product lines and
recall-related items, net sales in our preschool, youth and adult products
category decreased 10.8%.  Net sales in our mother, infant and toddler
products category decreased 3.5%, primarily driven by decreases in our infant
and toddler toys and care product lines, somewhat offset by increases in our
infant feeding and infant and toddler gear product lines.  Information
in this paragraph regarding net sales in our preschool, youth and adult products
category excluding recall-related items and excluding discontinued product lines
constitutes non-GAAP financial information.  See discussion of
“Non-GAAP Financial Information” below.





A
reconciliation to the nearest GAAP financial measure follows:





Net Sales(in
      millions)
            
            2008
            
            
            2007
            
            
            Difference
            
            
            %
      ChangePreschool,
      youth and adult products actual
            
            $
            258.5
            
            
            $
            304.1
            
            
            $
            (45.6
            )
            
            
            (15.0
            )%Add:
      recall-related items
            
            
            (0.3
            )
            
            
            4.9
            
            
            
            (5.2
            )
            
            
            (106.1
            )Deduct:
      discontinued product lines
            
            
            2.3
            
            
            
            22.2
            
            
            
            (19.9
            )
            
            
            (89.6
            )As
      adjusted
            
            $
            255.9
            
            
            $
            286.8
            
            
            $
            (30.9
            )
            
            
            (10.8
            )%





Gross
profit.  Gross profit decreased $22.5 million, or 10.5%, to
$191.8 million for 2008, from $214.3 million for 2007.  The gross
profit margin, as a percentage of net sales, increased slightly to 43.9% for
2008, compared to 43.8% for 2007.  Gross profit for the year ended
December 31, 2008, includes $2.7 million for a write-off of tooling and $0.2
million of severance charges, partially offset by recall-related recoveries of
$1.5 million.  Gross profit for the year ended December 31, 2007,
includes $10.2 million of recall-related items.  Excluding these
non-recurring charges, gross profit margin was adversely affected by a less
favorable product mix and higher product costs, which were partially offset by
cost improvement initiatives and price increases.  There were no major
changes in components of cost of sales.





21


Selling, general
and administrative expenses.  Selling, general and
administrative expenses decreased $5.7 million, or 3.5%, to $155.9 million for
2008, from $161.6 million for 2007.  The decrease in selling, general
and administrative expenses was primarily due to lower marketing and variable
sales costs, partially offset by $2.0 million of severance and other related
charges.  As a percentage of net sales, selling, general and
administrative expenses increased to 35.7% for 2008, from 33.0% for 2007,
resulting from reduced sales leverage, as a portion of these costs are fixed in
nature.





Operating income
(loss).  The Company reported an operating loss of $238.0
million, or 54.5% of net sales, for 2008, as compared to operating income of
$33.8 million, or 6.9% of net sales, for 2007.  Operating loss for the
year ended December 31, 2008, includes an impairment of goodwill and other
intangible assets of $255.9 million, recall-related items of $14.3 million, a
$2.7 million write-off of tooling, $2.2 million of severance and other related
charges, a $2.1 million write-off of investment and $1.4 million of terminated
acquisition costs.  Operating income for the year ended December 31,
2007, was negatively impacted by $28.3 million of recall-related items and $8.3
million of investment spending to support our new product launches and to build
consumer awareness of our owned brands.





Interest
expense.  Interest expense of $6.6 million for 2008 and $2.7
million for 2007 relates primarily to the bank term loan and line of
credit.  The increase in interest expense in 2008 was primarily due to
the increase in average outstanding debt balances.





Income
tax.  Income tax expense (benefit) for the years ended December
31, 2007 and 2008, includes provisions for federal, state and foreign income
taxes at an effective rate of 36.6% and a benefit of 14.8%, respectively,
including discrete items.  Discrete items include significant,
infrequent, unusual or non-recurring items.  The decrease in the
effective tax rate primarily resulted from the goodwill impairment, the majority
of which was non-tax deductible.





Non-GAAP
Financial Information





This
section includes non-GAAP financial information consisting of net sales
excluding recall-related items and excluding discontinued product lines,
Adjusted EBITDA (as described in more detail in the next section) and diluted
earnings (loss) per common share adjusted to exclude certain
items.  Internally, we use this non-GAAP financial information for the
following purposes: financial and operational decision making, evaluating
period-to-period results and making comparisons of our results with those of our
competitors.  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.  Because
the sales related to discontinued product lines have decreased significantly as
the Company sells off the remaining inventory and recall-related items have
decreased significantly, the Company believes that the presentation of this
non-GAAP information enhances an investor’s ability to make period-to-period
comparisons of the Company’s operating results.  This information
should be considered in addition to the results presented in accordance with
GAAP, and should not be considered a substitute for the GAAP
results.





Adjusted
EBITDA





Adjusted
EBITDA is defined as earnings before interest expense, taxes, depreciation and
amortization as further adjusted to eliminate the impact of the other items set
forth in “Calculation of
Adjusted EBITDA” above that we do
not believe are indicative of our core operating performance. 
Adjusted EBITDA is not adjusted for all non-cash expenses or for working
capital, capital expenditures or other investment requirements and, accordingly,
is not necessarily indicative of amounts that may be available for discretionary
uses.  Because of these limitations, Adjusted EBITDA should not be
considered in isolation or as a substitute for net income or cash provided by
operating activities, each prepared in accordance with GAAP, when measuring
RC2’s profitability or liquidity as more fully discussed in the Company’s
accompanying consolidated financial statements.





Liquidity
and Capital Resources





We
generally fund our operations and working capital needs through cash generated
from operations and borrowings under our credit facility.  Our
operating activities generated cash of $63.5 million in 2007, $17.5 million in
2008 and $62.8 million in 2009.





22


Working
capital increased $62.6 million to $188.4 million at December 31, 2009, from
$125.8 million at December 31, 2008.  This increase in working capital
resulted from the increase in cash and cash equivalents due to the $57.1 million
of net proceeds from the Company’s public offering in the third quarter of 2009,
and a reduction in current liabilities at December 31, 2009, primarily because
no part of our outstanding debt was classified as current liabilities at
December 31, 2009, as compared to $15.0 million classified as current
liabilities at December 31, 2008.  Cash and cash equivalents increased
$55.9 million to $88.0 million at December 31, 2009, from $32.1 million at
December 31, 2008.  Our inventory levels decreased $8.1 million to
$65.9 million at December 31, 2009, from $74.0 million at December 31, 2008,
primarily due to improved inventory management.  Accounts payable and
accrued expenses decreased $4.0 million to $70.0 million at December 31, 2009,
from $74.0 million at December 31, 2008, primarily due to lower inventory
purchases and lower customer allowance expenses.





Net cash
used in investing activities was $20.3 million in 2007, $9.5 million in
2008 and $12.9 million in 2009.  The increase in 2009 was primarily
attributable to investments made in unrestricted certificates of deposit with
maturities greater than 90 days.  Capital expenditures, primarily for
molds and tooling, in 2008 and 2009 were $9.4 million and $8.6 million,
respectively, and we expect capital expenditures for 2010, primarily for molds
and tooling, to be in the range of $11.0 million to $12.0 million.





Net cash
used in financing activities was $12.3 million in 2007 and $26.0 million in
2008.  Net cash provided by financing activities was $3.4 million in
2009.  Payments of outstanding debt under our credit facility were
$56.9 million for the year ended December 31, 2009, of which $33.8 million
related to payments on the term loan and $23.1 million related to payments on
the line of credit, and $173.0 million for the year ended December 31, 2008, all
of which were made on our line of credit.  Borrowings under our credit
facility were $3.0 million on our line of credit during the year ended December
31, 2009, and $75.0 million on our term loan and $98.1 million on our line of
credit during the year ended December 31, 2008.  During the year ended
December 31, 2009, the Company received net proceeds of $57.1 million from the
completion of a public offering of 4.0 million shares of common
stock.  During the year ended December 31, 2008, we purchased $24.7
million of our common stock pursuant to a stock repurchase program which
terminated on December 31, 2008, which we funded primarily with cash from
operations.





On
November 3, 2008, the Company entered into a credit facility to replace its
previous credit facility.  The credit facility is comprised of a term
loan and provides for borrowings up to $70.0 million under a revolving line of
credit.  The total borrowing capacity available under the credit
facility is subject to a formula based on the Company’s leverage ratio, as
defined in the credit agreement.  The term loan and the revolving line
of credit both have a scheduled maturity date of November 1,
2011.  Under this credit facility, the term loan and the revolving
line of credit bear interest, at the Company’s option, at a base rate or at
LIBOR, plus applicable margins, which are based on the Company’s
leverage ratio.  Applicable margins vary between 2.25% and 3.25%
on LIBOR borrowings and 1.25% and 2.25% on base rate borrowings.  At
December 31, 2009, the applicable margins in effect were 2.50% for LIBOR
borrowings and 1.50% for base rate borrowings.  Principal payments on
the term loan are $3.8 million per calendar quarter, with the remaining
principal of $33.8 million due on November 1, 2011.  During the fourth
quarter of 2009, the Company prepaid $18.8 million on its term loan, with the
next quarterly principal payment of $3.8 million due on June 30,
2011.  The Company is also required to pay a commitment fee which
varies from 0.45% and 0.50% per annum on the average daily unused portion of the
revolving line of credit.  At December 31, 2009, the commitment fee in
effect was 0.50% 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, buy back shares of its
common stock, incur additional debt and make acquisitions above certain
amounts.  The credit facility also includes a clean down provision
that limits the maximum amount of borrowings under the revolving line of credit
for a period of 60 consecutive days during the first four calendar
months.  The clean down provision limits are $27.5 million for a
period of 60 consecutive days during the first four calendar months of 2010, and
$25.0 million for a period of 60 consecutive days during the first four calendar
months of 2011.  The Company has met its clean down provision for the
year 2010, as of the date of this filing.  The credit facility is
secured by the Company’s domestic assets along with a portion of the Company’s
equity interests in its foreign subsidiaries.  On December 31, 2009,
the Company had $41.3 million outstanding on its bank term loan and no
borrowings under its revolving line of credit.  Additionally at
December 31, 2009, the Company had $70.0 million available on its revolving line
of credit and was in compliance with all covenants.





In
conjunction with this credit facility, the Company incurred approximately $2.4
million in financing fees which are being charged to interest expense using
the effective interest rate method in the accompanying consolidated statements
of operations through the term of the credit agreement, which is currently
November 1, 2011.  The net balance of $2.2 million and $1.2 million is
included in other non-current assets in the accompanying consolidated balance
sheets at December 31, 2008 and 2009, respectively.








23


The
Company’s Hong Kong subsidiary maintains credit facilities with two banks
providing for documentary and standby letters of credit of up to $4.9
million and overdraft protection of up to $0.2 million.  Amounts
borrowed are due on demand, but are generally available for 90 days, bear
interest at the bank’s prime rate or prevailing funding cost, whichever is
higher, and are cross guaranteed by the Company.  As of December 31,
2009, there were no amounts outstanding under these credit
facilities.





The
following table summarizes our significant contractual commitments at December
31, 2009:








Payment Due by Period(in
      thousands)
              Contractual
      Obligations
            
            Total
            
            
            2010
            
            
            
            2011-2012
            
            
            
            2013-2014
            
            
            2015
      and
              beyondLong-term
      debt
            
            $
            41,250
            
            
            $
            —
            
            
            $
            41,250
            
            
            $
            —
            
            
            $
            —Estimated
      future interest payments on long-term debt (1)
            
            
            2,416
            
            
            
            1,484
            
            
            
            932
            
            
            
            —
            
            
            
            —Minimum
      guaranteed royalty payments
            
            
            25,493
            
            
            
            5,610
            
            
            
            13,608
            
            
            
            6,275
            
            
            
            —Operating
      leases
            
            
            29,334
            
            
            
            4,365
            
            
            
            6,780
            
            
            
            5,556
            
            
            
            12,633Unconditional
      purchase obligations
            
            
            74,847
            
            
            
            26,368
            
            
            
            33,420
            
            
            
            15,059
            
            
            
            —Total
      contractual cash obligations
            
            $
            173,340
            
            
            $
            37,827
            
            
            $
            95,990
            
            
            $
            26,890
            
            
            $
            12,633





(1)  Estimated
future interest payments on our long-term debt were based upon the interest
rates in effect at December 31, 2009, and the balance outstanding on the term
loan, and the unused portion of the line of credit at December 31,
2009.


(2)  The
above table does not reflect unrecognized tax benefits of $2.8 million, the
timing of which is uncertain.





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





As we
anticipate our working capital levels in 2010 will be relatively consistent with
2009, and there are no scheduled debt repayments in 2010, we believe that
our cash flows from operations, cash on hand and available borrowings will be
sufficient to meet our working capital and capital expenditures requirements and
provide us with adequate liquidity to meet anticipated operating needs in
2010.  Any significant future acquisitions, including up-front
licensing payments for new products, may require additional debt or equity
financing.  Due to seasonal increases in demand for our toy products,
our working capital is typically highest during the third and fourth quarters,
and our debt levels are highest during the third quarter.





Off-Balance
Sheet Arrangements





The
Company did not have any off-balance sheet arrangements during any of the years
ended December 31, 2007, 2008 and 2009.





Critical
Accounting Policies and Estimates





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


Allowance for
doubtful accounts.The allowance for
doubtful accounts represents adjustments to customer trade accounts receivable
for amounts deemed uncollectible.  The allowance for doubtful accounts
reduces gross trade receivables to their estimated net realizable
value.  The Company’s allowance is based on management’s assessment of
the business environment, customers’ financial condition, historical trends,
customer payment practices, receivable aging and customer
disputes.  The Company maintains credit insurance for some of
its major domestic customers, and the amount of this insurance covers
a limited amount of the total amount of its accounts receiveable.  The
Company will continue to proactively review its credit risks and adjust its
customer terms to reflect the current environment.





24


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





Impairment of
long-lived assets, goodwill and other intangible
assets.  Long-lived assets have been reviewed for impairment
based on the requirements under the Intangibles-Goodwill and Other Topic of the
FASB Accounting Standards Codification.  This Topic requires that an
impairment loss be recognized whenever the carrying value of an asset exceeds
the sum of the undiscounted cash flows expected to result from the use and
eventual disposition of that asset, excluding future interest costs the entity
would recognize as an expense when incurred.  Goodwill and other
intangible assets have been reviewed for impairment based on the requirements
under the Intangibles-Goodwill and Other Topic of the FASB Accounting Standards
Codification.  Under this Topic, goodwill and other intangible assets
that have indefinite useful lives are not amortized, but rather tested at least
annually for impairment.  In the fourth quarter of 2008, the Company
recorded an impairment charge, writing-off its entire balance of
goodwill.  In the fourth quarters of 2008 and 2009, the Company
recorded other intangible asset impairment charges in the North America segment
of $11.9 million and $2.4 million, respectively.  The next scheduled
annual test for impairment on its other indefinite lived intangibles will be as
of October 1, 2010, and will be completed in the fourth quarter of
2010.  The Company’s management reviews for indicators that might
suggest an impairment loss could exist.  An interim test for
impairment is performed if a triggering event occurs suggesting possible
impairment.  Testing for impairment requires estimates of expected
cash flows to be generated from the use of the assets.  Various
uncertainties, including changes in consumer preferences, ability to maintain
related licenses, deterioration in the political environment, adverse conditions
in the capital markets or changes in general economic conditions, could impact
the expected cash flows to be generated by an asset or group of
assets.  Intangible assets that have finite useful lives are amortized
over their useful lives.





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.





Management
considers certain tax exposures and all available evidence when evaluating and
estimating tax positions and tax benefits, which may require periodic
adjustments and which may not accurately anticipate actual
outcomes.  If the available evidence were to change in the future, an
adjustment to the tax-related balances may be required.  Estimates for
such tax contingencies are classified in other current liabilities and other
non-current liabilities in the accompanying consolidated balance
sheets.





