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, 2010.





[   ]   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___     NoX





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___     NoX





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.


YesX     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___     NoX





Aggregate market value of the Registrant’s common stock held by non-affiliates as of June 30, 2010 (the last business day of the Registrant’s most recently completed second quarter): $340,016,806.  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, 2011: 21,659,048





DOCUMENTS INCORPORATED BY REFERENCE





Portions of the Proxy Statement for the 2011 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,” “opportunity,” “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®, Lamaze® and JJ Cole® Collections brands, as well as popular and classic licensed properties such as Thomas & Friends, Bob the Builder, Special Agent Oso, Chuggington, Dinosaur Train, John Deere, Disney’sWinnie the Pooh, Princesses, Cars, FairiesandToy Story, Ziploc, 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.


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Recent Acquisition





At the close of business on August 4, 2010, the Company acquired substantially all of the assets of White Pines, LLC (the JJ Cole Business), a privately-held, developer and marketer of mother, infant and toddler stylized travel, storage, comfort and convenience products marketed under the JJ Cole Collections brand.  The acquired brands and products and the new additions to the Company’s management team will allow the Company to rapidly expand its presence in stylized and fashion-driven mother, infant and toddler products.  Closing consideration consisted of $44.6 million of cash, of which $4.0 million was provided by the sale of non-controlling interest, resulting in a net cash outlay by the Company of $40.7 million.  The Company holds an approximate 91.1% interest in the subsidiary formed to acquire the assets of the JJ Cole Business and senior management of the JJ Cole Business holds the remaining interest in the subsidiary.





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.





Our mother, infant and toddler products category includes a wide-range of products related to infant and toddler feeding, gear, care, play and soft goods, which are marketed under such brands as The First Years, Lamaze and JJ Cole Collections.  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 gear, potty seats and safety gates.  In 2010, we introduced a new infant seat and a line of strollers under The First Years brand.  In 2011, we plan to introduce additional new products under The First Years, including co-branding products with Ziploc and Gumdrop, JJ Cole Collections 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 2010, we introduced a new product line featuring the characters from the PBS television show Dinosaur Train.  This product line features characterized dinosaurs, train cars and plush toys.  Additionally, in 2010, we had a limited U.S. introduction of the Chuggington Die-Cast product line which features a range of collectible die-cast engines and playsets featuring the characters from the Chuggington television show broadcast in the U.S. on the Disney Channel.  In 2011, we plan to introduce additional new products under the Chuggington, Dinosaur Train, Thomas & Friends Wooden Railway and John Deere product lines.





International.  In addition to our business in North America, in 2010, we operated in more than 60 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 2010 included Learning Curve, Thomas & Friends Wooden Railway, Chuggington, Bob the Builder, The First Years, Lamaze, Ertl, including the John Deere product line, and Britains®.  Significant product introductions for 2010 included two new train play product lines based on the Chuggington television show, as well as extending the product line of Thomas & Friends Wooden Railway.  In 2011, we plan on expanding the international presence of our Chuggington, Dinosaur Train, The First Years, Lamaze and JJ Cole Collections product lines.





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), Lamaze International, Inc. and S.C. Johnson & Son, Inc. (related to the Ziploc brand).  In addition to our Chuggington global master toy licensing rights, we hold a 50.0% interest in Chuggington’s intellectual property rights.


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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, 2010, royalty expense was 7.1% of our net sales.  For the year ended December 31, 2010, 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, 2010.





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, 2010, approximately 34% 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, 2010, are $23.1 million, with individual minimum guarantees ranging up to $12.0 million.  Royalty expense related to licenses with minimum guarantees for the year ended December 31, 2010, was $19.7 million.





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 2010 to chain retailers were 71.9% 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 28.1% of our net sales in 2010.  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 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 JJ Cole®.  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 specialty and independent toy, infant product and hobby stores.


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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 31.5% of our net sales in 2010.  External sales representatives earn commissions of up to 12.0% 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.





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.  Additionally, increased levels of advertising can occur in conjunction with new product introductions.  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.jjcolecollections.com, www.duematernity.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, including new product introductions, 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.  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.





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 supplier relationships 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 China, and employ 257 people in Hong Kong and in 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.





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Far east production.  Most of our products are manufactured in China.  Our China-based product sourcing accounted for 87.1% of our product purchases in 2010.  During 2010, we used four third-party, dedicated, China-based suppliers who manufactured only our products.  Third-party, dedicated suppliers produced 27.0% of our China-based product purchases in 2010.  In addition to our third-party, dedicated suppliers, we use numerous other suppliers in China.  Many of our suppliers have been producing for us for more than ten years.  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 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.





Tooling.  To create many of our new products, we invest in tooling.  Tooling represents the majority of our capital expenditures.  Depending on the size and complexity of the product, the cost of tooling a product can range from $3,000 to approximately $300,000.  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.








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.