Product
recalls.  The Company establishes a reserve for a product
recall on a product-specific basis during the period in which the circumstances
giving rise to the recall become known and estimable.  Facts
underlying the recall, including, among others, estimates of retailer inventory
returns, consumer replacement costs, fines and penalties, and shipping costs are
considered when establishing a product recall reserve.  In 2007 and
2008, the Company also considered additional replacement costs or refunds,
donations, notice charges, claims administration, licensor indemnification
claims and plaintiffs’ legal fees related to settlement of litigation related to
the recalls.  The Company’s legal costs to defend recall-related
matters are expensed as incurred.  When facts or circumstances become
known that would indicate that the recall reserve is either not sufficient to
cover or exceeds the estimated product recall expenses, the reserve is adjusted,
as appropriate.





25


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





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





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





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





Recently
Issued Accounting Codification





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





In August
2009, the FASB issued new requirements under the Compensation – Retirement
Benefits Topic of the Codification.  The new requirements provide
guidance on an employer’s disclosures about plan assets of a defined benefit
plan or other postretirement plan.  The objectives of the new
requirements are to provide users of financial statements with an understanding
of (a) how investment allocation decisions are made, including the factors that
are pertinent to an understanding of investment policies and strategies; (b) the
major categories of plan assets; (c) the inputs and valuation techniques used to
measure the fair value of plan assets; (d) the effect of fair value measurements
using significant unobservable inputs (Level 3) on changes in plan assets for
the period; and (e) significant concentrations of risk within plan
assets.  The disclosures under the new requirements are effective for
fiscal years ending after December 15, 2009.  The Company adopted
these requirements with the year ended December 31, 2009.





In June
2009, the FASB issued new requirements under the Subsequent Event Topic of the
Codification.  The requirements under this Topic establish general
standards of accounting for and disclosure events that occur after the balance
sheet date but before financial statements are issued or are available to be
issued.  In accordance with this Topic, an entity should apply these
requirements to interim or annual financial periods ending after June 15,
2009.  The Company adopted these requirements on June 30,
2009.  In preparing the accompanying consolidated financial
statements, the Company evaluated the events and transactions that occurred
between December 31, 2009 and March 1, 2010, the date the accompanying
consolidated financial statements were issued.


26


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





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





Item
7A. Quantitative and Qualitative Disclosures About Market Risk





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





Based on
the Company’s interest rate exposure on variable rate borrowings at December 31,
2009, a one percentage point increase in average interest rates on the Company’s
borrowings would increase future interest expense by less than $0.1 million per
month and a five percentage point increase would increase future interest
expense by approximately $0.2 million per month.  The Company
determined these amounts based on $41.3 million of variable rate borrowings at
December 31, 2009, multiplied by 1.0% and 5.0%, respectively, and divided by
twelve.  The Company is currently not using any interest rate collars,
hedges or other derivative financial instruments to manage or reduce interest
rate risk.  As a result, any increase in interest rates on the
Company’s variable rate borrowings would increase interest expense and reduce
net income.





The
Company’s net sales are primarily denominated in U.S. dollars, with 21.9% of net
sales for the year ended December 31, 2009, denominated in British pounds
sterling, Australian dollars, Euros and Canadian dollars.  The
Company’s purchases of finished goods from Chinese manufacturers are primarily
denominated in Hong Kong dollars.  Expenses for these manufacturers
are primarily denominated in Chinese renminbi.  Any material increase
in the value of the Chinese renminbi relative to the U.S. dollar would increase
our suppliers’ expenses, and therefore, the cost of our products, which could
adversely affect the Company’s profitability.  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.  A 10.0% change
in the exchange rate of the U.S. dollar with respect to the Hong Kong dollar for
the year ended December 31, 2009, would have changed the total dollar amount of
our gross profit by 9.9%.  The Company is also subject to exchange
rate risk relating to transfers of funds or other transactions denominated in
British pounds sterling, Australian dollars, Canadian dollars or Euros from its
foreign subsidiaries to the United States, such as for purchases of inventory by
certain of our foreign subsidiaries, effectively in U.S. dollars.  A
10.0% change in the exchange rate of the U.S. dollar with respect to the British
pound sterling, the Australian dollar and the Canadian dollar for the year ended
December 31, 2009, would have changed the total dollar amount of our gross
profit by 1.3%, 0.7% and 0.7%, respectively.  A 10.0% change in the
exchange rate of the U.S. dollar with respect to the translation of financial
reporting denominated in the British pound sterling, the Australian dollar or
the Euro for the year ended December 31, 2009, individually would not have had a
significant impact on the Company’s net income.  The Company is not
currently using and has not historically used hedges or other derivative
financial instruments to manage or reduce exchange rate risk.





27


Item
8.  Financial Statements and Supplementary Data





Financial
Statements





Our
consolidated financial statements and notes thereto are filed under this item
beginning on page F-1 of this report.





Quarterly
Results of Operations





The
following tables set forth our unaudited quarterly results of operations for
2008 and 2009.  We have prepared this unaudited information on a basis
consistent with the audited consolidated financial statements contained in this
report and this unaudited information includes all adjustments, consisting only
of normal recurring adjustments that we consider necessary for a fair
presentation of our results of operations for the quarters
presented.  You should read this quarterly financial data along with
the Condensed Consolidated Financial Statements and the related notes to those
statements included in our Quarterly Reports on Form 10-Q filed with the
Commission.  The operating results for any quarter are not necessarily
indicative of the results for the annual period or any future
period.





Fiscal Year 2008(in
      thousands, except per share data)
            
            
            Q1
            
            
            
            Q2
            
            
            
            Q3
            
            
            
            Q4Net
      sales
            
            $
            93,290
            
            
            $
            89,193
            
            
            $
            132,856
            
            
            $
            121,690Cost
      of sales (1)
            
            
            50,748
            
            
            
            48,300
            
            
            
            72,114
            
            
            
            75,139Recall-related
      items
            
            
            20
            
            
            
            401
            
            
            
            (1,357
            )
            
            
            (178
            )Gross
      profit
            
            
            42,522
            
            
            
            40,492
            
            
            
            62,099
            
            
            
            46,729Selling,
      general and administrative expenses (1)
            
            
            36,453
            
            
            
            34,909
            
            
            
            41,026
            
            
            
            43,515Amortization
      of intangible assets
            
            
            225
            
            
            
            226
            
            
            
            219
            
            
            
            219Impairment
      of goodwill and other intangible assets
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            255,853Recall-related
      items
            
            
            1,420
            
            
            
            15,229
            
            
            
            (1,464
            )
            
            
            597Terminated
      acquisition costs
            
            
            —
            
            
            
            —
            
            
            
            1,416
            
            
            
            (17
            )Operating
      income (loss)
            
            
            4,424
            
            
            
            (9,872
            )
            
            
            20,902
            
            
            
            (253,438
            )Interest
      expense
            
            
            1,464
            
            
            
            1,200
            
            
            
            1,714
            
            
            
            2,206Interest
      income
            
            
            (389
            )
            
            
            (460
            )
            
            
            (476
            )
            
            
            (254
            )Write-off
      of investment
            
            
            —
            
            
            
            —
            
            
            
            2,057
            
            
            
            —Other
      (income) expense, net
            
            
            (448
            )
            
            
            390
            
            
            
            229
            
            
            
            (3,724
            )Income
      (loss) before income taxes
            
            
            3,797
            
            
            
            (11,002
            )
            
            
            17,378
            
            
            
            (251,666
            )Income
      tax expense (benefit)
            
            
            1,796
            
            
            
            (4,589
            )
            
            
            6,269
            
            
            
            (39,217
            )Net
      income (loss)
            
            $
            2,001
            
            
            $
            (6,413
            )
            
            $
            11,109
            
            
            $
            (212,449
            )Earnings
      (loss) per common share:Basic
            
            $
            0.11
            
            
            $
            (0.37
            )
            
            $
            0.65
            
            
            $
            (12.32
            )Diluted
            
            $
            0.11
            
            
            $
            (0.37
            )
            
            $
            0.64
            
            
            $
            (12.32
            )Weighted
      average shares outstanding:Basic
            
            
            17,912
            
            
            
            17,260
            
            
            
            17,210
            
            
            
            17,245Diluted
            
            
            18,180
            
            
            
            17,260
            
            
            
            17,463
            
            
            
            17,245





(1)  Depreciation
expense was $3.1 million, $3.1 million, $3.2 million and $6.0 million for Q1,
Q2, Q3 and Q4 2008, respectively.


28





Fiscal Year 2009(in
      thousands, except per share data)
            
            
            Q1
            
            
            
            Q2
            
            
            
            Q3
            
            
            
            Q4Net
      sales
            
            $
            86,268
            
            
            $
            87,039
            
            
            $
            126,507
            
            
            $
            121,325Cost
      of sales (1)
            
            
            51,589
            
            
            
            50,313
            
            
            
            67,982
            
            
            
            66,359Recall-related
      items
            
            
            —
            
            
            
            —
            
            
            
            (197
            )
            
            
            (101
            )Gross
      profit
            
            
            34,679
            
            
            
            36,726
            
            
            
            58,722
            
            
            
            55,067Selling,
      general and administrative expenses (1)
            
            
            29,400
            
            
            
            29,888
            
            
            
            36,869
            
            
            
            40,712Amortization
      of intangible assets
            
            
            196
            
            
            
            165
            
            
            
            153
            
            
            
            94Impairment
      of intangible assets
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            2,432Recall-related
      items
            
            
            303
            
            
            
            246
            
            
            
            (112
            )
            
            
            139Operating
      income
            
            
            4,780
            
            
            
            6,427
            
            
            
            21,812
            
            
            
            11,690Interest
      expense
            
            
            1,177
            
            
            
            972
            
            
            
            819
            
            
            
            955Interest
      income
            
            
            (85
            )
            
            
            (106
            )
            
            
            (153
            )
            
            
            (202
            )Other
      expense (income), net
            
            
            723
            
            
            
            202
            
            
            
            (311
            )
            
            
            166Income
      before income taxes
            
            
            2,965
            
            
            
            5,359
            
            
            
            21,457
            
            
            
            10,771Income
      tax expense
            
            
            1,177
            
            
            
            2,030
            
            
            
            7,864
            
            
            
            2,519Net
      income
            
            $
            1,788
            
            
            $
            3,329
            
            
            $
            13,593
            
            
            $
            8,252Earnings
      per common share:Basic
            
            $
            0.10
            
            
            $
            0.19
            
            
            $
            0.68
            
            
            $
            0.39Diluted
            
            $
            0.10
            
            
            $
            0.19
            
            
            $
            0.66
            
            
            $
            0.38Weighted
      average shares outstanding:Basic
            
            
            17,248
            
            
            
            17,290
            
            
            
            20,078
            
            
            
            21,383Diluted
            
            
            17,306
            
            
            
            17,633
            
            
            
            20,602
            
            
            
            21,886





(1)  Depreciation
expense was $2.9 million, $2.9 million, $2.9 million and $2.8 million for Q1,
Q2, Q3 and Q4 2009, respectively.





Item
9.  Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure





Not
applicable.





Item
9A.  Controls and Procedures





Evaluation
of Disclosure Controls and Procedures





The
Company maintains disclosure controls and procedures (as defined in Rules
13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) designed to
ensure that information required to be disclosed by the Company in the reports
that it files or submits under the Securities Exchange Act of 1934 is recorded,
processed, summarized and reported within the time periods specified in the
SEC’s rules and forms, and that the information required to be disclosed by the
Company in reports that it files or submits under the Securities Exchange Act of
1934 is accumulated and communicated to its management, including its Chief
Executive Officer and Chief Financial Officer, as appropriate to allow timely
decisions regarding required disclosure.  The Company carried out an
evaluation as of December 31, 2009, under the supervision and with the
participation of the Company’s management, including its Chief Executive Officer
and Chief Financial Officer, of the effectiveness of the design and operation of
the Company’s disclosure controls and procedures.  Based on such
evaluation, the Company’s Chief Executive Officer and Chief Financial Officer
concluded that the Company’s disclosure controls and procedures were effective
as of December 31, 2009, at reaching a level of reasonable
assurance.  In designing and evaluating the disclosure controls and
procedures, management recognized that any controls and procedures, no matter
how well designed and operated, can provide only reasonable assurance of
achieving the desired control objectives, and management necessarily was
required to apply its judgment in evaluating the cost-benefit relationship of
possible controls and procedures.  The Company has designed its
disclosure controls and procedures to reach a level of reasonable assurance of
achieving the desired control objectives.





Changes
in Internal Control Over Financial Reporting





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.


29


Management’s
Report on Internal Control Over Financial Reporting





Management
of the Company is responsible for establishing and maintaining effective
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).  The
Company’s internal control over financial reporting is designed to provide
reasonable assurance to the Company’s management and board of directors
regarding the preparation and fair presentation of published financial
statements.  The Company’s internal control over financial reporting
includes those policies and procedures that:





(i)     pertain
to the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the
Company;





(ii)     provide
reasonable assurance that transactions are recorded as necessary to permit
preparation of financial statements in accordance with the U.S. generally
accepted accounting principles, and that receipts and expenditures of the
Company are being made only in accordance with authorizations of management and
directors of the Company; and





(iii)     provide
reasonable assurance regarding prevention or timely detection of unauthorized
acquisition, use or disposition of the Company’s assets that could have a
material effect on the financial statements.





Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements.  Therefore, even those systems
determined to be effective can provide only reasonable assurance with respect to
financial statement preparation and presentation.  Also, projections
of any evaluation of effectiveness to future periods are subject to the risk
that controls may become inadequate because of changes in conditions, or that
the degree of compliance with the policies or procedures may
deteriorate.





Management
assessed the effectiveness of the Company’s internal control over financial
reporting as of December 31, 2009.  In making this assessment,
management used the criteria set forth by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO) in Internal Control-Integrated
Framework.  Based on our assessment, management believes that,
as of December 31, 2009, the Company’s internal control over financial reporting
was effective based on those criteria.





KPMG LLP,
the independent registered public accounting firm that audited the Company’s
consolidated financial statements, has issued an attestation report on the
Company’s internal control over financial reporting, which appears on page F3
hereof.





Item
9B.  Other Information





Not
applicable.






Part
  III




Item
10.  Directors, Executive Officers and Corporate
Governance





Information
regarding the executive officers and directors of the Company is incorporated
herein by reference to the discussions under “Election of Directors,” “Executive
Officers,” “Section 16(a) Beneficial Ownership Reporting Compliance” and “Audit
Committee Matters-Audit Committee Financial Experts” in the Company’s Proxy
Statement for the 2010 Annual Meeting of Stockholders, which will be filed with
the Commission on or before April 30, 2010.  Information regarding the
Company’s Code of Business Ethics is incorporated herein by reference to the
discussions under “Corporate Governance Matters-Code of Business Ethics” in the
Company’s Proxy Statement for the 2010 Annual Meeting of
Stockholders.





The Audit
Committee of our Board of Directors is an “audit committee” for purposes of
Section 3(a)(58)(A) of the Securities Exchange Act of 1934.  The
members of the Audit Committee are John J. Vosicky
(Chairman),  Michael J. Merriman, Jr. and Daniel M.
Wright.





Item
11.  Executive Compensation





Information
regarding executive compensation is incorporated herein by reference to the
discussion under “Executive Compensation” and “Director Compensation” in the
Company’s Proxy Statement for the 2010 Annual Meeting of Stockholders, which
will be filed with the Commission on or before April 30, 2010.


30


The
information incorporated by reference from the “Report of the Compensation
Committee” in the Company’s Proxy Statement for the 2010 Annual Meeting of
Stockholders shall not be deemed “filed” for purposes of Section 18 of the
Securities Exchange Act of 1934, nor shall it be deemed incorporated by
reference in any filing under the Securities Act of 1933 or the Securities
Exchange Act of 1934, except as shall be expressly set forth by specific
reference in such filing.





Item
12.  Security Ownership of Certain Beneficial Owners and Management
and Related Stockholder Matters





Information
regarding our equity compensation plan and the security ownership of certain
beneficial owners and management is incorporated herein by reference to the
discussion under “Security Ownership” and “Equity Compensation Plan Information”
in the Company’s Proxy Statement for the 2010 Annual Meeting of Stockholders,
which will be filed with the Commission on or before April 30,
2010.


Item
13.  Certain Relationships and Related Party Transactions, and
Director Independence





Information
regarding certain relationships and related transactions is incorporated herein
by reference to the discussions under “Transactions with Related Persons” in the
Company’s Proxy Statement for 2010 Annual Meeting of Stockholders, which will be
filed with the Commission on or before April 30, 2010.  Information
regarding director independence is incorporated by reference to the discussions
under “Corporate Governance Matters-Director Independence” in the Company’s
Proxy Statement for the 2010 Annual Meeting of Stockholders, which will be filed
with the Commission on or before April 30, 2010.





Item
14.  Principal Accountant Fees and Services





Information
regarding the fees and services of the independent registered public accounting
firm is incorporated herein by reference to the discussion under “Audit
Committee Matters-Fees of Independent Registered Public Accounting Firm” in the
Company’s Proxy Statement for the 2010 Annual Meeting of Stockholders, which
will be filed with the Commission on or before April 30, 2010.








Part
  IV




Item
15.  Exhibits and Financial Statement Schedules





(a)        The
following documents are filed as part of this report:





1.         Financial
Statements





The
following consolidated financial statements of the Company are included in Item
8 of this report:





Reports
of Independent Registered Public Accounting Firm





Consolidated
Balance Sheets as of December 31, 2008 and 2009





Consolidated
Statements of Operations for the Years Ended December 31, 2007, 2008 and
2009





Consolidated
Statements of Stockholders’ Equity for the Years Ended December 31, 2007, 2008
and 2009





Consolidated
Statements of Cash Flows for the Years Ended December 31, 2007, 2008 and
2009





Notes to
Consolidated Financial Statements





31


2.        Financial
Statement Schedules





Report of
Independent Registered Public Accounting Firm





Financial
Statement Schedule for the Years Ended December 31, 2007, 2008 and
2009:





Schedule
              Number
            Description
            PageII
            Valuation
      and Qualifying Accounts
            36





All other
schedules for which provision is made in the applicable accounting regulations
of the Commission are not required under the related instructions, are
inapplicable or the required information is shown in the financial statements or
notes thereto, and therefore, have been omitted.




3.
            
            Exhibits3.1
            
            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)).3.2
            
            First Amendment to
      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)).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)).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)).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)).10.1*
            
            Employment
      Agreement, dated April 1, 2008, between the Company and Curtis W.
      Stoelting (incorporated by reference to Exhibit 10.1 of the Company’s
      Quarterly Report on Form 10-Q for the quarter ended March 31,
      2008 (File No. 0-22635)).10.2*
            
            Employment
      Agreement, dated April 1, 2008, between the Company and Peter J. Henseler
      (incorporated by reference to Exhibit 10.2 of the Company’s Quarterly
      Report on Form 10-Q for the quarter ended March 31, 2008 (File
      No. 0-22635)).10.3*
            
            Employment
      Agreement, dated November 5, 2008, between the Company and Peter A.
      Nicholson (incorporated by reference to Exhibit 99.1 of the Company’s
      Current Report on Form 8-K dated November 5, 2008 (File No.  0-22635)
      filed by the Company with the Securities and Exchange Commission on
      November 10, 2008).10.4*
            
            Employment
      Agreement, dated April 1, 2008, between the Company and Helena Lo
      (incorporated by reference to Exhibit 10.4 of the Company’s Quarterly
      Report on Form 10-Q for the quarter ended March 31, 2008 (File No.
      0-22635)).10.5*
            
            Employment
      Agreement, dated April 1, 2008, between the Company and Gregory J. Kilrea
      (incorporated by reference to Exhibit 10.5 of the Company’s Quarterly
      Report on Form 10-Q for the quarter ended March 31, 2008 (File No.
      0-22635)).10.6*
            
            RC2 Corporation 2005
      Stock Incentive Plan, as amended.






32


10.7*
              
              Form of Non
      Statutory Stock Option Grant Agreement for the RC2 Corporation 2005 Stock
      Incentive Plan (incorporated
      by reference to Exhibit 99.2 of the Company’s Current Report on Form 8-K
      (File No. 0-22635)filed
      by the Company with the Securities and Exchange Commission on May 10,
      2005).10.8*
              
              Form of
      Stock-Settled Stock Appreciation Right Grant Agreement for RC2 Corporation
      2005 Stock Incentive Plan.10.9*
              
              Form of Cash-Settled
      Stock Appreciation Right Grant Agreement for RC2 Corporation 2005 Stock
      Incentive Plan.10.10*
              
              Form of Restricted
      Stock Grant Agreement for RC2 Corporation 2005 Stock Incentive
    Plan.10.11*
              
              RC2 Corporation 2008
      Incentive Bonus Plan (incorporated by reference to Exhibit 99.2 of the
      Company’s Current Report
      on Form 8-K (File No. 0-22635) filed by the Company with the Securities
      and Exchange Commission onMay
      12, 2008).10.12*
              
              Outside Director
      Compensation Plan (incorporated by reference to Exhibit 10.4 to the
      Company’s Quarterly Report on
      Form 10-Q for the quarter ended June 30, 2005 (File No.
      0-22635)).10.13*
              
              Amendment to Outside
      Director Compensation Plan effective January 1, 2007 (incorporated by
      reference to Exhibit 10.1
      to the Company’s Quarterly Report on Form 10-Q for the quarter ended March
      31, 2007 (File No. 0-22635)).10.14*
              
              Racing Champions
      Ertl Corporation Stock Incentive Plan, as amended (incorporated by
      reference to Exhibit 10.5 of
      the Company’s Quarterly Report on Form 10-Q for the quarter ended
      September 30, 2002 (File No. 0-22635)).10.15*
              
              Wheels Sports Group,
      Inc. 1995 Omnibus Stock Plan (incorporated by reference to Exhibit 99.1 of
      the Company’s Quarterly
      Report on Form 10-Q for the quarter ended June 30, 1998 (File No.
      0-22635)).10.16*
              
              RC2 Corporation
      Employee Stock Purchase Plan, as amended (incorporated by reference to
      Exhibit 99.1 of the Company’s
      Current Report on Form 8-K dated May 4, 2007 (File No. 0-22635) filed by
      the Company with theSecurities
      and Exchange Commission on May 10, 2007).10.17
              
              Credit
      Agreement, dated as of November 3, 2008, among the Company, certain of its
      subsidiaries, Bank of Montreal,
      as administrative agent, BMO Capital Markets as sole lead arranger and
      sole book runner, and otherlenders
      named therein.10.18
              
              First
      Amendment to Credit Agreement, dated as of February 12, 2009, among the
      Company, certain of its subsidiaries, Bank of Montreal, as
      administrative agent, and other lenders named therein.21
              
              Subsidiaries of the
      Company.23.1
              
              Consent
      of Independent Registered Public Accounting Firm.24
              
              Power
      of Attorney (included as part of the signature page
    thereof).




33








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).






*
            Management contract
      or compensatory plan or arrangement.**
            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.(b)
            Exhibits
              The
      response to this portion of Item 15 is submitted as a separate section of
      this report.(c)
            Financial
      Statement Schedules
              The
      response to this portion of Item 15 is submitted as a separate section of
      this report.






34


SIGNATURES





Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
1934, the registrant has duly caused this Form 10-K to be signed on its behalf
by the undersigned, thereunto duly authorized.





Date:  March
1,
2010


RC2
CORPORATION




By /s/ Curtis W.
Stoelting


Curtis W.
Stoelting, Chief Executive Officer





POWER
OF ATTORNEY





Each
person whose signature appears below hereby appoints Curtis W. Stoelting and
Peter A. Nicholson, and each of them individually, his true and lawful
attorney-in-fact, with power to act with or without the other and with full
power of substitution and resubstitution, in any and all capacities, to sign any
or all amendments to the Form 10-K and file the same with all exhibits thereto,
and other documents in connection therewith, with the Securities and Exchange
Commission, granting unto said attorneys-in-fact and agents full power and
authority to do and perform each and every act and thing requisite and necessary
to be done in and about the premises, as fully to all intents and purposes as he
might or could do in person, hereby ratifying and confirming all that said
attorneys-in-fact and agents, or their substitutes, may lawfully cause to be
done by virtue hereof.





Pursuant
to the requirements of the Securities and Exchange Act of 1934, this Form 10-K
has been signed below by the following persons on behalf of the Registrant and
in the capabilities and on the dates indicated.





/s/ Robert E.
      Dods
            
            Chairman
      of the Board and Director
            March
      1, 2010Robert
      E. Dods/s/ Curtis W.
      Stoelting
            
            Chief
      Executive Officer and
            March
      1, 2010Curtis
      W. Stoelting
            
            Director
      (Principal Executive Officer)/s/ Peter A.
      Nicholson
            
            Chief
      Financial Officer and Secretary
            March
      1, 2010Peter
      A. Nicholson
            
            (Principal
      Financial and Accounting Officer)/s/ Peter J.
      Henseler
            
            Director
            March
      1, 2010Peter
      J. Henseler/s/ Linda A.
      Huett
            
            Director
            March
      1, 2010Linda
      A. Huett/s/ Paul E.
      Purcell
            
            Director
            March
      1, 2010Paul
      E. Purcell/s/ John S.
      Bakalar
            
            Director
            March
      1, 2010John
      S. Bakalar/s/ John J.
      Vosicky
            
            Director
            March
      1, 2010John
      J. Vosicky/s/ Daniel M.
      Wright
            
            Director
            March
      1, 2010Daniel
      M. Wright/s/ Thomas M.
      Collinger
            
            Director
            March
      1, 2010Thomas
      M. Collinger/s/ Michael J. Merriman,
      Jr.
            
            Director
            March
      1, 2010Michael
      J. Merriman, Jr.


35


REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM





The Board
of Directors and Stockholders


RC2
Corporation:





Under
date of March 1, 2010, we reported on the consolidated balance sheets of RC2
Corporation and subsidiaries as of December 31, 2008 and 2009, and the related
consolidated statements of operations, stockholders’ equity and cash flows for
each of the years in the three-year period ended December 31,
2009.  In connection with our audits of the aforementioned
consolidated financial statements, we also audited the related consolidated
financial statement schedule of Valuation and Qualifying Accounts. The financial
statement schedule is the responsibility of the Company’s
management.  Our responsibility is to express an opinion on the
financial statement schedule based on our audits.





In our
opinion, this financial statement schedule, when considered in relation to the
basic consolidated financial statements taken as a whole, presents fairly, in
all material respects, the information set forth therein.





/s/ KPMG
LLP




Chicago,
Illinois


March 1,
2010





Schedule
      II
              Description
              Valuation and Qualifying
      Accounts
              (in
      thousands)Description
            
            Balance
      at
              Beginning
      of
              Year
            
            
            Charged
      to
              Costs
      and
              Expenses
            
            
            Charged
              (Credited)
              to
              Other
              Accounts
            
            
            Deductions
            
            
            Balance
      at
              End
      of YearAllowance
      for doubtful accounts:Year
      ended December 31, 2007
            
            $
            1,751
            
            
            $
            1,157
            
            
            $
            42
            
            
            $
            (1,142
            )
            
            $
            1,808Year
      ended December 31, 2008
            
            
            1,808
            
            
            
            1,424
            
            
            
            (221
            )
            
            
            (1,218
            )
            
            
            1,793Year
      ended December 31, 2009
            
            $
            1,793
            
            
            $
            558
            
            
            $
            48
            
            
            $
            (1,052
            )
            
            $
            1,347





36


RC2
CORPORATION AND SUBSIDIARIES


INDEX
TO FINANCIAL STATEMENTS








Reports
      of Independent Registered Public Accounting Firm
            F-2Consolidated
      Balance Sheets as of December 31, 2008 and 2009
            F-4Consolidated
      Statements of Operations for the Years Ended December 31, 2007, 2008 and
      2009
            F-5Consolidated
      Statements of Stockholders’ Equity for the Years Ended December 31, 2007,
      2008 and 2009
            F-6Consolidated
      Statements of Cash Flows for the Years Ended December 31, 2007, 2008 and
      2009
            F-7Notes
      to Consolidated Financial Statements
            F-8





F-1


REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM








The Board
of Directors and Stockholders


RC2
Corporation:





We have
audited the accompanying consolidated balance sheets of RC2 Corporation and
subsidiaries as of December 31, 2008 and 2009, and the related consolidated
statements of operations, stockholders’ equity and cash flows for each of the
years in the three-year period ended December 31, 2009.  These
consolidated financial statements are the responsibility of the Company’s
management.  Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.





We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States).  Those standards require
that we plan and perform the audit to obtain reasonable assurance about whether
the financial statements are free of material misstatement.  An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements.  An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement
presentation.  We believe that our audits provide a reasonable basis
for our opinion.





In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of RC2 Corporation and
subsidiaries as of December 31, 2008 and 2009, and the results of their
operations and their cash flows for each of the years in the three-year period
ended December 31, 2009, in conformity with U.S. generally accepted accounting
principles.





We have
also audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), RC2 Corporation’s internal control over
financial reporting as of December 31, 2009, based on criteria established in
Internal Control-Integrated
Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO), and our report dated March 1, 2010, expressed an
unqualified opinion on the effectiveness of the Company’s internal control over
financial reporting.





/s/ KPMG
LLP




Chicago,
Illinois


March 1,
2010


F-2


REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM








The Board
of Directors and Stockholders


RC2
Corporation:





We have
audited RC2 Corporation’s internal control over financial reporting as of
December 31, 2009, based on criteria established in Internal Control-Integrated
Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO).  RC2 Corporation’s management is
responsible for maintaining effective internal control over financial reporting
and for its assessment of the effectiveness of internal control over financial
reporting, included in the accompanying Management’s Report on Internal Control
Over Financial Reporting.  Our responsibility is to express an opinion
on the Company’s internal control over financial reporting based on our
audit.





We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States).  Those standards require
that we plan and perform the audit to obtain reasonable assurance about whether
effective internal control over financial reporting was maintained in all
material respects.  Our audit included obtaining an understanding of
internal control over financial reporting, assessing the risk that a material
weakness exists, and testing and evaluating the design and operating
effectiveness of internal control based on the assessed risk.  Our
audit also included performing such other procedures as we considered necessary
in the circumstances.  We believe that our audit provides a reasonable
basis for our opinion.





A
company’s internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles.  A company’s internal
control over financial reporting includes those policies and procedures that (1)
pertain to the maintenance of records that, in reasonable detail, accurately and
fairly reflect the transactions and dispositions of the assets of the company;
(2) provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company’s
assets that could have a material effect on the financial
statements.





Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements.  Also, projections of any evaluation
of effectiveness to future periods are subject to the risk that controls may
become inadequate because of changes in conditions, or that the degree of
compliance with the policies or procedures may deteriorate.





In our
opinion, RC2 Corporation maintained, in all material respects, effective
internal control over financial reporting as of December 31, 2009, based
on criteria established in Internal Control-Integrated
Framework issued by COSO.





We have
also audited in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the consolidated balance sheets of RC2
Corporation and subsidiaries as of December 31, 2008 and 2009, and the related
consolidated statements of operations, stockholders’ equity and cash flows for
each of the years in the three-year period ended December 31, 2009, and our
report dated March 1, 2010, expressed an unqualified opinion on those
consolidated financial statements.