6


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 preschool, youth and adult products business is highly seasonal primarily due to high consumer demand for our toy products during the year-end holiday season.  As a result, 58.8% of our consolidated net sales for the three years ended December 31, 2010, were generated in the second half of the year, with September being the largest shipping month.  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 38.9% of our net sales in 2010.  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 2010.  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, 2010, we had 816 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 96 of our employees who work in the Company’s U.S. distribution facilities.  We consider our employee relations to be very good.  Our continued success will depend, in part, on our ability to attract, train and retain qualified personnel at all of our locations.





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 current license agreement with HIT Entertainment for the Thomas & Friends Wooden Railway product line expires at the end of 2012.  For the year ended December 31, 2010, net sales of our products under this license agreement accounted for over ten percent of our total net sales.  Any non-renewal of this license may have an adverse effect on our net sales and profitability.  Our intangible assets as of December 31, 2010, include approximately $32.0 million relating to this license.  Based on expectations relating to the renewal of this license, we may need to record a charge for impairment of the intangible asset prior to the expiration of the license.  See “Risk Factors – Impairment charges could reduce our profitability” for additional information regarding risks relating to impairment charges.





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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 or other product safety issues 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.  A product safety warning regarding one of our products may result in charges due to retailer returns and inventory obsolescence even if there is not a product recall.  Product recalls or other product safety issues 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.  Product recalls or other product safety issues 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.





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 labor, transportation, raw materials or other items used to manufacture our products could increase our cost of sales and reduce our 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.  We directly pay transportation costs to ship many of our products and have recently encountered increased transportation costs which have adversely affected our margins.  During 2010, we experienced higher input costs, including ocean transportation costs, along with China labor and currency inflation. In 2011, we expect input costs to increase from 2010 levels.





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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 23.8% of our net sales in 2010 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.





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, competition in the distribution and quality of our products 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 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;






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●

the loss of key personnel of the acquired business;●

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 2010, 71.9% 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.





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 certain of our domestic customers, and the amount of this insurance covers a limited portion of the total amount of our accounts receivable.  At December 31, 2009 and 2010, our credit insurance covered 5.8% and 10.5%, respectively, of our gross accounts receivable.  Insurance coverage for future sales is subject to reduction or cancellation.





Because we rely on third-party suppliers to manufacture our products, we face the risk of supply disruptions due to factors outside of our control.
 
 We rely on third-party suppliers to manufacture our products.  We enter into purchase orders with our suppliers and generally do not enter into long-term contracts.  As a result, any of these suppliers could stop manufacturing our products due to a business shutdown, an arrangement to exclusively manufacture for another party or other reasons.  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.


10


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;●

limitations, including taxes, on repatriation of earnings;●

timely shipping of product and unloading of product, which primarily come 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.





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 the 2008 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, 2010, we had goodwill and other intangible assets of $17.4 million and $104.7 million, respectively.  Goodwill and other intangible assets represented 4.2% and 25.2% of our total assets at December 31, 2010, respectively.  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.





11


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.  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.





Our credit agreement matures on November 1, 2011, and we currently anticipate that we will refinance during 2011 to fund working capital needs.  We may not be able to refinance on acceptable terms or the terms of any refinancing may be less advantageous to us than our current credit agreement, including with respect to the amount of credit available, interest rates and the terms of the restrictive debt covenants.  A refinancing on less advantageous terms may adversely affect our business and may reduce our profitability.





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 preschool, youth and adult products are seasonal, which causes our operating results to vary from quarter to quarter.





Our preschool, youth and adult products 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.





12


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.





13


Item 2.  Properties
  As of December 31, 2010, 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

OwnedJJCC, Inc. office and warehouse (1)
25,299

Logan, UT

March 2012Learning Curve Brands, Inc. office
12,452

Canton, MA

August 2015Learning Curve Brands, Inc. office
3,300

Bentonville, AR

October 2013Learning Curve Brands, Inc. storage
1,875

Stoughton, MA

June 2011Learning Curve Brands, Inc. office
1,455

Kettering, OH

April 2012RC2 (H.K.) Limited quarters
68,230

Dongguan City, China

March 2012RC2 (H.K.) Limited office,warehouse and storage
123,603

Dongguan City, China

March 2012RC2 (H.K.) Limited office
7,563

Kowloon, Hong Kong

August 2012RC2 (H.K.) Limited quarters
2,173

Weng Yuan, Shao Guan,

December 2011ChinaRC2 (H.K.) Limited office
1,124

Weng Yuan, Shao Guan,

December 2011ChinaRacing Champions International Limited office
8,512

Exeter, United Kingdom

October 2013Racing Champions International Limited officeand showroom
2,035

Thatcham, United Kingdom

August 2011Racing Champions International Limited office
1,034

Lauren, Holland

December 2011Racing Champions International Limited office
674

Marcq-En-Baroeul, France

September 2014Racing Champions International Limited office
549

Barcelona, Spain

May 2013RC2 Deutschland GmbH office
2,562

Koln, Germany

August 2013RC2 Australia, Pty. Ltd. office and warehouse (2)
174,376

Dandenong South,

September 2019Victoria, Australia





(1)  21,456 square feet of the Logan, Utah facility represents warehouse space and is no longer being used in our operations.