/s/ KPMG
LLP




Chicago,
Illinois


March 1,
2010


F-3


RC2
CORPORATION AND SUBSIDIARIES


CONSOLIDATED
BALANCE SHEETS





December 31,(in
      thousands)
            
            2008
            
            
            2009AssetsCurrent
      assets:Cash
      and cash equivalents
            
            $
            32,095
            
            
            $
            88,049Accounts
      receivable, net of allowances for doubtful accounts of $1,793 and
      $1,347
            
            
            91,647
            
            
            
            88,905Inventory
            
            
            73,989
            
            
            
            65,888Deferred
      and prepaid taxes, net
            
            
            11,898
            
            
            
            6,223Prepaid
      expenses
            
            
            5,900
            
            
            
            6,600Other
      current assets
            
            
            1,764
            
            
            
            5,348Total
      current assets
            
            
            217,293
            
            
            
            261,013Property
      and equipment, net
            
            
            30,901
            
            
            
            28,073Intangible
      assets, net
            
            
            82,504
            
            
            
            80,309Other
      non-current assets
            
            
            5,952
            
            
            
            6,390Total
      assets
            
            $
            336,650
            
            
            $
            375,785Liabilities
      and stockholders’ equityCurrent
      liabilities:Accounts
      payable
            
            $
            25,873
            
            
            $
            23,266Accrued
      expenses
            
            
            48,113
            
            
            
            46,685Current
      maturities of bank term loan
            
            
            15,000
            
            
            
            —Other
      current liabilities
            
            
            2,508
            
            
            
            2,629Total
      current liabilities
            
            
            91,494
            
            
            
            72,580Line
      of credit
            
            
            20,120
            
            
            
            —Bank
      term loan
            
            
            60,000
            
            
            
            41,250Deferred
      income taxes
            
            
            5,470
            
            
            
            7,741Other
      non-current liabilities
            
            
            10,877
            
            
            
            9,481Total
      liabilities
            
            
            187,961
            
            
            
            131,052Commitments
      and contingenciesStockholders’
      equity:Common
      stock, voting, $0.01 par value, 28,000 shares authorized, 23,186 shares
      issued and
              17,245 shares outstanding at December 31, 2008, and 24,277 shares issued
      and 21,384 shares outstanding
              at December 31, 2009
            
            
            232
            
            
            
            232Additional
      paid-in capital
            
            
            246,284
            
            
            
            264,738Accumulated
      other comprehensive loss
            
            
            (13,949
            )
            
            
            (6,368
            )Retained
      earnings
            
            
            37,232
            
            
            
            64,194269,799
            
            
            
            322,796Treasury
      stock, at cost, 5,941 shares at December 31, 2008 and 2,893 shares
      at December 31, 2009
            
            
            (121,110
            )
            
            
            (78,063
            )Total
      stockholders’ equity
            
            
            148,689
            
            
            
            244,733Total
      liabilities and stockholders’ equity
            
            $
            336,650
            
            
            $
            375,785





The
accompanying notes are an integral part of these consolidated financial
statements.


F-4


RC2
CORPORATION AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF OPERATIONS








Year Ended December 31,(in
      thousands, except per share data)
            
            2007
            
            
            2008
            
            
            2009Net
      sales, including recall-related items of $(5,596), $341 and $438 for
      theyears
      ended December 31, 2007, 2008 and 2009
            
            $
            488,999
            
            
            $
            437,029
            
            
            $
            421,139Cost
      of sales, related parties
            
            
            15,406
            
            
            
            4,761
            
            
            
            —Cost
      of sales other
            
            
            254,653
            
            
            
            241,540
            
            
            
            236,243Recall-related
      items
            
            
            4,624
            
            
            
            (1,114
            )
            
            
            (298
            )Gross
      profit
            
            
            214,316
            
            
            
            191,842
            
            
            
            185,194Selling,
      general and administrative expenses
            
            
            161,560
            
            
            
            155,903
            
            
            
            136,869Amortization
      of intangible assets
            
            
            893
            
            
            
            889
            
            
            
            608Impairment
      of goodwill and other intangible assets
            
            
            —
            
            
            
            255,853
            
            
            
            2,432Recall-related
      items
            
            
            18,068
            
            
            
            15,782
            
            
            
            576Terminated
      acquisition costs
            
            
            —
            
            
            
            1,399
            
            
            
            —Operating
      income (loss)
            
            
            33,795
            
            
            
            (237,984
            )
            
            
            44,709Interest
      expense
            
            
            2,712
            
            
            
            6,584
            
            
            
            3,923Interest
      income
            
            
            (1,197
            )
            
            
            (1,579
            )
            
            
            (546
            )Write-off
      of investment
            
            
            —
            
            
            
            2,057
            
            
            
            —Other
      (income) expense, net
            
            
            (1,768
            )
            
            
            (3,553
            )
            
            
            780Income
      (loss) from continuing operations before income taxes
            
            
            34,048
            
            
            
            (241,493
            )
            
            
            40,552Income
      tax expense (benefit)
            
            
            12,472
            
            
            
            (35,741
            )
            
            
            13,590Income
      (loss) from continuing operations
            
            
            21,576
            
            
            
            (205,752
            )
            
            
            26,962Income
      from discontinued operations, net of tax
            
            
            110
            
            
            
            —
            
            
            
            —Net
      income (loss)
            
            $
            21,686
            
            
            $
            (205,752
            )
            
            $
            26,962Basic
      earnings (loss) per common share:Income
      (loss) from continuing operations
            
            $
            1.05
            
            
            $
            (11.82
            )
            
            $
            1.42Income
      from discontinued operations
            
            
            0.01
            
            
            
            —
            
            
            
            —Net
      income (loss)
            
            $
            1.06
            
            
            $
            (11.82
            )
            
            $
            1.42Diluted
      earnings (loss) per common share:Income
      (loss) from continuing operations
            
            $
            1.04
            
            
            $
            (11.82
            )
            
            $
            1.39Income
      from discontinued operations
            
            
            0.01
            
            
            
            —
            
            
            
            —Net
      income (loss)
            
            $
            1.05
            
            
            $
            (11.82
            )
            
            $
            1.39Weighted
      average shares outstanding:Basic
            
            
            20,395
            
            
            
            17,406
            
            
            
            19,014Diluted
            
            
            20,748
            
            
            
            17,406
            
            
            
            19,362





The
accompanying notes are an integral part of these consolidated financial
statements.


F-5


RC2
CORPORATION AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF STOCKHOLDERS’ EQUITY





(in
      thousands)
            
            Common
              Stock
              Shares
            
            
            Common
              Stock
              Amount
            
            
            Treasury
      Stock
              Shares
            
            
            Treasury
      Stock
              Amount
            
            
            Accumulated
      Other
              Comprehensive
              Income
      (Loss)
            
            
            Additional
              Paid-in
      Capital
            
            
            RetainedEarnings
            
            
            Total
      Stockholders’
              EquityBalance,
      December 31, 2006
            
            
            21,052
            
            
            $
            229
            
            
            
            1,824
            
            
            $
            (8,623
            )
            
            $
            8,838
            
            
            $
            230,776
            
            
            $
            220,706
            
            
            $
            451,926Net
      income
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            21,686
            
            
            
            21,686Stock
      issued upon option exercise
            
            
            156
            
            
            
            2
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            1,976
            
            
            
            —
            
            
            
            1,978Tax
      benefit of stock option exercise
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            1,463
            
            
            
            —
            
            
            
            1,463Stock
      issued under ESPP
            
            
            6
            
            
            
            —
            
            
            
            (6
            )
            
            
            59
            
            
            
            —
            
            
            
            116
            
            
            
            —
            
            
            
            175Deferred
      compensation from restricted stock awards
            
            
            40
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            495
            
            
            
            —
            
            
            
            495Stock-based
      compensation expense
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            4,195
            
            
            
            —
            
            
            
            4,195Treasury
      stock acquisition
            
            
            (2,934
            )
            
            
            —
            
            
            
            2,934
            
            
            
            (87,937
            )
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (87,937
            )FIN
      48 adoption
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (683
            )
            
            
            (683
            )Other
      comprehensive income:Foreign
      currency translation adjustments
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            3,029
            
            
            
            —
            
            
            
            —
            
            
            
            3,029Pension
      liability adjustment, net of tax
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            1,051
            
            
            
            —
            
            
            
            —
            
            
            
            1,051Balance,
      December 31, 2007
            
            
            18,320
            
            
            $
            231
            
            
            
            4,752
            
            
            $
            (96,501
            )
            
            $
            12,918
            
            
            $
            239,021
            
            
            $
            241,709
            
            
            $
            397,378Net
      loss
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (205,752
            )
            
            
            (205,752
            )Stock
      issued upon option exercise
            
            
            82
            
            
            
            1
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            955
            
            
            
            —
            
            
            
            956Tax
      benefit of stock option exercise
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            193
            
            
            
            —
            
            
            
            193Stock
      issued under ESPP
            
            
            9
            
            
            
            —
            
            
            
            (9
            )
            
            
            51
            
            
            
            —
            
            
            
            125
            
            
            
            —
            
            
            
            176Deferred
      compensation from restricted stock awards
            
            
            32
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            589
            
            
            
            —
            
            
            
            589Tax
      expense of restricted stock issuance
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (88
            )
            
            
            —
            
            
            
            (88
            )Stock-based
      compensation expense
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            5,489
            
            
            
            —
            
            
            
            5,489Treasury
      stock acquisition
            
            
            (1,198
            )
            
            
            —
            
            
            
            1,198
            
            
            
            (24,660
            )
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (24,660
            )Previous
      years’ foreign currency translation net loss
              recorded as income tax expense
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (1,275
            )
            
            
            —
            
            
            
            1,275
            
            
            
            —Other
      comprehensive loss:Foreign
      currency translation adjustments, net of tax
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (23,084
            )
            
            
            —
            
            
            
            —
            
            
            
            (23,084
            )Pension
      liability adjustment, net of tax
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (2,508
            )
            
            
            —
            
            
            
            —
            
            
            
            (2,508
            )Balance,
      December 31, 2008
            
            
            17,245
            
            
            $
            232
            
            
            
            5,941
            
            
            $
            (121,110
            )
            
            $
            (13,949
            )
            
            $
            246,284
            
            
            $
            37,232
            
            
            $
            148,689Net
      income
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            26,962
            
            
            
            26,962Public
      stock offering
            
            
            4,025
            
            
            
            —
            
            
            
            (3,025
            )
            
            
            42,900
            
            
            
            —
            
            
            
            14,185
            
            
            
            —
            
            
            
            57,085Stock
      option repurchase and cancellation
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (182
            )
            
            
            —
            
            
            
            (182
            )Stock
      issued upon option exercise
            
            
            37
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            185
            
            
            
            —
            
            
            
            185Tax
      benefit of stock option exercise
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            110
            
            
            
            —
            
            
            
            110Unrealized
      tax asset from unexercised options
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (2,026
            )
            
            
            —
            
            
            
            (2,026
            )Stock
      issued under ESPP
            
            
            23
            
            
            
            —
            
            
            
            (23
            )
            
            
            147
            
            
            
            —
            
            
            
            3
            
            
            
            —
            
            
            
            150Deferred
      compensation from restricted stock awards
            
            
            54
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            697
            
            
            
            —
            
            
            
            697Tax
      expense of restricted stock issuance
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (119
            )
            
            
            —
            
            
            
            (119
            )Stock-based
      compensation expense
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            5,601
            
            
            
            —
            
            
            
            5,601Other
      comprehensive income (loss):Foreign currency translation adjustments, net of tax
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            7,946
            
            
            
            —
            
            
            
            —
            
            
            
            7,946Pension
      liability adjustment, net of tax
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (365
            )
            
            
            —
            
            
            
            —
            
            
            
            (365
            )Balance,
      December 31, 2009
            
            
            21,384
            
            
            $
            232
            
            
            
            2,893
            
            
            $
            (78,063
            )
            
            $
            (6,368
            )
            
            $
            264,738
            
            
            $
            64,194
            
            
            $
            244,733





The
accompanying notes are an integral part of these consolidated financial
statements.


F-6


RC2
CORPORATION AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF CASH FLOWS








Year Ended December 31,(in
      thousands)
            
            2007
            
            
            2008
            
            
            2009Operating
      activitiesNet
      income (loss)
            
            $
            21,686
            
            
            $
            (205,752
            )
            
            $
            26,962Income
      from discontinued operations
            
            
            (110
            )
            
            
            —
            
            
            
            —Adjustments
      to reconcile net income (loss) to net cash provided by operating
      activities:Depreciation
      and amortization
            
            
            14,843
            
            
            
            16,279
            
            
            
            12,058Impairment
      of goodwill and other intangible assets
            
            
            —
            
            
            
            255,853
            
            
            
            2,432Write-off
      of investment
            
            
            —
            
            
            
            2,057
            
            
            
            —Provision
      for uncollectible accounts
            
            
            1,157
            
            
            
            1,424
            
            
            
            558Amortization
      and write-off of deferred financing costs
            
            
            587
            
            
            
            944
            
            
            
            1,177Stock-based
      compensation and deferred compensation from restricted stock
      awards
            
            
            4,705
            
            
            
            6,078
            
            
            
            6,298Excess
      tax benefit on stock option exercises
            
            
            (1,024
            )
            
            
            (182
            )
            
            
            (63
            )Deferred
      income taxes
            
            
            (360
            )
            
            
            (41,809
            )
            
            
            4,831Other
            
            
            (20
            )
            
            
            (51
            )
            
            
            141Changes
      in operating assets and liabilities:Accounts
      and other receivables
            
            
            3,962
            
            
            
            13,182
            
            
            
            3,483Inventory
            
            
            8,488
            
            
            
            (4,960
            )
            
            
            11,712Prepaid
      expenses and other assets
            
            
            (1,317
            )
            
            
            (3,110
            )
            
            
            (1,379
            )Accounts
      payable and accrued expenses
            
            
            12,112
            
            
            
            (20,926
            )
            
            
            (3,391
            )Other
      liabilities
            
            
            (1,283
            )
            
            
            (1,490
            )
            
            
            (2,046
            )Net
      cash provided by continuing operations
            
            
            63,426
            
            
            
            17,537
            
            
            
            62,773Net
      cash provided by discontinued operations
            
            
            110
            
            
            
            —
            
            
            
            —Net
      cash provided by operating activities
            
            
            63,536
            
            
            
            17,537
            
            
            
            62,773Investing
      activitiesPurchase
      of property and equipment
            
            
            (11,467
            )
            
            
            (9,422
            )
            
            
            (8,559
            )Proceeds
      from disposition of property and equipment
            
            
            13
            
            
            
            72
            
            
            
            34Purchase
      price of acquisitions, net of cash acquired
            
            
            (9,033
            )
            
            
            13
            
            
            
            270Proceeds
      from sale of discontinued operations
            
            
            110
            
            
            
            —
            
            
            
            —Decrease
      (increase) in other assets
            
            
            82
            
            
            
            (141
            )
            
            
            (4,661
            )Net
      cash used in investing activities
            
            
            (20,295
            )
            
            
            (9,478
            )
            
            
            (12,916
            )Financing
      activitiesNet
      cash proceeds from public stock offering
            
            
            —
            
            
            
            —
            
            
            
            57,085Stock
      option repurchase and cancellation
            
            
            —
            
            
            
            —
            
            
            
            (106
            )Issuance
      of stock upon option exercises
            
            
            1,978
            
            
            
            956
            
            
            
            185Excess
      tax benefit on stock option exercises
            
            
            1,024
            
            
            
            182
            
            
            
            63Issuance
      of stock under ESPP
            
            
            175
            
            
            
            176
            
            
            
            150Purchase
      of treasury stock
            
            
            (87,937
            )
            
            
            (24,660
            )
            
            
            —Borrowings
      on bank term loan
            
            
            —
            
            
            
            75,000
            
            
            
            —Payments
      on bank term loan
            
            
            (22,438
            )
            
            
            —
            
            
            
            (33,750
            )Net
      borrowings (payments) on line of credit
            
            
            95,000
            
            
            
            (74,880
            )
            
            
            (20,120
            )Financing
      fees paid
            
            
            (118
            )
            
            
            (2,792
            )
            
            
            (157
            )Net
      cash (used in) provided by financing activities
            
            
            (12,316
            )
            
            
            (26,018
            )
            
            
            3,350Effect
      of exchange rate changes on cash
            
            
            1,519
            
            
            
            (7,755
            )
            
            
            2,747Net
      increase (decrease) in cash and cash equivalents
            
            
            32,444
            
            
            
            (25,714
            )
            
            
            55,954Cash
      and cash equivalents, beginning of year
            
            
            25,365
            
            
            
            57,809
            
            
            
            32,095Cash
      and cash equivalents, end of year
            
            $
            57,809
            
            
            $
            32,095
            
            
            $
            88,049Supplemental
      disclosure of cash flow information:Cash
      paid for interest during the period
            
            $
            2,172
            
            
            $
            5,393
            
            
            $
            2,842Cash
      paid for income taxes during the period
            
            
            18,879
            
            
            
            7,621
            
            
            
            10,572Cash
      refunds received from income taxes
            
            $
            1,289
            
            
            $
            4,851
            
            
            $
            3,002


The
accompanying notes are an integral part of these consolidated financial
statements.


F-7


RC2
CORPORATION AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS








1.  DESCRIPTION
OF BUSINESS





Founded
in 1989, RC2 Corporation and Subsidiaries, (collectively, the Company or RC2),
is a leading designer, producer and marketer of a broad range of
innovative, high-quality products for mothers, infants and toddlers, as
well as toys and collectible products sold to preschoolers, youths and
adults.  RC2’s mother, infant, toddler and preschool products are
primarily marketed under its Learning Curve® family of brands, which includes
The First Years® and Lamaze brands, as well as popular and classic licensed
properties such as Thomas
& Friends, Bob the
Builder, Super WHY!, Chuggington, Dinosaur Train, John Deere,
Disney’sWinnie the Pooh,
Princesses, Cars, Fairies and Toy
Story, and other well known properties.  RC2 markets its youth
and adult products primarily under the Johnny Lightning® and Ertl®
brands.  RC2 reaches its target consumers through multiple channels of
distribution supporting more than 25,000 retail outlets throughout North
America, Europe, Australia, Asia Pacific and South America.





2.  SIGNIFICANT
ACCOUNTING POLICIES





Principles
of Consolidation





The
consolidated financial statements include the accounts of RC2 Corporation and
its wholly owned subsidiaries.  All intercompany transactions and
balances have been eliminated.





Reclassifications





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





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.





Fair
Value of Financial Instruments





The
carrying amounts of cash and cash equivalents, unrestricted certificates of
deposit, accounts receivable, accounts payable and accrued expenses approximate
fair value because of the short-term nature of these items.  The
carrying amounts of the line of credit and bank term loan approximate their fair
value.





Derivative
Instruments





The
Company had no derivative instruments during the years ended December 31, 2007,
2008 and 2009.





Cash
and Cash Equivalents





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





Allowance
for Doubtful Accounts





The
allowance for doubtful accounts represents adjustments to customer trade
accounts receivable for amounts deemed uncollectible.  The allowance
for doubtful accounts reduces gross trade receivables to their estimated net
realizable value and is disclosed on the face of the accompanying consolidated
balance sheets.  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 maintains credit insurance for some of its
major domestic customers, and the amount of this insurance covers a limited
amount of the total amount of its accounts receivable.  The Company
will continue to proactively review its credit risks and adjust its customer
terms to reflect the current environment.


F-8


RC2
CORPORATION AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)








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





Other
Current Assets





At
December 31, 2009, the Company had unrestricted certificates of deposit with
maturities greater than 90 days.  These unrestricted certificates of
deposit are included in other current assets in the accompanying consolidated
balance sheet at December 31, 2009.  The carrying amounts of these
unrestricted certificates of deposit of $4.0 million approximate their fair
value.





Property
and equipment





Property
and equipment are recorded at cost.  Depreciation is computed using
the straight-line method for financial statement purposes at rates adequate to
depreciate the cost of applicable assets over their expected
useful lives.  Accelerated methods are used for income
tax purposes.  Repairs and maintenance are charged to expense as
incurred.  Gains and losses resulting from sales, dispositions or
retirements are recorded as incurred, at which time related costs and
accumulated depreciation are removed from the accounts.  The estimated
useful lives in computing depreciation for financial statement purposes are as
follows:




Asset
      Descriptions
            Estimated
      Useful LifeBuildings
      and improvements
            Lesser
      of lease term or 15 yearsTooling
            3 –
      7 yearsOther
      equipment
            2 –
      10 years





In 2008,
the Company recorded charges of $2.7 million in the North America segment to
write-off undepreciated tooling primarily related to discontinued product
lines.  The charges for 2008 are included in cost of sales, other in
the accompanying consolidated statement of operations for the year ended
December 31, 2008.





Goodwill
and Intangible Assets





In
accordance with the provisions of the Intangibles – Goodwill and Other Topic of
the FASB Accounting Standards Codification, the Company tests goodwill and other
intangible assets with indefinite useful lives for impairment on an annual basis
or on an interim basis if a triggering event occurs that might reduce the fair
value of the reporting unit below its carrying value.  The fair value
of the Company’s reporting units and its separately identifiable intangible
assets are determined based on the discounted cash flow associated with the
reporting unit or identifiable intangible asset.  The Company conducts
testing for impairment at least annually during the fourth quarter of its fiscal
year.  Intangible assets that do not have indefinite lives are
amortized over their useful lives.  Costs incurred to renew or extend the
term of a recognized intangible asset are expensed as incurred.  In the
fourth quarter of 2008, the Company recorded an impairment charge, writing-off
its entire balance of goodwill (see Note 6 – Goodwill and Intangible
Assets).





F-9


RC2
CORPORATION AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)








Other
Non-Current Assets





Other
non-current assets at December 31, 2008 and 2009, consist primarily of deferred
financing fees and deposits on leased property, as well as the Company’s
investment in the development of a media property under a collaborative
arrangement.  The deferred financing fees are being amortized over the
related borrowing period.  Amortization and write-offs of deferred
financing fees for the years ended December 31, 2007, 2008 and 2009, were $0.6
million, $0.9 million and $1.2 million, respectively, and are included in
interest expense on the accompanying consolidated statements of
operations.  The
collaborative arrangement, in which the Company participates, is designed for
the development and exploitation of an animated television seriesthrough which the
Company has a 50% interest in the related intellectual property rights, and
bears an obligation to fund a portion of the development and production costs.
Capitalized costs related to the development and production of the television
series were $3.4 million at December 31, 2009.  These costs will be
amortized over future periods based on the proportion of the Company’s share of
both the current net distributable proceeds to the estimated remaining future
net distributable proceeds generated by the property.  In accordance
with the requirements of the applicable accounting standard, the Company's
estimate of net distributable proceeds cannot exceed a ten year period at each
measurement date.  Amortization expense is expected to be approximately
$0.4 million in 2010, with approximately 30% and 80% of the unamortized costs to
be amortized in the next three years and six years,
respectively.





Accrued
Expenses





Accrued
expenses at December 31, 2008, consists primarily of accrued allowances of
$17.6 million, accrued royalties of $10.9 million, recall-related accruals of
$6.0 million and payroll-related accruals of $3.8 million.  Accrued
expenses at December 31, 2009, consists primarily of accrued allowances of
$15.6 million, accrued royalties of $10.3 million and payroll-related accruals
of $9.5 million.





Accrued
Allowances





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





Accrued
Royalties





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





Foreign
Currency Translation/Transactions





Foreign
subsidiary assets and liabilities are recorded in their respective functional
currencies and translated into U.S. dollars at the rates of exchange at the
balance sheet date, while statement of operations accounts and cash flows are
translated at the average exchange rates in effect during the
period.  Unrealized gains and losses resulting from translation for
the years ended December 31, 2007, 2008 and 2009, have been recorded as
components of accumulated other comprehensive income (loss) in stockholders’
equity.  The net exchange losses and gains are included in other
(income) expense, net in the accompanying consolidated statements of
operations.  The net exchange gains resulting from transactions
denominated in other than the functional currencies for the years ended December
31, 2007 and 2008, were $1.0 million and $2.8 million,
respectively.  The net exchange loss resulting from transactions
denominated in other than the functional currencies for the year ended December
31, 2009, was $1.0 million.





Comprehensive
Income (Loss)





The
Company reports comprehensive income (loss) in accordance with the
requirements of the Comprehensive Income Topic of the FASB Accounting Standards
Codification, which requires companies to report all changes in equity during a
period, except those resulting from investment by owners and distribution to
owners, in a financial statement for the period in which they are
recognized.  The income tax expense (benefit) related to the
components of comprehensive income (loss) in 2007, 2008 and 2009, was $0.6
million, $(1.8) million and $0.2 million, respectively.


F-10


RC2
CORPORATION AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)








Revenue
Recognition





The
Company recognizes revenue based upon transfer of title and risk of loss of
products to customers, which is generally FOB shipping
point.  The Company provides estimated credits and other concessions
at the time the sale is recorded, and these credits and other concessions are
recorded as a reduction of gross sales.  The Company’s revenue
recognition policy is the same for each channel of distribution.





The
Company ordinarily accepts returns only for defective merchandise.  In
certain instances, where retailers are unable to resell the quantity of products
that they have purchased from the Company, the Company may, in accordance with
industry practice, assist retailers in selling excess inventory by offering
credits and other price concessions, which are typically evaluated and issued
annually.  Other allowances can also be issued primarily for defective
merchandise, volume programs and co-op advertising.  Allowances are
accrued throughout the year, as sales are recorded.





Shipping
and Handling Costs





Shipping
and handling costs, which comprise only those costs incurred to transport
products to the customer, are included in selling, general and administrative
expenses in the accompanying consolidated statements of
operations.  For the years ended December 31, 2007, 2008 and 2009,
shipping and handling costs were $22.5 million, $14.0 million and $11.8 million,
respectively.  Shipping and handling costs for the years ended
December 31, 2007, 2008 and 2009, include costs related to the 2007 recalls of
$5.0 million, $(1.8) million and $(0.2) million, respectively.





Advertising





The
Company expenses the production costs of advertising the first time the
advertising takes place.  Advertising expense, including promotion and
placement costs, for the years ended December 31, 2007, 2008 and 2009, was $20.7
million, $17.2 million and $13.2 million, respectively.  Advertising
expense is included in net sales and selling, general and administrative
expenses in the accompanying consolidated statements of operations.





Product
Recalls





The
Company establishes a reserve for a product recall on a product-specific basis
during the period in which the circumstances giving rise to the recall become
known and estimable.  Facts underlying the recall, including, among
others, estimates of retailer inventory returns, consumer replacement costs,
fines and penalties, and shipping costs, are considered when establishing a
product recall reserve.  In 2007 and 2008, the Company also considered
additional replacement costs or refunds, donations, notice charges, claims
administration, licensor indemnification claims and plaintiffs’ legal fees
related to settlement of litigation related to the recalls (see Note 17 -
Product Recalls).  The Company’s legal costs to defend recall-related
matters are expensed as incurred.  When facts or circumstances become
known that would indicate the recall reserve is either not sufficient to cover
or exceeds the estimated product recall expenses, the reserve is adjusted, as
appropriate.





Stock-based
Compensation





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





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











F-11





RC2
CORPORATION AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)








Income
and Other Taxes





The
Company accounts for income taxes in accordance with the Income Taxes Topic
under the FASB Accounting Standards Codification.  Under the asset and
liability method of this Topic, deferred income taxes are recognized for the
expected future tax consequences of temporary differences between financial
statement carrying amounts and the tax bases of existing assets and liabilities,
as well as net operating loss and tax credit carry-forwards, using enacted tax
rates expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled, or the carry-forwards
applied.  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.





Management
considers certain tax exposures and all available evidence when evaluating and
estimating its tax positions and tax benefits, which may require periodic
adjustments to the tax-related balances.  Estimates for such tax
contingencies are classified in other current liabilities and other non-current
liabilities in the accompanying consolidated balance sheets.





The
Company collects taxes imposed by governmental authorities, including sales and
value added taxes, which are generated from revenue producing transactions
between the Company and its customers, and remits such taxes directly to these
governmental authorities.  The Company records these taxes on a net
basis, therefore having no impact on the Company’s consolidated statements of
operations.





Earnings
(Loss) Per Common Share from Continuing Operations





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





Year Ended December 31,(in
      thousands, except per share data)
            
            2007
            
            
            2008
            
            
            2009Income
      (loss) from continuing operations
            
            $
            21,576
            
            
            $
            (205,752
            )
            
            $
            26,962Weighted
      average common and common equivalent shares outstanding:Weighted
      average common shares outstanding
            
            
            20,395
            
            
            
            17,406
            
            
            
            19,014Add
      effect of diluted securities – assumed exercise of stock
      options
            
            
            353
            
            
            
            —
            
            
            
            348Weighted
      average common and common equivalent shares outstanding
            
            
            20,748
            
            
            
            17,406
            
            
            
            19,362Basic
      earnings (loss) per common share from continuing
operations
            
            $
            1.05
            
            
            $
            (11.82
            )
            
            $
            1.42Diluted
      earnings (loss) per common share from continuing
operations
            
            $
            1.04
            
            
            $
            (11.82
            )
            
            $
            1.39





The
computation of diluted earnings (loss) per common share from continuing
operations excludes 571,586 shares, 1,921,142 shares and 1,266,956 shares in
2007, 2008 and 2009, respectively, because the options were
anti-dilutive.  Because actual results for 2008 generated a loss from
continuing operations, any potential common shares would be anti-dilutive, and
accordingly, were excluded from the diluted earnings (loss) per common share
calculation.


F-12


RC2
CORPORATION AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)








Concentration
of Credit Risk





Concentration
of credit risk is limited to accounts receivable and is subject to the financial
conditions of certain major customers.  The Company’s top three
customers, Toys “R” Us/Babies “R” Us, Target and Wal-Mart, combined for 42.6%,
40.1% and 43.5% of the Company’s net sales in 2007, 2008 and 2009,
respectively.  Over the last three years each of these three customers
accounted for between 11.9% and 16.6% of the Company’s net sales.  No
other customers accounted for more than 10.0% of the Company’s net sales in any
of the years ended December 31, 2007, 2008 or 2009.





Additionally,
over the last two years, each of these three customers accounted for between
9.2% and 19.6% of the Company’s accounts receivable.  No other
customers accounted for more than 10.0% of the Company’s accounts receivable at
December 31, 2008 and 2009.  The Company does not require collateral
or other security to support customers’ receivables.  The Company
continually monitors its customers’ financial condition and vendor payment
practices to minimize collection risks on trade accounts
receivable.





Supplier
Concentration





The
Company did not have purchases from any of its third-party, dedicated suppliers
in 2007 that were greater than 10.0% of its total product
purchases.  The Company’s purchases from one of its third-party,
dedicated suppliers was 10.1% and 10.2% in 2008 and 2009, respectively, of its
total product purchases.  The Company’s purchases from another one of
its third-party, dedicated suppliers was 11.4% in 2009 of its total product
purchases.  There were no other suppliers accounting for more than
10.0% of the Company's total product purchases in any of the years ended
December 31, 2007, 2008 and 2009.





Recently
Issued Accounting Codification





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





In August
2009, the FASB issued new requirements under the Compensation – Retirement
Benefits Topic of the Codification.  The new requirements provide
guidance on an employer’s disclosures about plan assets of a defined benefit
plan or other post retirement plan.  The objectives of the new
requirements are to provide users of financial statements with an understanding
of (a) how investment allocation decisions are made, including the factors that
are pertinent to an understanding of investment policies and strategies; (b) the
major categories of plan assets; (c) the inputs and valuation techniques used to
measure the fair value of plan assets; (d) the effect of fair value measurements
using significant unobservable inputs (Level 3) on changes in plan assets for
the period; and (e) significant concentrations of risk within plan
assets.  The disclosures under the new requirements are effective for
fiscal years ending after December 15, 2009.  The Company adopted
these requirements with the year ended December 31, 2009.





In June
2009, the FASB issued new requirements under the Subsequent Event Topic of the
Codification.  The requirements under this Topic establish general
standards of accounting for and disclosure events that occur after the balance
sheet date but before financial statements are issued or are available to be
issued.  In accordance with this Topic, an entity should apply these
requirements to interim or annual financial periods ending after June 15,
2009.  The Company adopted these requirements on June 30,
2009.  In preparing the accompanying consolidated financial
statements, the Company evaluated the events and transactions that occurred
between December 31, 2009 and March 1, 2010, the date the accompanying
consolidated financial statements were issued.





F-13


RC2
CORPORATION AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)








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





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





3.  BUSINESS
COMBINATIONS





Angels
Landing, Inc.





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 Kettering, Ohio.  Closing consideration
consisted of $6.6 million of cash, excluding transaction
expenses.  This transaction has been accounted for under the purchase
method of accounting, and accordingly, the operating results of the Compass
Business have been included in the accompanying consolidated statements of
operations since the effective date of the acquisition.  The unaudited
pro forma consolidated results of operations for the Compass Business are not
presented due to the immateriality of its results of operations.





Mother’s
Intuition Inc.