(2)  15,500 square feet of the Dandenong South, Victoria, Australia warehouse has been sublet and is not being used in our operations.





Item 3.  Legal Proceedings





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





Item 4. [Reserved]





14


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.





2009:

High


LowFirst Quarter

$
10.73


$
3.40Second Quarter


15.07



5.40Third Quarter


16.92



12.67Fourth Quarter

$
16.16


$
12.462010:

High


LowFirst Quarter

$
16.53


$
14.11Second Quarter


19.72



14.95Third Quarter


20.95



14.80Fourth Quarter

$
24.00


$
20.75





As of December 31, 2010, there were 137 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, 2008, 2009 and 2010, and the consolidated balance sheet data as of December 31, 2009 and 2010, are derived from our audited consolidated financial statements included elsewhere herein.  The consolidated statements of operations for the years ended December 31, 2006 and 2007, and the consolidated balance sheet data as of December 31, 2006, 2007 and 2008, are derived from our audited consolidated financial statements, as adjusted for discontinued operations, that are not included herein.





15





Year Ended December 31,2006


2007


2008


2009


2010Consolidated Statements of Operations:

(in thousands, except per share data)Net sales (1)

$
518,829


$
488,999


$
437,029


$
421,139


$
427,343Cost of sales (2)


275,754



270,059



246,301



236,243



246,637Restructuring charge related to discontinued

automotive collectibles


1,872



—



—



—



—Recall-related items


—



4,624



(1,114
)


(298
)


(131
)Gross profit


241,203



214,316



191,842



185,194



180,837Selling, general and administrative expenses (2)


155,180



161,560



155,903



136,869



134,569Amortization


1,149



893



889



608



1,597Impairment of goodwill and other intangible assets


—



—



255,853



2,432



—Restructuring charge related to discontinued

automotive collectibles


12,631



—



—



—



—Recall-related items


—



18,068



15,782



576



(247
)Terminated acquisition costs


—



—



1,399



—



—Operating income (loss)


72,243



33,795



(237,984
)


44,709



44,918Interest expense


4,375



2,712



6,584



3,923



2,221Interest income


(910
)


(1,197
)


(1,579
)


(546
)


(891
)Write-off of investment


—



—



2,057



—



—Other expense (income), net


530



(1,768
)


(3,553
)


780



(718
)Income (loss) from continuing operationsbefore income taxes


68,248



34,048



(241,493
)


40,552



44,306Income tax expense (benefit)


24,478



12,472



(35,741
)


13,590



14,522Income (loss) from continuing operations


43,770



21,576



(205,752
)


26,962



29,784(Loss) income from discontinued operations, net of tax


(9,676
)


110



—



—



—Net income (loss)


34,094



21,686



(205,752
)


26,962



29,784Less: net income attributable to non-controlling interest


—



—



—



—



96Net income (loss) attributable to common stockholders

$
34,094


$
21,686


$
(205,752
)

$
26,962


$
29,688Basic earnings (loss) per share attributable to common stockholders:Income (loss) from continuing operations

$
2.09


$
1.05


$
(11.82
)

$
1.42


$
1.38(Loss) income from discontinued operations


(0.46
)


0.01



—



—



—Net income (loss) attributable to common stockholders

$
1.63


$
1.06


$
(11.82
)

$
1.42


$
1.38Diluted earnings (loss) per share attributable to common stockholders:Income (loss) from continuing operations

$
2.04


$
1.04


$
(11.82
)

$
1.39


$
1.34(Loss) income from discontinued operations


(0.45
)


0.01



—



—



—Net income (loss) attributable to common stockholders

$
1.59


$
1.05


$
(11.82
)

$
1.39


$
1.34Weighted average shares outstanding:Basic


20,884



20,395



17,406



19,014



21,564Diluted


21,377



20,748



17,406



19,362



22,113





(1)  Net sales for the years ended December 31, 2007, 2008, 2009 and 2010, include $(5.6) million, $0.3 million, $0.4 million and $0.1 million, respectively, in recall-related items.


(2)  Depreciation expense was $14.1 million, $13.9 million, $15.4 million, $11.5 million and $9.6 million for the years ended December 31, 2006, 2007, 2008, 2009 and 2010, respectively.





General Note:  Results include the operations 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 date of the acquisitions do not include any results for Angels Landing, Inc. or Mother’s Intuition Inc.  Results for 2010 include the JJ Cole Business from August 4, 2010.  As this acquisition was accounted for using the acquisition method of accounting, periods prior to the date of the acquisition do not include any results for the JJ Cole Business.  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.


16





As of December 31,Consolidated Balance Sheet Data: (in thousands)

2006


2007


2008


2009


2010Working capital

$
129,603


$
67,128


$
125,799


$
188,433


$
147,677Total assets


614,640



650,245



336,650



375,785



415,957Total debt


22,438



95,000



95,120



41,250



41,250Total equity

$
451,926


$
397,378


$
148,689


$
244,733


$
286,495





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 and risk of loss 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, 2008, 2009 and 2010, sales to chain retailers comprised 70.3%, 73.5% and 71.9%, 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 25.3%, 23.9% and 27.0%, of our net sales for the years ended December 31, 2008, 2009 and 2010, respectively.  We expect international sales to continue to increase in local currencies as we expand our geographic reach.  Net sales in our international segment increased 14.7% for the year ended December 31, 2010, which includes a favorable impact of 3.3% 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 40.1%, 43.5% and 38.9% of our net sales in 2008, 2009 and 2010, respectively.  Over the last three years, each of these three customers accounted for between 11.8% 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, 2008, 2009 or 2010.





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, 2008, 2009 and 2010, direct sales from China constituted 14.1%, 15.2% and 13.0%, respectively, of our net sales.





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 8.4% of our net sales over the last three years.





17


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 80.0%, 82.6% and 78.8% of our cost of sales in 2008, 2009 and 2010, respectively.  The remainder of our cost of sales primarily includes tooling depreciation, freight-in from suppliers, inventory write-downs, testing fees, concept and design expenses, employee compensation related to product sourcing, expense related to stock-based compensation 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.  During 2010, we experienced higher input costs, including ocean transportation costs, along with China labor and currency inflation.  In 2011, we expect input costs to increase from 2010 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 and other general selling-related costs, 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 2010, 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, 2008, 2009 and 2010.  Additionally, during the year ended December 31, 2010, income of $4.0 million was recognized based upon our 50.0% interest in the Chuggington intellectual property.  Sales commissions range up to 12.0% of the net sales price, and are generally paid quarterly to our external sales representative organizations.  Sales subject to commissions represented 30.9%, 32.6% and 31.5% of our net sales for the years ended December 31, 2008, 2009 and 2010, respectively.  Sales commission expense was 1.1% of our net sales for each of the years ended December 31, 2008, 2009 and 2010.





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 preschool, youth and adult products business is highly seasonal primarily due to the high consumer demand for our toy products during the year-end holiday season.  As a result, 58.8% of our consolidated net sales for the three years ended December 31, 2010, 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.


18


Results of Operations








Year Ended December 31,2008


2009


2010(in thousands, except per share data)

Amount


Percent


Amount


Percent


Amount


PercentNet sales

$
437,029



100.0
%

$
421,139



100.0
%

$
427,343



100.0
%Cost of sales


246,301



56.4



236,243



56.1



246,637



57.7Recall-related items


(1,114
)


(0.3
)


(298
)


(0.1
)


(131
)


—Gross profit


191,842



43.9



185,194



44.0



180,837



42.3Selling, general and administrative expenses


155,903



35.7



136,869



32.5



134,569



31.5Amortization


889



0.2



608



0.2



1,597



0.4Impairment of goodwill and other intangible assets


255,853



58.6



2,432



0.6



—



—Recall-related items


15,782



3.6



576



0.1



(247
)


(0.1
)Terminated acquisition costs


1,399



0.3



—



—



—



—Operating (loss) income


(237,984
)


(54.5
)


44,709



10.6



44,918



10.5Interest expense


6,584



1.5



3,923



0.9



2,221



0.5Interest income


(1,579
)


(0.4
)


(546
)


(0.1
)


(891
)


(0.2
)Write-off of investment


2,057



0.5



—



—



—



—Other (income) expense, net


(3,553
)


(0.8
)


780



0.2



(718
)


(0.2
)(Loss) income before income taxes


(241,493
)


(55.3
)


40,552



9.6



44,306



10.4Income tax (benefit) expense


(35,741
)


(8.2
)


13,590



3.2



14,522



3.4Net (loss) income


(205,752
)


(47.1
)


26,962



6.4



29,784



7.0Less: net income attributable to non-controlling interest


—



—



—



—



96



—Net (loss) income attributable to common stockholders

$
(205,752
)


(47.1
)%

$
26,962



6.4
%

$
29,688



7.0
%(Loss) earnings per share attributable to common stockholders:Basic

$
(11.82
)





$
1.42






$
1.38Diluted

$
(11.82
)





$
1.39






$
1.34Weighted average shares outstanding:Basic


17,406







19,014







21,564Diluted


17,406







19,362







22,113








19


Calculation of Adjusted EBITDA (1)








Year Ended December 31,(in thousands)

2008


2009


2010(Loss) income before income taxes and non-controlling interest

$
(241,493
)

$
40,552


$
44,306Impairment of goodwill and other intangible assets


255,853



2,432



—Depreciation and amortization


16,279



12,058



11,148Compensation expense for equity awards


6,078



6,298



4,997Sleep-related product costs


—



—



2,045Acquisition and integration costs


—



—



537Litigation settlement costs regarding pre-acquisition intellectual property


—



—



1,101Cash-based severance charges


1,344



—



—Recall-related items


14,327



—



—Terminated acquisition costs


1,399



—



—Write-off of investment


2,057



—



—(Gain) loss on disposal of fixed assets


(51
)


141



21Interest expense


6,584



3,923



2,221Adjusted EBITDA

$
62,377


$
65,404


$
66,376





(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.