On
November 30, 2007, the Company acquired substantially all of the assets of
Mother’s Intuition Inc. (MI), a privately-held, start-up developer and marketer
of women’s prenatal bodycare products based in Mission Viejo,
California.  Closing consideration consisted of $2.2 million of cash,
excluding transaction expenses.  The transaction included an
additional $1.5 million in deferred purchase price.  The remaining
deferred purchase price is included in other current liabilities and other
non-current liabilities in the accompanying consolidated balance sheets at
December 31, 2008 and 2009.  This transaction has been accounted for
under the purchase method of accounting, and accordingly, the operating results
of MI have been included in the accompanying consolidated statements of
operations since the effective date of acquisition.  The unaudited pro
forma consolidated results of operations of MI are not presented due to the
immateriality of its results of operations.





F-14


RC2
CORPORATION AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)








Terminated
Acquisition Costs





On June
23, 2008, the Company announced it signed a definitive purchase agreement to
acquire certain assets of the children’s book division of a privately-held
publishing company.  However, on September 30, 2008, the Company
announced that due to adverse capital markets, it terminated the purchase
agreement.  Costs of $1.4 million, incurred by the Company related to
this proposed transaction, are included in terminated acquisition costs on the
accompanying consolidated statement of operations for the year ended December
31, 2008.





4.  BUSINESS
SEGMENTS





The
Company is a leading designer, producer and marketer of a broad range of
innovative, high-quality products for mothers, infants and toddlers, as well as
toys and collectible products sold to preschoolers, youths and
adults.





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





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





Results
are not necessarily those that would be achieved if each segment were an
unaffiliated business enterprise.  Information by segment and a
reconciliation to reported amounts for the years ended December 31, 2007, 2008
and 2009, are as follows:








Year Ended December 31,(in
      thousands)
            
            2007
            
            
            2008
            
            
            2009Net
      sales:North
      America
            
            $
            381,792
            
            
            $
            327,311
            
            
            $
            321,380International
            
            
            108,081
            
            
            
            110,451
            
            
            
            100,648Sales
      and transfers between segments
            
            
            (874
            )
            
            
            (733
            )
            
            
            (889
            )Combined
      total
            
            $
            488,999
            
            
            $
            437,029
            
            
            $
            421,139Operating
      income (loss):North
      America
            
            $
            19,092
            
            
            $
            (235,393
            )
            
            $
            29,631International
            
            
            14,811
            
            
            
            (2,664
            )
            
            
            15,118Sales
      and transfers between segments
            
            
            (108
            )
            
            
            73
            
            
            
            (40
            )Combined
      total
            
            $
            33,795
            
            
            $
            (237,984
            )
            
            $
            44,709Depreciation
      and amortization:North
      America
            
            $
            13,487
            
            
            $
            14,656
            
            
            $
            10,551International
            
            
            1,356
            
            
            
            1,623
            
            
            
            1,507Combined
      total
            
            $
            14,843
            
            
            $
            16,279
            
            
            $
            12,058Capital
      expenditures:North
      America
            
            $
            9,733
            
            
            $
            7,758
            
            
            $
            7,046International
            
            
            1,734
            
            
            
            1,664
            
            
            
            1,513Combined
      total
            
            $
            11,467
            
            
            $
            9,422
            
            
            $
            8,559





F-15


RC2
CORPORATION AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)





December 31,(in
      thousands)
            
            2008
            
            
            2009Total
      assets:North
      America
            
            $
            235,499
            
            
            $
            258,815International
            
            
            101,151
            
            
            
            116,970Combined
      total
            
            $
            336,650
            
            
            $
            375,785





Under the
entity-wide disclosure requirements of the Business Segments Topic of the FASB
Accounting Standards Codification, the Company reports net sales by product
category and by distribution channel.  The Company groups its products
into two product categories: mother, infant and toddler products, and preschool,
youth and adult products.  Amounts for the years ended December 31,
2007, 2008 and 2009, are as shown in the tables below:





Year Ended December 31,(in
      thousands)
            
            2007
            
            
            2008
            
            
            2009Mother,
      infant and toddler products
            
            $
            184,936
            
            
            $
            178,548
            
            
            $
            183,335Preschool,
      youth and adult products
            
            
            304,063
            
            
            
            258,481
            
            
            
            237,804Net
      sales
            
            $
            488,999
            
            
            $
            437,029
            
            
            $
            421,139Chain
      retailers
            
            $
            333,775
            
            
            $
            307,341
            
            
            $
            309,560Specialty
      retailers, wholesalers, OEM dealers and other
            
            
            155,224
            
            
            
            129,688
            
            
            
            111,579Net
      sales
            
            $
            488,999
            
            
            $
            437,029
            
            
            $
            421,139





5.  PROPERTY
AND EQUIPMENT





Property
and equipment, net consist of the following:





December 31,(in
      thousands)
            
            2008
            
            
            2009Land
            
            $
            686
            
            
            $
            686Buildings
      and improvements
            
            
            9,517
            
            
            
            9,866Tooling
            
            
            109,545
            
            
            
            116,566Other
      equipment
            
            
            24,122
            
            
            
            24,245143,870
            
            
            
            151,363Accumulated
      depreciation
            
            
            (112,969
            )
            
            
            (123,290
            )Property
      and equipment, net
            
            $
            30,901
            
            
            $
            28,073





Depreciation
expense for the years ended December 31, 2007, 2008 and 2009, was $13.9 million,
$15.4 million and $11.5 million, respectively.





6.  GOODWILL
AND INTANGIBLE ASSETS





Primarily
due to the decline in the Company’s market capitalization, in the fourth quarter
of 2008, the Company recorded a goodwill impairment charge of $231.9 million and
$12.1 million in the North America and International segments, respectively, to
write-off all of its recorded goodwill.  The impairment charge is
included in impairment of goodwill and other intangible assets in the
accompanying consolidated statement of operations for the year ended December
31, 2008.


F-16


RC2
CORPORATION AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)








The
carrying value of goodwill by reporting unit for the year ended 2008 is shown
below:





(in
      thousands)
            
            North
      America
            
            
            International
            
            
            TotalBalance
      at December 31, 2007
            
            $
            232,194
            
            
            $
            15,620
            
            
            $
            247,814Compass
      Business fair value allocation
            
            
            (351
            )
            
            
            —
            
            
            
            (351
            )MI
      fair value allocation
            
            
            42
            
            
            
            —
            
            
            
            42Impairment
            
            
            (231,885
            )
            
            
            (12,101
            )
            
            
            (243,986
            )Other
      adjustments
            
            
            —
            
            
            
            (3,519
            )
            
            
            (3,519
            )Balance
      at December 31, 2008
            
            $
            —
            
            
            $
            —
            
            
            $
            —





Other
adjustments made during the year ended December 31, 2008, relate to currency
exchange rate changes.





In the
fourth quarters of 2008, the Company recorded intangible asset impairment
charges in the North America segment of $11.9 million, primarily due to the
decline in the Company’s market capitalization. In the fourth quarter of 2009,
the Company recorded intangible asset impairment charges in the North America
segment of $2.4 million, relating to the Sesame
Street infant and toddler products license, which is not being renewed
after 2010.  These impairment charges are included in impairment of
goodwill and other intangible assets in the accompanying consolidated statement
of operations for the years ended December 31, 2008 and 2009,
respectively.





The
components of net intangible assets are as follows:





December 31,(in
      thousands)
            
            2008
            
            
            2009Gross
      amount of amortizable intangible assets:Customer
      relationships
            
            $
            8,582
            
            
            $
            8,582Other
            
            
            4,321
            
            
            
            4,98612,903
            
            
            
            13,568Accumulated
      amortization of amortizable intangible assets:Customer
      relationships
            
            
            939
            
            
            
            1,172Other
            
            
            3,471
            
            
            
            3,8164,410
            
            
            
            4,988Intangible
      assets not subject to amortization:Licenses
      and trademarks
            
            
            74,011
            
            
            
            71,729Total
      intangible assets, net
            
            $
            82,504
            
            
            $
            80,309





Other
amortizable intangible assets consist primarily of patents, non-compete
agreements, trademarks and licenses and have estimated useful lives primarily
ranging from two to eight years.  Customer relationships have useful
lives from eight to fifty years, depending on the type of
customer.  We have determined that our relationships with our largest
customers, Toys “R” Us/Babies “R” Us, Target and Wal-Mart, have useful lives of
fifty years because we have longstanding, continuous relationships with these
customers.  Furthermore, in determining these useful lives, we
considered such factors as competition, demand for our products and the
likelihood of the customer changing suppliers, as well as the financial and
operating performance of our largest customers.  The weighted average
period to renewal of our licenses and trademarks not subject to amortization is
approximately three years.





Estimated
amortization expense for other intangible assets for the years ended December
31, is as follows:





(in
      thousands)2010
            
            $
            6822011
            
            
            4212012
            
            
            4072013
            
            
            3672014
            
            $
            355


F-17


RC2
CORPORATION AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)








7.  INCOME
TAXES





For
financial reporting purposes, income (loss) from continuing operations
before income taxes includes the following components:





Year Ended December 31,(in
      thousands)
            
            2007
            
            
            2008
            
            
            2009Income
      (loss) from continuing operations before income taxes:United
      States
            
            $
            20,186
            
            
            $
            (239,729
            )
            
            $
            25,715Foreign
            
            
            13,862
            
            
            
            (1,764
            )
            
            
            14,837$
            34,048
            
            
            $
            (241,493
            )
            
            $
            40,552





The
significant components of income tax expense (benefit) allocated to continuing
operations are as follows:





Year Ended December 31,(in
      thousands)
            
            2007
            
            
            2008
            
            
            2009CurrentFederal
            
            $
            6,667
            
            
            $
            1,088
            
            
            $
            4,465State
            
            
            546
            
            
            
            (94
            )
            
            
            1,122Foreign
            
            
            5,618
            
            
            
            4,839
            
            
            
            3,15612,831
            
            
            
            5,833
            
            
            
            8,743DeferredFederal
            
            
            (157
            )
            
            
            (36,690
            )
            
            
            3,821State
            
            
            (96
            )
            
            
            (4,119
            )
            
            
            334Foreign
            
            
            (106
            )
            
            
            (765
            )
            
            
            692(359
            )
            
            
            (41,574
            )
            
            
            4,847Income
      tax expense (benefit)
            
            $
            12,472
            
            
            $
            (35,741
            )
            
            $
            13,590





A
reconciliation of the U.S. statutory federal tax rate and actual effective
income tax rate is as follows:





Year Ended December 31,(in
      thousands)
            
            2007
            
            
            2008
            
            
            2009U.S.
      statutory rate
            
            
            35.0
            %
            
            
            35.0
            %
            
            
            35.0
            %State
      taxes, net of federal benefit
            
            
            2.0
            
            
            
            —
            
            
            
            2.0Foreign
            
            
            (1.8
            )
            
            
            —
            
            
            
            (2.8
            )Impairment
            
            
            —
            
            
            
            (20.5
            )
            
            
            (0.9
            )Other
            
            
            1.4
            
            
            
            0.3
            
            
            
            0.2Effective
      rate
            
            
            36.6
            %
            
            
            14.8
            %
            
            
            33.5
            %





Included
in other in the above table are permanent tax adjustments, tax return to accrual
adjustments, changes to the tax reserves and the impact of statutory tax rate
changes in various jurisdictions.  Also included is the impact of rate
changes on the Company’s deferred tax assets and liabilities.





F-18


RC2
CORPORATION AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)








The
significant components of deferred tax assets and liabilities are as
follows:





December 31(in
      thousands)
            
            2008
            
            
            2009Deferred
      tax assets attributable toCapital
      loss carry-forward
            
            $
            5,887
            
            
            $
            5,856Stock
      options
            
            
            4,824
            
            
            
            4,713Bad
      debt allowance
            
            
            330
            
            
            
            211Inventory
            
            
            4,344
            
            
            
            3,563Sales
      allowances
            
            
            1,971
            
            
            
            1,677Federal
      credit carry-forwards (1)
            
            
            1,937
            
            
            
            1,875Net
      operating loss carry-forwards
            
            
            2,658
            
            
            
            1,773Accrued
      expenses
            
            
            2,402
            
            
            
            1,531Purchase
      accounting
            
            
            587
            
            
            
            486Other
            
            
            3,962
            
            
            
            3,548Total
      deferred tax assets before valuation allowance
            
            
            28,902
            
            
            
            25,233Valuation
      allowance related to capital loss carry-forward
            
            
            (5,887
            )
            
            
            (5,856
            )Valuation
      allowance related to partnership investment
            
            
            (126
            )
            
            
            (125
            )Valuation
      allowance related to net operating loss carry-forwards
            
            
            (1,282
            )
            
            
            (873
            )Net
      deferred tax assets
            
            
            21,607
            
            
            
            18,379Deferred
      tax liabilities attributable toGoodwill
      and intangible assets
            
            
            (15,159
            )
            
            
            (16,873
            )Property
      and equipment
            
            
            (1,817
            )
            
            
            (1,398
            )Other
            
            
            (1,577
            )
            
            
            (2,036
            )Net
      deferred tax liabilities
            
            
            (18,553
            )
            
            
            (20,307
            )Net
      deferred tax asset (liability)
            
            $
            3,054
            
            
            $
            (1,928
            )





(1)  Federal
credit carry-forwards relate to foreign tax credits that expire in
2018.





No
provision has been made for U.S. federal or non-U.S. deferred income taxes on
$37.9 million of accumulated and undistributed earnings of foreign subsidiaries
at December 31, 2009, since it is the present intention of management to
reinvest the undistributed earnings indefinitely in those foreign
operations.  The determination of the amount of unrecognized U.S.
federal or non-U.S. deferred income tax liabilities for unremitted earnings is
not practicable.





Net
prepaid income taxes at December 31, 2008 and 2009, were $3.3 million and $0.4
million, respectively.





The
Company has a pre-tax capital loss of $15.6 million.  A valuation
allowance of $5.9 million has been established because the Company does not
believe recoverability of this amount is more likely than not.  This
capital loss carry-forward will expire in 2011.


The
Company’s German subsidiary accumulated a net operating loss carry-forward, for
which the Company has established a full valuation allowance.  While
German net operating losses have an unlimited carry-forward period, the future
projections for taxable income in that jurisdiction are
undetermined.  In 2009, the subsidiary generated taxable income and,
as such, the valuation allowance was reduced by $0.2 million.





The
Company adopted a new accounting pronouncement which clarifies the accounting
for uncertainty in income taxes recognized in an enterprise’s financial
statements effective January 1, 2007.  As a result of the adoption of
this pronouncement, 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.  As of the date of adoption, the Company had approximately
$5.0 million of total gross unrecognized tax benefits.





F-19


RC2
CORPORATION AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)








The
uncertain tax positions as of December 31, 2008 and 2009, totaled $3.6 million
and $2.8 million, respectively.  The following table summarizes the
activity related to the unrecognized tax benefits:





December 31,(in
      thousands)
            
            2008
            
            
            2009Unrecognized
      tax benefits, beginning of period
            
            $
            4,223
            
            
            $
            3,582Increases
      in positions taken in a prior period
            
            
            224
            
            
            
            —Decreases
      in positions taken in a prior period
            
            
            (269
            )
            
            
            (48
            )Increases
      in positions taken in a current period
            
            
            249
            
            
            
            130Decreases
      due to settlements
            
            
            (335
            )
            
            
            (339
            )Decreases
      due to lapse of statute of limitations
            
            
            (510
            )
            
            
            (529
            )Unrecognized
      tax benefits, end of period
            
            $
            3,582
            
            
            $
            2,796





At
December 31, 2008 and 2009, approximately $2.5 million and $2.2 million,
respectively, of 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 taxes of multiple state and foreign
jurisdictions.  The Company has substantially concluded all U.S.
federal income tax matters for years though 2005.  Substantially all
material state and local and foreign income tax matters have been concluded for
years through 2005.  U.S. federal income tax returns for 2006 through
2008 are currently open for examination.  In the next twelve months,
the Company expects to reduce the unrecognized tax position reserves by
approximately $1.1 million, primarily due to the settlement of various state and
international income tax audits and court cases and the closing of various
statutes.  The Company’s continuing practice is to recognize interest
and/or penalties related to income tax matters in income tax
expense.  During the years ended December 31, 2008 and 2009, the
Company recorded adjustments for interest of $0.2 million in each year, and less
than $0.1 million for potential penalties, related to these unrecognized tax
benefits.  In total, as of December 31, 2008 and 2009, the Company has
recorded a liability for interest of $2.0 million and $2.2 million,
respectively, and $0.3 million and $0.4 million, respectively, for potential
penalties.