Operating Highlights





Net sales for the year ended December 31, 2010, increased 1.5%.  Gross margins decreased to 42.3% for 2010, from 44.0% for 2009.  Selling, general and administrative expenses, as a percentage of net sales, decreased to 31.5% in 2010, from 32.5% in 2009.  The Company recorded operating income of $44.9 million in 2010, compared with $44.7 million in 2009.





On August 4, 2010, the Company completed the acquisition of substantially all of the assets of White Pines, LLC (the JJ Cole Business), a privately-held, developer and marketer of mother, infant and toddler stylized travel, storage, comfort and convenience products marketed under the JJ Cole® Collections brand.  The Company funded the acquisition with approximately $41.0 million from its existing cash.  Senior management of the JJ Cole Business has retained an approximate 9% carry-over ownership in the subsidiary of the Company that acquired the assets.  The Company incurred costs of $0.5 million during the year ended December 31, 2010, primarily related to the acquisition and successful integration of the JJ Cole Business’ logistics and back office operations.





On September 29, 2010, the U.S. Consumer Product Safety Commission and the U.S. Food and Drug Administration issued a blanket warning related to all infant sleep positioners.  The Company has had no reported injuries from its line of Airflow® infant sleep positioners, but has stopped production of these products and is cooperating with retailers who request product returns.  Accordingly, the results of operations for year ended December 31, 2010, include amounts relating to estimated retailer product returns, write-down of existing inventory and other related costs totaling $2.0 million.  Annualized 2010 net sales of Airflow infant sleep positioners represent less than 1% of consolidated net sales.





The Company incurred costs of $1.1 million during the year ended December 31, 2010, in connection with a litigation settlement related to certain of its Learning Curve subsidiary’s intellectual property from before the 2003 acquisition.





The Company recorded charges for non-cash impairment of intangible assets of $1.1 million, net of tax, or $0.06 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.






20





Adjusted EBITDA for the years ended December 31, 2008, 2009 and 2010, was $62.4 million, $65.4 million and $66.4 million, respectively.





Year Ended December 31, 2010, Compared to Year Ended December 31, 2009





Net sales.  Net sales increased $6.2 million, or 1.5%, to $427.3 million for 2010, from $421.1 million for 2009.  Net sales were positively impacted by 1.1% due to favorable fluctuations in foreign currency exchange rates.  Net sales in our North America segment decreased 2.7%, and net sales in our international segment increased 14.7%, which was positively impacted by 3.3% due to favorable fluctuations in foreign currency exchange rates.





Net sales in our mother, infant and toddler products category increased 6.6%, due to increases in The First Years® gear product lines, Lamaze® infant development toys, and contributions from the acquisition of JJ Cole Collections.  Net sales in our preschool, youth and adult products category decreased 2.5%, primarily driven by lower sales in our discontinued product lines.  Excluding the impact of the decrease in net sales from discontinued product lines of $41.1 million, net sales in the preschool, youth and adult products category were up 19.2% due to increases from our new Chuggington and Dinosaur Train product lines, as well as positive results from our Ertl® and Thomas & Friends Wooden Railway product lines.  Information in this paragraph regarding net sales excluding the impact of the decrease in net sales from discontinued product lines constitutes non-GAAP information.  See discussion of “Non-GAAP Financial Information” below.  A reconciliation to the nearest GAAP financial measure follows:





Net Sales(in millions)

2010


2009


Difference


% ChangePreschool, youth and adult products actual

$
231.9


$
237.8


$
(5.9
)


(2.5
)%Deduct: discontinued product lines


12.9



54.0



(41.1
)


(76.1
)As adjusted

$
219.0


$
183.8


$
35.2



19.2
%





Gross profit.  Gross profit decreased $4.4 million, or 2.4%, to $180.8 million for 2010, from $185.2 million for 2009.  The gross profit margin, as a percentage of net sales, decreased to 42.3% for 2010, from 44.0% for 2009. Infant sleep positioners retailer product returns and inventory charges decreased 2010 gross margin by 0.4 percentage points.  The remaining gross margin decrease was primarily due to higher product costs and unfavorable sales mix, as well as increased retail promotional allowances and higher transportation costs.  There were no major changes in the components of cost of sales.





Selling, general and administrative expenses.  Selling, general and administrative expenses decreased $2.3 million, or 1.7%, to $134.6 million for 2010, from $136.9 million for 2009, primarily due to lower royalty and other variable costs partially offset by increased distribution, marketing and legal expenses.  Because of our 50.0% interest in the Chuggington intellectual property rights, income of $4.0 million was recognized in 2010.  As a percentage of net sales, selling, general and administrative expenses decreased to 31.5% for 2010, from 32.5% for 2009.





Operating income.  The Company reported operating income of $44.9 million, or 10.5% of net sales, for 2010, as compared to 44.7 million, or 10.6% of net sales, for 2009.  Operating income for the year ended December 31, 2010, includes $2.0 million of retailer product returns, inventory charges and costs related to infant sleep positioners, as well as $1.6 million of acquisition and integration costs related to the JJ Cole Business and costs related to a litigation settlement regarding certain pre-acquisition Learning Curve intellectual property.  Operating income for the year ended December 31, 2009, includes a $2.4 million impairment charge on intangible assets.