8.  DEBT





On
November 3, 2008, the Company entered into a credit facility to replace its
previous credit facility.  The credit facility is comprised of a term
loan and provides for borrowings up to $70.0 million under a revolving line of
credit.  The total borrowing capacity available under the credit
facility is subject to a formula based on the Company’s leverage ratio, as
defined in the credit agreement.  The term loan and the revolving line
of credit both have a scheduled maturity date of November 1,
2011.  Under this credit facility, the term loan and the revolving
line of credit bear interest, at the Company’s option, at a base rate or at
LIBOR, plus applicable margins, which are based on the Company’s leverage
ratio.  Applicable margins vary between 2.25% and 3.25% on LIBOR
borrowings and 1.25% and 2.25% on base rate borrowings.  At December
31, 2009, the applicable margins in effect were 2.50% for LIBOR borrowings and
1.50% for base rate borrowings.  Principal payments on the term loan
are $3.8 million per calendar quarter, with the remaining principal of $33.8
million due on November 1, 2011.  During the fourth quarter of 2009,
the Company prepaid $18.8 million on its term loan, with the next quarterly
principal payment of $3.8 million due on June 30, 2011.  The Company
is also required to pay a commitment fee which varies from 0.45% and 0.50% per
annum on the average daily unused portion of the revolving line of
credit.  At December 31, 2009, the commitment fee in effect was 0.5%
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, buy back its stock, incur
additional debt and make acquisitions above certain amounts.  The
credit facility also includes a clean down provision that limits the maximum
amount of borrowings under the revolving line of credit for a period of 60
consecutive days during the first four calendar months.  The clean
down provision limits are $27.5 million for a period of 60 consecutive days
during the first four calendar months of 2010, and $25.0 million for a period of
60 consecutive days during the first four calendar months of 2011. The
Company has met its clean down provision for the year 2010, as of the date of
this filing.  The credit facility is secured by the Company’s domestic
assets along with a portion of the Company’s equity interests in its foreign
subsidiaries.  On December 31, 2009, the Company had $41.3 million
outstanding on its bank term loan and no borrowings under its revolving line of
credit.  At December 31, 2009, the Company had $70.0 million available
on its revolving line of credit and was in compliance with all
covenants.





F-20


RC2
CORPORATION AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)





In
conjunction with this credit facility, the Company incurred approximately $2.4
million in financing fees which are being charged to interest expense using
the effective interest rate method in the accompanying consolidated statements
of operations through the term of the credit agreement, which is currently
November 1, 2011.  The net balance of $2.2 million and $1.2 million is
included in other non-current assets in the accompanying consolidated balance
sheets at December 31, 2008 and 2009, respectively.


The
Company’s Hong Kong subsidiary maintains credit facilities with two banks
providing for documentary and standby letters of credit of up to $4.9
million and overdraft protection of up to $0.2 million.  Amounts
borrowed are due on demand, but are generally available for 90 days, bear
interest at the bank’s prime rate or prevailing funding cost, whichever is
higher, and are cross guaranteed by the Company.  As of December 31,
2009, there was no amounts outstanding under these credit
facilities.





Non-current
debt consists of the following:





December 31,(in
      thousands)
            
            2008
            
            
            2009U.S.
      revolving line of credit, bearing interest ranging from 4.00% to
      5.25%as of December 31, 2008
            
            $
            20,120
            
            
            $
            —Term
      loan payable to banks, bearing interest at 4.94% as of December
      31,2008,and
                2.75% as of December 31,
      2009
            
            
            75,000
            
            
            
            41,250Less
      current maturities
            
            
            (15,000
            )
            
            
            —$
            80,120
            
            
            $
            41,250





9.  COMMITMENTS
AND CONTINGENCIES





The
Company markets a significant portion of its products with licenses from other
parties.  These licenses are generally limited in scope and duration
and authorize the sale of specific licensed products, generally on a
nonexclusive basis.  The Company is party to more than 250 licenses
with, among others, various entertainment, publishing and media companies,
automotive and truck manufacturers, and agricultural and construction vehicle
and equipment manufacturers.  Many of the licenses include minimum
guaranteed royalty payments that the Company must pay whether or not it meets
specified sales targets.  Aggregate future minimum guaranteed royalty
payments are as follows:





Year
Ending December 31,


(in
      thousands)2010
            $  5,6102011
            7,2172012
            6,3912013
            6,2752014
      and thereafter
            $       —





Royalty
expense for licenses, including any unearned guaranteed minimums, was $34.7
million, $31.2 million and $29.9 million for the years ended December 31, 2007,
2008 and 2009, respectively.





Rental
expense for office and warehouse space and other equipment under cancelable and
noncancelable operating leases amounted to $4.7 million, $4.6 million and $4.7
million for the years ended December 31, 2007, 2008 and 2009,
respectively.  Certain operating leases provided for scheduled
increases in rental payments during the term of the lease or for no rent during
part of the term of the lease.  For these leases, the Company
recognizes total rent expense on a straight-line basis over the minimum lease
term.


F-21





RC2
CORPORATION AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)








Commitments
for future minimum lease payments for noncancelable operating leases with terms
extending beyond one year at December 31, 2009, are as follows:





Year
Ending December 31,


(in
      thousands)2010
            $  4,3652011
            3,4712012
            3,3092013
            2,9872014
            2,569Thereafter
            $12,633





Unconditional
purchase obligations include agreements for purchases of product, tooling and
services such as advertising, and hardware and software
agreements.  Payments made and allowances given in connection with
these cancelable and noncancelable long-term unconditional purchase obligations
amounted to $28.6 million, $33.7 million and $31.4 million for the years ended
December 31, 2007, 2008 and 2009, respectively.





Commitments
for future minimum payments with terms extending beyond one year at December 31,
2009, for noncancelable unconditional purchase obligations are as
follows:





Year
Ending December 31,


(in
      thousands)2010
            $26,3682011
            18,3722012
            15,0482013
            15,0252014
      and thereafter
            $      34





10.  LEGAL
PROCEEDINGS





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





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





11.  COMMON
STOCK





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





(in
      thousands, except par value)
            
            Authorized
              Shares
            
            
            Par
              Value
            
            
            Shares
      Outstanding
              at
      December 31, 2008
            
            
            Shares
      Outstanding at
              December
      31, 2009Voting
      common stock
            
            
            28,000
            
            
            $
            0.01
            
            
            
            17,245
            
            
            
            21,384





During
the years ending December 31, 2008 and 2009, the Company sold a total of 9,514
shares and 23,449 shares, respectively, out of treasury to Company employees
under the Employee Stock Purchase Plan (ESPP) for $0.2 million in each of the
years then ended.  At December 31, 2009, the Company held 2.9 million
shares of its common stock in treasury.





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


F-22




RC2
CORPORATION AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)





The
Company’s Board of Directors authorized the adoption of a program to repurchase
up to $150.0 million of the Company’s common stock which terminated on December
31, 2008.  Under this program, shares were repurchased from time to
time in open market transactions.  Shares repurchased by the Company
are held as treasury shares.  During the years ended December 31, 2007
and 2008, the Company repurchased 2.9 million shares and 1.2 million shares for
$87.9 million and $24.7 million, respectively, under this program.  At
the conclusion of this program, through December 31, 2008, the Company had
repurchased an aggregate of 4.1 million shares for $112.6 million under the
$150.0 million stock repurchase authorization. These repurchases were funded
with borrowings on the Company’s previous credit facility and with cash flow
from operations.





12.    STOCK-BASED
PAYMENT ARRANGEMENTS





At
December 31, 2009, the Company has three stock incentive plans, two of which are
dormant, and an ESPP, which are described below.  Amounts recognized
in the financial statements with respect to these stock-based payment
arrangements for the years ended December 31, 2007, 2008 and 2009, are as
follows:





Year Ended December 31(in
      thousands)
            
            2007
            
            
            2008
            
            
            2009Total
      expense recognized for stock-based payment plans
            
            $
            4,705
            
            
            $
            6,078
            
            
            $
            6,298Amount
      of related income tax benefit recognized in determining net
      income
            
            $
            1,774
            
            
            $
            2,291
            
            
            $
            1,965





Stock-based
compensation expense is included in (a) cost of sales, other and (b) selling,
general and administrative expenses in the accompanying consolidated statements
of operations for the years ended December 31, 2007, 2008 and 2009.





Employee
Stock Purchase Plan





The
Company has an ESPP to provide its employees with an opportunity to purchase
common stock of the Company through accumulated payroll
deductions.  The plan allows eligible employees to purchase shares of
the Company’s common stock through quarterly offering periods commencing on each
January 1, April 1, July 1 and October 1.  The price for each share of
common stock purchased equals 90.0% of the last quoted sales price of a share of
the Company’s common stock as reported by NASDAQ on the first day of the
quarterly offering period or the last day of the quarterly offering period,
whichever is lower.  The Company has reserved 500,000 shares of common
stock held in treasury for issuance under the plan of which 428,804 shares
remain available as of December 31, 2009.  The plan was to initially
terminate on July 1, 2007.  However, in May 2007, the Board of
Directors approved an extension of the plan for an additional five years, and it
is now scheduled to terminate on July 1, 2012.





The fair
value of each option for shares under the ESPP during the years ended December
31, 2007, 2008 and 2009, is estimated on the date of grant based on the
Black-Scholes option pricing model with the following assumptions:




2007
            
            
            2008
            
            
            2009Weighted
      average expected life
            
            3
      months
            
            3
      months
            
            3
      monthsWeighted
      average risk-free rate of return
            
            
            4.8
            %
            
            
            1.8
            %
            
            
            0.1
            %Weighted
      average expected volatility
            
            
            42.0
            %
            
            
            76.7
            %
            
            
            120.2
            %Weighted
      average dividend yield
            
            None
            
            None
            
            None





The
weighted average fair value of options granted under the ESPP during the years
ended December 31, 2007, 2008 and 2009, was $9.07, $7.70 and $4.24,
respectively.





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


F-23





RC2
CORPORATION AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)








Stock
Incentive Plan





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





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





During
2005, a new stock incentive plan was approved by the Company’s
stockholders.  Under this plan, restricted stock awards, SARs or
options to purchase stock may be granted for up to 1,200,000 shares of common
stock.  During 2008, the Company’s stockholders approved an increase
of 1,000,000 shares of common stock to be available for grants of restricted
stock awards, SARs or options to purchase stock.  Options and SARs
granted generally vest over a three to five-year period.  These
options and SARs expire on the tenth anniversary of the date of grant or 90 days
after the date of termination of the employee’s employment with the
Company.  Under this plan, cancelled options revert back into the plan
and are available for future issuance.  Restricted stock awards
generally vest over a two to three year period.





The fair
value of stock options and SARs granted under the stock incentive plans during
the years ended December 31, 2007, 2008 and 2009, is estimated on the date of
grant based on the Black-Scholes option-pricing model with the following
assumptions:





2007
            
            
            2008
            
            
            2009Weighted
      average expected life
            
            7
      years
            
            7
      years
            
            6
      yearsWeighted
      average risk-free rate of return
            
            
            4.7
            %
            
            
            2.9
            %
            
            
            2.2
            %Weighted
      average expected volatility
            
            
            48.4
            %
            
            
            40.5
            %
            
            
            59.0
            %Weighted
      average dividend yield
            
            None
            
            None
            
            None





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








F-24


RC2
CORPORATION AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)








A summary
of stock option and SAR activity for the Company’s stock incentive plans for the
years ended December 31, 2007, 2008 and 2009, is as follows:





Shares
            
            
            Weighted
              Average
              Exercise
              Price
            
            
            Aggregate
              Intrinsic
              Value
              (in
      000s)
            
            
            Weighted
              Average
              Remaining
              Contractual
      Life
            
            
            Shares
              Available
              for
      Future
              GrantsOutstanding
      as of December 31, 2006
            
            
            1,412,201
            
            
            $
            20.15
            
            
            
            
            
            
            
            
            
            934,2252007Granted
            
            
            257,009
            
            
            
            39.12Exercised
            
            
            156,100
            
            
            
            12.67Forfeited
            
            
            5,400
            
            
            
            33.90Expired
            
            
            16,320
            
            
            
            9.84Outstanding
      as of December 31, 2007
            
            
            1,491,390
            
            
            
            24.27
            
            
            
            
            
            
            
            
            
            641,3792008Granted
            
            
            639,500
            
            
            
            19.44Exercised
            
            
            82,118
            
            
            
            11.64Forfeited
            
            
            115,600
            
            
            
            29.93Expired
            
            
            12,030
            
            
            
            33.53Outstanding
      as of December 31, 2008
            
            
            1,921,142
            
            
            
            22.80
            
            
            
            
            
            
            
            
            
            1,073,8552009Granted
            
            
            1,000,300
            
            
            
            5.20Exercised
            
            
            37,000
            
            
            
            5.01Forfeited
            
            
            41,377
            
            
            
            17.57Cancelled
            
            
            224,600
            
            
            
            37.30Expired
            
            
            84,460
            
            
            
            27.37Outstanding
      as of December 31, 2009
            
            
            2,534,005
            
            
            $
            14.76
            
            
            $
            12,212
            
            
            
            7.0
            
            
            
            278,399Exercisable
      and vested as of
              December31,
      2009
            
            
            959,005
            
            
            $
            19.52
            
            
            $
            2,695Expected
      to vest at December 31, 2009
            
            
            1,553,987
            
            
            
            11.88
            
            
            
            9,384Total
      vested and expected to vest
            
            
            2,512,992
            
            
            $
            14.80
            
            
            $
            12,079
            
            
            
            6.9





The
following table summarizes information about stock options and SARs outstanding
at December 31, 2009:





Range
      of
              Exercise
      Prices
            
            Number
              Outstanding
            
            
            Weighted
              Average
      Remaining
              Contractual
      Life
            
            
            Weighted
      Average
              Exercise
      Price
            
            
            Number
              Exercisable
            
            
            Weighted
      Average
              Exercise
      Price$  1.41
      - $  5.11
            
            
            1,061,049
            
            
            
            8.5
            
            
            $
            4.83
            
            
            
            85,249
            
            
            $
            1.58$  7.94
      - $15.10
            
            
            389,497
            
            
            
            3.3
            
            
            
            10.45
            
            
            
            341,497
            
            
            
            10.17$16.59
      - $24.78
            
            
            686,075
            
            
            
            7.3
            
            
            
            21.22
            
            
            
            263,875
            
            
            
            22.93$28.87
      - $43.06
            
            
            397,384
            
            
            
            5.9
            
            
            $
            34.36
            
            
            
            268,384
            
            
            $
            33.77





The
weighted average fair value of options and SARs granted under the Company’s
stock incentive plans for the years ended December 31, 2007, 2008 and 2009, was
$21.54, $9.00 and $2.63 per share, respectively.  The total intrinsic
value of options and SARs exercised during the years ended December 31, 2007,
2008 and 2009, was $4.4 million, $1.0 million and $0.3 million,
respectively.





As of
December 31, 2009, there was $5.9 million of total unrecognized compensation
cost related to nonvested stock-based compensation arrangements granted under
the Company’s stock incentive plans.  That cost is expected to be
recognized over a
weighted average period of 2.6 years.  The total fair value of options
vested during the year ended December 31, 2009, was $5.1 million.