Interest expense.  Interest expense of $2.2 million for 2010 and $3.9 million for 2009 relates primarily to the bank term loan and line of credit.  The decrease in interest expense for 2010 was primarily due to lower average outstanding debt.





Income tax.  Income tax expense for the years ended December 31, 2010 and 2009, includes federal, state and foreign income taxes at an effective rate of 32.8% and 33.5%, respectively, including discrete items.  Discrete items include significant, infrequent, unusual or non-recurring items.  The decrease in the effective tax rate is primarily due to a more favorable mix of discrete items.





21


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 certain new product lines 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 (benefit) expense 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.





Non-GAAP Financial Information





This section includes non-GAAP financial information consisting of Adjusted EBITDA (as described in more detail in the next section) and net sales in our preschool, youth and adult products category excluding discontinued product lines.  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.  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.





22


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 $17.5 million, $62.8 million and $15.0 million in 2008, 2009 and 2010, respectively.





Working capital decreased $40.7 million to $147.7 million at December 31, 2010, from $188.4 million at December 31, 2009.  This decrease in working capital resulted from the classification of our entire debt balance as short-term at December 31, 2010, as well as lower cash and cash equivalents partially offset by an increase in inventory.  Cash and cash equivalents decreased $29.2 million to $58.8 million at December 31, 2010, from $88.0 million at December 31, 2009, primarily due to the funding of the acquisition of the JJ Cole Business.  Our inventory levels increased $24.9 million to $90.8 million at December 31, 2010, from $65.9 million at December 31, 2009, primarily as a result of supporting our growing international business and new preschool and mother, infant and toddler product lines, purchasing products ahead of anticipated 2011 cost increases, timing of Chinese New Year and lower-than-expected December 2010 sales.





Net cash used in investing activities was $9.5 million in 2008, $12.9 million in 2009 and $51.8 million in 2010.  The increase in 2010 was primarily attributable to the acquisition of the JJ Cole Business.  Capital expenditures, primarily for molds and tooling, in 2009 and 2010 were $8.6 million and $11.0 million, respectively, and we expect capital expenditures for 2011, primarily for molds and tooling, to be in the range of $10.0 million to $11.0 million.





Net cash used in financing activities was $26.0 million in 2008.  Net cash provided by financing activities was $3.4 million and $5.8 million in 2009 and 2010, respectively.  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.  Therefore, there were no payments on outstanding debt in 2010.  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.  Borrowings under our credit facility were $3.0 million on our line of credit during the year ended December 31, 2009.  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.





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, 2010, the applicable margins in effect were 2.25% for LIBOR borrowings and 1.25% 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.  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, 2010, the commitment fee in effect was 0.45% per annum.





23


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.  During the fourth quarter of 2010, the credit facility was amended to remove the clean down provision which limited borrowings for a 60 day period.  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, 2010, 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, 2010, 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 $1.2 million and $0.5 million is included in other non-current assets in the accompanying consolidated balance sheets at December 31, 2009 and 2010, respectively.





The Company’s Hong Kong subsidiary maintains credit facilities with two banks providing for documentary and standby letters of credit of up to $5.0 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 and 2010, there were no amounts outstanding under these credit facilities.





The following table summarizes our significant contractual commitments at December 31, 2010:





Payment Due by Period(in thousands)













2016 andContractual Obligations (2)

Total


2011



2012-2013



2014-2015


beyondCredit facility

$
41,250


$
41,250


$
—


$
—


$
—Estimated future interest payments on credit facility (1)


1,130



1,130



—



—



—Minimum guaranteed royalty payments


23,085



4,255



18,670



160



—Operating leases


28,896



4,531



7,559



6,194



10,612Unconditional purchase obligations


3,148



2,169



934



45



—Total contractual cash obligations

$
97,509


$
53,335


$
27,163


$
6,399


$
10,612





(1)  Estimated future interest payments on our credit facility were based upon the interest rates in effect at December 31, 2010, and the balance outstanding on the term loan and the unused portion of the line of credit at December 31, 2010.


(2)  The table does not reflect unrecognized tax benefits of $1.8 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.





The Company’s existing credit facility matures November 1, 2011, and the Company currently anticipates that it will refinance its credit facility during 2011 to fund future working capital needs.  There can be no assurance that financing will be available on terms acceptable to the Company, if at all.  Excluding the classification of debt, we anticipate our working capital levels in 2011 will be relatively consistent with 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 2011.  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 and related liabilities are typically highest during the third and fourth quarters.




Off-Balance Sheet Arrangements





The Company did not have any off-balance sheet arrangements during any of the years ended December 31, 2008, 2009 and 2010.





24


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 certain of its domestic customers, and the amount of this insurance covers a limited portion 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.





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, non-conforming 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, changes in regulatory requirements 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 at that time.  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.  No impairment charges were recognized based on the Company’s annual test for impairment on its other indefinite lived intangibles in 2010.  At December 31, 2010, the Company had other intangible assets of $104.7 million, or 25.2% of its total assets, and goodwill of $17.4 million, or 4.2% of its total assets.  The next scheduled annual test for impairment on the Company’s goodwill and other indefinite lived intangibles will be as of October 1, 2011, and will be completed in the fourth quarter of 2011.  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.





25


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 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 2007 recalls.  The Company’s legal costs to defend recall-related matters are expensed as incurred.  When facts or circumstances become known that would indicate that the recall reserve is either not sufficient to cover or exceeds the estimated product recall expenses, the reserve is adjusted, as appropriate.





Accrued allowances.  The Company ordinarily accepts returns only for defective merchandise.  In certain instances, where retailers are unable to resell the quantity of products that they have purchased from the Company, the Company may, in accordance with industry practice, assist retailers in selling excess inventory by offering credits and other price concessions, which are typically evaluated and issued annually.  Other allowances can also be issued primarily for defective merchandise, volume programs and co-op advertising.  All allowances are accrued throughout the year, as sales are recorded.  The allowances are based on the terms of the various programs in effect; however, management also takes into consideration historical trends and specific customer and product information when making its estimates.  For the volume programs, the Company generally sets a volume target for the year with each participating customer and issues the discount if the target is achieved.  The allowance for the volume program is accrued throughout the year, and if it becomes clear to management that the estimated target for the participating customer requires adjustment, 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 stock-settled stock appreciation rights (SSARs) granted under the stock incentive plan is estimated on the date of grant based on the Black-Scholes option-pricing model.  The fair value of cash-settled stock appreciation rights (CSARs) is estimated on the last day of the reported period 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, SSARs and CSARs granted represents the period of time that stock options, SSARs and CSARs granted are expected to be outstanding.  The risk-free rate for the period within the contractual term of the stock option, SSAR or CSAR 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.  The fair value of performance-based restricted stock units (RSUs) granted under the stock incentive plan is calculated using the market price on the grant date.  The Company records stock-based compensation expense for performance-based RSUs based on its estimate of the amount of the performance-based RSUs to be earned upon completion of the performance period.





Recently Issued Accounting Codification





The Company did not implement any new recently issued accounting codifications during the year ended December 31, 2010.





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.





26


Based on the Company’s interest rate exposure on variable rate borrowings at December 31, 2010, 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, 2010, 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 23.8% of net sales for the year ended December 31, 2010, denominated in British pounds sterling, Australian dollars, Euros or 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, 2010, would have changed the total dollar amount of our gross profit by 11.9%.  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, 2010, would have changed the total dollar amount of our gross profit by 1.7%, 0.8% and 0.9%, 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, 2010, 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.





Item 8.  Financial Statements and Supplementary Data





Financial Statements





Our consolidated financial statements and notes thereto are filed under this item beginning on page F1 of this report.





Quarterly Results of Operations





The following tables set forth our unaudited quarterly results of operations for 2009 and 2010.  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.


27





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



67,785



66,258Gross profit


34,679



36,726



58,722



55,067Selling, general and administrative expenses (1)


29,703



30,134



36,757



40,851Amortization


196



165



153



94Impairment of intangible assets


—



—



—



2,432Operating 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.





Fiscal Year 2010(in thousands, except per share data)


Q1



Q2



Q3



Q4Net sales

$
88,083


$
86,121


$
128,974


$
124,165Cost of sales (1)


49,301



49,511



75,577



72,117Gross profit


38,782



36,610



53,397



52,048Selling, general and administrative expenses (1)


32,607



30,341



34,747



36,627Amortization


219



309



435



634Operating income


5,956



5,960



18,215



14,787Interest expense


550



548



559



564Interest income


(183
)


(289
)


(193
)


(226
)Other expense (income), net


31



357



(867
)


(239
)Income before income taxes


5,558



5,344



18,716



14,688Income tax expense


2,181



1,516



6,259



4,566Net income


3,377



3,828



12,457



10,122Less: net income attributable to non-controlling interest


—



—



44



52Net income attributable to common stockholders

$
3,377


$
3,828


$
12,413


$
10,070Earnings per share attributable to common stockholders:Basic

$
0.16


$
0.18


$
0.57


$
0.47Diluted

$
0.15


$
0.17


$
0.56


$
0.45Weighted average shares outstanding:Basic


21,405



21,561



21,636



21,651Diluted


21,933



22,088



22,118



22,244





(1)  Depreciation expense was $2.5 million, $2.2 million, $2.4 million and $2.4 million for Q1, Q2, Q3 and Q4 2010, respectively.





General Note: Results for 2010 include the results of the JJ Cole Business from August 4, 2010.  As this acquisition was accounted for using the acquisition method of accounting, periods prior to the acquisition effective date do not include any results for the JJ Cole Business.


28


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 Commission’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, 2010, 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, 2010, 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.





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).  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, 2010.  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, 2010, the Company’s internal control over financial reporting was effective based on those criteria.


29





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 2011 Annual Meeting of Stockholders, which will be filed with the Commission on or before May 2, 2011.  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 2011 Annual Meeting of Stockholders, which will be filed with the Commission on or before May 2, 2011.