F-25


RC2
CORPORATION AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)








Restricted
stock awards require no payment from the grantee.  The related
compensation cost of each award is calculated using either the market price on
the grant date or the market price on the last day of the reported period and is
expensed equally over the vesting period.  A summary of restricted
stock awards for the Company’s stock incentive plan for the years ended December
31, 2007, 2008 and 2009, is as follows:





Number
      of
              Shares
            
            
            Weighted
      Average
              Grant
      Date
              Fair
      Value
            
            Weighted
      Average
              Remaining
              Contractual
      LifeUnvested
      restricted stock awards as of December 31, 2006
            
            
            —
            
            
            $
            —2007Granted
            
            
            39,837
            
            
            
            38.32Vested
            
            
            4,195
            
            
            
            40.57Unvested
      restricted stock awards as of December 31, 2007
            
            
            35,642
            
            
            
            38.052008Granted
            
            
            34,496
            
            
            
            17.39Vested
            
            
            9,939
            
            
            
            41.75Forfeited
            
            
            2,348
            
            
            
            42.61Unvested
      restricted stock awards as of December 31, 2008
            
            
            57,851
            
            
            
            21.902009Granted
            
            
            53,656
            
            
            
            10.72Vested
            
            
            20,271
            
            
            
            27.89Unvested
      restricted stock awards as of December 31, 2009
            
            
            91,236
            
            
            $
            14.44
            
            1.8





As of
December 31, 2009, there was $0.7 million of total unrecognized compensation
cost related to nonvested stock-based compensation arrangements granted under
the Company’s stock incentive plan for restricted stock awards.  That
cost is expected to be recognized over a weighted average period of 1.8
years.





13.  COMPREHENSIVE
INCOME (LOSS)





Comprehensive
income (loss) for the years ended December 31, 2007, 2008 and 2009, is
calculated as follows:





Year Ended December 31,(in
      thousands)
            
            2007
            
            
            2008
            
            
            2009Net
      income (loss)
            
            $
            21,686
            
            
            $
            (205,752
            )
            
            $
            26,962Foreign
      currency translation adjustments, net of tax
            
            
            3,029
            
            
            
            (23,084
            )
            
            
            7,946Pension
      liability adjustment, net of tax
            
            
            1,051
            
            
            
            (2,508
            )
            
            
            (365
            )Comprehensive
      income (loss)
            
            $
            25,766
            
            
            $
            (231,344
            )
            
            $
            34,543





14.  RELATED
PARTY TRANSACTIONS





The
Company purchased $11.0 million of product during 2007 from a company in which a
relative of a Company stockholder and former director of the Company had an
ownership interest.  Additionally, in 2008, the Company purchased,
from this same company, $4.8 million of product through May 2008, at which time
the former director completed his board of directors tenure.  The
Company also purchased $4.4 million of product during 2007, from another company
in which relatives of a Company stockholder and former director of the Company
had ownership interests.




A member
of our Board of Directors is the President and Chief Executive Officer of the
investment banking firm which acted as lead underwriter for our public offering
of 4.0 million shares of common stock completed in August 2009.  The
investment banking firm received an underwriting discount of $2.4 million in the
transaction.


F-26


RC2
CORPORATION AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)








15.  EMPLOYEE
BENEFIT PLANS





The
Company is self-insured on medical benefits offered to employees generally up to
a limit of $0.1 million per employee or $2.8 million in aggregate per coverage
year.  The Company holds excess loss coverage for those amounts that
exceed the self-insured limits.





The
Company has a 401(k) savings plan.  Employees meeting certain
eligibility requirements, as defined, may contribute up to 100.0% of pre-tax
gross wages, limited to a maximum annual amount as set periodically by the
IRS.  In 2007 and 2008, the Company made matching contributions of
100% on the first 4.0% of employees' annual wages and 50.0% on the next 6.0% of
employees' annual wages.  In 2009, the Company made matching contributions
of 100.0% of the first 3.0% of employees’ annual wages and 50.0% on the next
2.0% of employees’ annual wages.  For the years ended December 31,
2007, 2008 and 2009, the Company contributions were $1.2 million, $1.1 million
and $0.7 million, respectively.





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
employees’ years of service.  The Company uses a December 31
measurement date for this Plan.





The
Company recognizes the overfunded or underfunded status of a defined benefit
postretirement plan as an asset or a liability in its balance sheet and
recognizes changes in that funded status in the year in which the changes occur
through accumulated other comprehensive income (loss).  The Company
also measures the funded status of the Plan as of the date of its year-end
balance sheet.





Reconciliation
of Beginning and End of Year Fair Value of Plan Assets and
Obligations





December 31,(in
      thousands)
            
            2007
            
            
            2008
            
            
            2009Change
      in benefit obligationBenefit
      obligation at beginning of year
            
            $
            14,522
            
            
            $
            13,415
            
            
            $
            13,214Service
      cost
            
            
            107
            
            
            
            101
            
            
            
            125Interest
      cost
            
            
            820
            
            
            
            854
            
            
            
            891Actuarial
      (gain) loss
            
            
            (1,518
            )
            
            
            (563
            )
            
            
            1,584Benefits
      paid and plan expenses
            
            
            (516
            )
            
            
            (593
            )
            
            
            (707
            )Benefit
      obligation at end of year
            
            $
            13,415
            
            
            $
            13,214
            
            
            $
            15,107Change
      in plan assetsFair
      value of assets at beginning of year
            
            $
            12,404
            
            
            $
            13,281
            
            
            $
            9,000Actual
      return on plan assets
            
            
            778
            
            
            
            (3,688
            )
            
            
            1,629Employer
      contributions
            
            
            615
            
            
            
            —
            
            
            
            1,500Benefits
      paid and plan expenses
            
            
            (516
            )
            
            
            (593
            )
            
            
            (707
            )Fair
      value of assets at end of year
            
            $
            13,281
            
            
            $
            9,000
            
            
            $
            11,422Funded
      Status at End of Year
            
            $
            (134
            )
            
            $
            (4,214
            )
            
            $
            (3,685
            )Amounts
      Recognized in the Consolidated Balance SheetsOther
      non-current liabilities
            
            $
            134
            
            
            $
            4,214
            
            
            $
            3,685Accumulated
      other comprehensive loss
            
            $
            3,228
            
            
            $
            7,253
            
            
            $
            7,929Amounts
      Recognized in Accumulated Other Comprehensive LossPrior
      service cost
            
            $
            114
            
            
            $
            95
            
            
            $
            76Actuarial
      loss
            
            
            3,114
            
            
            
            7,158
            
            
            
            7,853Accumulated
      other comprehensive loss
            
            $
            3,228
            
            
            $
            7,253
            
            
            $
            7,929





F-27


RC2
CORPORATION AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)




December 31,(in
      thousands)
            
            2007
            
            
            2008
            
            
            2009Information
      for Pension Plans with an Accumulated Benefit Obligation in Excess of Plan
      AssetsProjected
      benefit obligation
            
            $
            13,415
            
            
            $
            13,214
            
            
            $
            15,107Accumulated
      benefit obligation
            
            
            13,415
            
            
            
            13,214
            
            
            
            15,107Fair
      value plan assets
            
            $
            13,281
            
            
            $
            9,000
            
            
            $
            11,422Year Ended December 31,2007
            
            
            
            2008
            
            
            
            2009Components
      of Net Periodic Benefit CostService
      cost
            
            $
            107
            
            
            $
            101
            
            
            $
            125Interest
      cost
            
            
            820
            
            
            
            854
            
            
            
            891Expected
      return on plan assets
            
            
            (1,012
            )
            
            
            (1,110
            )
            
            
            (971
            )Amortization
      of prior service cost
            
            
            19
            
            
            
            19
            
            
            
            19Amortization
      of net loss
            
            
            384
            
            
            
            190
            
            
            
            231Net
      periodic benefit cost
            
            $
            318
            
            
            $
            54
            
            
            $
            295Other
      Changes in Plan Assets and Projected Benefit Obligation
              as Other Comprehensive (Income) LossNet
      actuarial (gain) loss
            
            $
            (1,284
            )
            
            $
            4,234
            
            
            $
            926Amortization
      of net actuarial gain
            
            
            (384
            )
            
            
            (190
            )
            
            
            (231
            )Amortization
      of prior service cost
            
            
            (19
            )
            
            
            (19
            )
            
            
            (19
            )Total
      other comprehensive (income) loss
            
            $
            (1,687
            )
            
            $
            4,025
            
            
            $
            676Estimated
      Items That Will Be Amortized from Accumulated Other
      Comprehensive
              Loss
      into Net Periodic Benefit Cost During 2010Prior
      service cost
            
            
            
            
            
            
            
            
            
            $
            19Actuarial
      loss
            
            
            
            
            
            
            
            
            
            
            506Expected
      recognition of expense
            
            
            
            
            
            
            
            
            
            $
            525Reconciliation
      of Funded StatusFunded
      status
            
            $
            (134
            )
            
            $
            (4,214
            )
            
            $
            (3,685
            )Unrecognized
      net actuarial loss
            
            
            3,114
            
            
            
            7,158
            
            
            
            7,853Unrecognized
      prior service cost
            
            
            114
            
            
            
            95
            
            
            
            76Prepaid
      benefit cost
            
            $
            3,094
            
            
            $
            3,039
            
            
            $
            4,244





Estimated Future Benefit
      Payments2010
            $    6222011
            6362012
            6602013
            7392014
            7762015
      to 2019
            $
      4,979





F-28


RC2
CORPORATION AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)





Assumptions
            
            2007
            
            
            2008
            
            
            2009Weighted
      Average Assumptions Used to Determine Benefit Obligations at December
      31Discount
      rate
            
            
            6.50
            %
            
            
            6.89
            %
            
            
            5.98
            %Rate
      of compensation increase
            
            
            N/A
            
            
            
            N/A
            
            
            
            N/AWeighted
      Average Assumptions Used to Determine Net Periodic Benefit Cost for the
      Years
              Ended December 31Discount
      rate
            
            
            5.75
            %
            
            
            6.50
            %
            
            
            6.89
            %Expected
      return on plan assets
            
            
            8.50
            %
            
            
            8.50
            %
            
            
            7.75
            %Rate
      of compensation increase
            
            
            N/A
            
            
            
            N/A
            
            
            
            N/A





The
discount rate is supported by the Hewitt Top Quartile yield curve, which is
developed using yields of various bonds rated Aa or higher.  The
Plan’s projected cash flow was matched to this yield curve and a present value
developed.





Expected
Return on Plan Assets





The
Company employs a building-block approach in determining the long-term rate of
return for plan assets.  Historical markets are studied, and long-term
historical relationships between equities and fixed income securities are
preserved consistent with the widely-accepted capital market principle that
assets with higher volatility generate a greater return over the long
run.  Current market factors such as inflation and interest rates are
evaluated before long-term capital market assumptions are
determined.  The long-term portfolio return is established via a
building-block approach with proper consideration of diversification and
rebalancing.  Peer data and historical returns are reviewed to check
for reasonableness and appropriateness.





Projected
Annual Returns





Based on
the current target allocation of assets, the expected return model estimates a
long-term average (50th
percentile) rate of return (nominal) of 7.95% per year for the
Plan.  The model incorporates real return assumptions for each asset
class adjusting for variations in volatility, correlation and
inflation.  The following table sets out the projected annual
returns.








Percentile ReturnsTime
      Period
            
            75th
            
            
            50th
            
            
            25th1
      year
            
            
            -0.28
            %
            
            
            7.95
            %
            
            
            16.86
            %5
      years
            
            
            4.19
            
            
            
            7.95
            
            
            
            11.8510
      years
            
            
            5.28
            
            
            
            7.95
            
            
            
            10.6920
      years
            
            
            6.05
            %
            
            
            7.95
            %
            
            
            9.88
            %





F-29


RC2
CORPORATION AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)








Plan
Assets





The
Company contributed $1.5 million on December 29, 2009, and the Company
anticipates the cash contribution will be invested in accordance with the target
allocation in the first quarter of 2010.  Excluding the contribution
on December 29, 2009, the allocation of assets between major asset categories as
of December 31, 2008 and 2009, as well as the target allocation, are as
follows:





Target
            
            
            Percentage
      of Plan Assets
              December 31,Asset
      Category
            
            Allocation
            
            
            2008
            
            
            2009Large
      cap domestic equity securities
            
            
            24
            %
            
            
            47
            %
            
            
            24
            %Mid
      cap domestic equity securities
            
            
            11
            
            
            
            —
            
            
            
            11Small
      cap domestic equity securities
            
            
            6
            
            
            
            16
            
            
            
            6International
      equity securities
            
            
            14
            
            
            
            3
            
            
            
            14Commodities
            
            
            5
            
            
            
            —
            
            
            
            5Fixed
      income securities
            
            
            40
            
            
            
            34
            
            
            
            40Total
            
            
            100
            %
            
            
            100
            %
            
            
            100
            %





Explanation
of Investment Strategies and Policies





The
Company employs a total return on investment approach whereby a mix of equities
and fixed income investments are used to maximize the long-term return of plan
assets for a prudent level of risk.  The intent of this strategy is to
minimize plan expenses by outperforming plan liabilities over the long
run.  Risk tolerance is established through careful consideration of
plan liabilities, plan funded status and corporate financial
condition.





The
investment portfolio contains a diversified blend of equity and fixed income
investments.  Furthermore, equity investments are diversified across
U.S. and non-U.S. stocks, as well as growth, value, and small and large
capitalizations.  Derivatives may be used to gain market exposure in
an efficient and timely manner; however, derivatives may not be used to leverage
the portfolio beyond the market value of the underlying
investments.  Investment risk is measured and monitored on an ongoing
basis through annual liability measurements, periodic asset/liability studies
and quarterly investment portfolio reviews.





Investment
Valuation





Following
is a description of the valuation methodologies used for assets measured at fair
value:





Cash and cash equivalents -
Valued at carrying amount, which approximates fair value because of the
short-term nature of these items.





Mutual funds - Valued at the
net asset value of shares held by the Plan at year-end.





The
methods described above may produce a fair value calculation that may not be
indicative of net realizable value or reflective of future fair
value.  Furthermore, while the Plan believes its valuation methods are
appropriate and consistent with other market participants, the use of different
methodologies or assumptions to determine the fair value of certain financial
instruments could result in a different fair value measurement at the reporting
date.


The
following table sets forth by level within the fair value hierarchy, the Plan’s
assets at fair value as of December 31, 2009:





(in
      thousands)
            
            Level
      1
            
            
            Level
      2
            
            
            Level
      3
            
            
            TotalCash
      equivalents
            
            $
            1,622
            
            
            $
            —
            
            
            $
            —
            
            
            $
            1,622Mutual
      funds
            
            
            9,800
            
            
            
            —
            
            
            
            —
            
            
            
            9,800Total
      assets at fair value
            
            $
            11,422
            
            
            $
            —
            
            
            $
            —
            
            
            $
            11,422






F-30








RC2
CORPORATION AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)





Employer Contributions




During
the year ended December 31, 2009, the Company contributed $1.5 million to the
Plan and does not expect to make any contributions to the plan during
2010.  There are no minimum required contributions to the Plan for
fiscal year 2010.  However, the Company may make contributions to the
Plan at its discretion.  The Company is not expecting a reversion of
the Plan assets to the employer during the next year.





16.  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.  A gain of
$0.1 million, net of tax, was recognized on this transaction during the year
ended December 31, 2007.  The gain on the sale is presented in income
from discontinued operations, net of tax, in the accompanying consolidated
statement of operations for the year ended December 31, 2007.





17.  PRODUCT
RECALLS





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





During
2008, the Company received an inquiry from the CPSC for information regarding
the 2007 recalls for the purpose of assessing whether the CPSC may impose a fine
on the Company.  In the fourth quarter of 2009, the Company agreed to
a settlement with the CPSC resolving this matter, which included a $1.3 million
civil penalty.  This penalty was included in accrued expenses in the
accompanying consolidated balance sheets at both December 31, 2008 and 2009, and
was paid subsequent to the end of 2009.





The
Company recorded charges related to the 2007 recalls of $28.3 million, $14.3
million and $0.2 million for the years ended December 31, 2007, 2008 and 2009,
respectively.  The Company had $6.0 million and $2.7 million of
accrued recall-related items included in accrued expenses in the accompanying
consolidated balance sheets at December 31, 2008 and December 31, 2009,
respectively.  These items are based on the latest estimates of
retailer inventory returns, consumer product replacement costs, fines and
penalties, and shipping costs as of the date of this filing, as well as
additional replacement costs or refunds, claims administration and unpaid legal
fees to defend recall-related matters incurred to date.  It is
reasonably possible that actual costs associated with the recalls and related
litigation could differ significantly from the estimates recorded.





18.  EVALUATION
OF SUBSEQUENT EVENTS





In
preparing these financial statements, the Company evaluated the events and
transactions that occurred between December 31, 2009, and March 1, 2010, the
date the accompanying consolidated financial statements were
issued.