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 Michael J. Merriman, Jr. (Chairman), John J. Vosicky and Joan K. Chow.





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 2011 Annual Meeting of Stockholders, which will be filed with the Commission on or before May 2, 2011.





The information incorporated by reference from the “Report of the Compensation Committee” in the Company’s Proxy Statement for the 2011 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 the security ownership of certain beneficial owners and management is incorporated herein by reference to the discussion under “Security Ownership” in the Company’s Proxy Statement for the 2011 Annual Meeting of Stockholders, which will be filed with the Commission on or before May 2, 2011.





30


Equity Compensation Plan Information





The following table summarizes share information, as of December 31, 2010, for RC2’s equity compensation plans, including the RC2 Corporation 2005 Stock Incentive Plan, the Racing Champions Ertl Corporation Stock Incentive Plan and the RC2 Corporation Employee Stock Purchase Plan (ESPP).  All of these plans have been approved by RC2’s stockholders.  The Racing Champions Ertl Corporation Stock Incentive Plan is dormant, and no future issuances are allowed under this plan.


Number of


WeightedCommon Shares to Be


Average


Number ofIssued Upon Exercise


Exercise Price of


Common SharesOf Outstanding


Outstanding


Available for FutureOptions and


Options/


Issuance Under EquityPlan Category

SSARs


SSARs


Compensation Plans (1)Equity compensation plansapproved  by stockholders


2,629,423


$
16.01



1,157,845Equity compensation plans not approvedby stockholders


—



—



—Total


2,629,423


$
16.01



1,157,845





(1) Number of common shares available for future issuance under equity compensation plans consists of 740,999 shares related to the 2005 Stock Incentive Plan and 416,846 shares related to the ESPP.


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 2011 Annual Meeting of Stockholders, which will be filed with the Commission on or before May 2, 2011.  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 2011 Annual Meeting of Stockholders, which will be filed with the Commission on or before May 2, 2011.




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 2011 Annual Meeting of Stockholders, which will be filed with the Commission on or before May 2, 2011.





Part IV





Item 15.  Exhibits and Financial Statement Schedules





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





31





1.

Financial StatementsThe following consolidated financial statements of the Company are included in Item 8 of this report:Reports of Independent Registered Public Accounting FirmConsolidated Balance Sheets as of December 31, 2009 and 2010Consolidated Statements of Operations for the Years Ended December 31, 2008, 2009 and 2010Consolidated Statements of Equity for the Years Ended December 31, 2008, 2009 and 2010Consolidated Statements of Cash Flows for the Years Ended December 31, 2008, 2009 and 2010Notes to Consolidated Financial Statements2.

Financial Statement SchedulesReport of Independent Registered Public Accounting FirmFinancial Statement Schedule for the Years Ended December 31, 2008, 2009 and 2010:


ScheduleNumber
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 theCompany’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 referenceto 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 referenceto 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’sQuarterly Report on Form 10-Q for the quarter ended March 31, 2004 (File No. 0-22635)).







32









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 (incorporated by reference to Exhibit 99.1 of the Company’s Current Report on Form 8-K (File No. 0-22635) filed by the Company with the Securities andExchange Commission on May 10, 2010).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 (incorporated by reference to Exhibit 10.8 of the Company’s Annual Report on Form 10-K for the year endedDecember 31, 2009 (File No. 0-22635)).10.9*

Form of Cash-Settled Stock Appreciation Right Grant Agreement for RC2 Corporation 2005 Stock Incentive Plan (incorporated by reference to Exhibit 10.9 of the Company’s Annual Report on Form 10-K for the year endedDecember 31, 2009 (File No. 0-22635)).10.10*

Form of Restricted Stock Grant Agreement for RC2 Corporation 2005 Stock Incentive Plan (incorporated by Reference to Exhibit 10.10 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2009(File No. 0-22635)).10.11*

Form of Performance-Based Restricted Stock Unit Agreement (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 ExchangeCommission on May 10, 2010).10.12*

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).10.13*

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)).10.14*

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)).10.15*

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)).




33




10.16*

RC2 Corporation Employee Stock Purchase Plan, as amended (incorporated by reference to Exhibit 99.1 of theCompany’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 (incorporated by reference to Exhibit 10.17 of the Company’s Annual Report on Form 10-Kfor the year ended December 31, 2009 (File No. 0-22635)).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 (incorporated byreference to Exhibit 10.18 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2009(File No. 0-22635)).10.19*

Second Amendment to Credit Agreement, dated as of November 10, 2010, among the Company, certain of its Subsidiaries, Bank of Montreal, as administrative agent, and other lenders named therein.10.20*

Technical Amendment to Employment Agreement for 409A Compliance, dated December 28, 2010, between the Company and Curtis W. Stoelting.10.21*

Technical Amendment to Employment Agreement for 409A Compliance, dated December 28, 2010, between the Company and Peter J. Henseler.10.22*

Technical Amendment to Employment Agreement for 409A Compliance, dated December 28, 2010, between the Company and Peter A. Nicholson.10.23*

Technical Amendment to Employment Agreement for 409A Compliance, dated December 28, 2010, between the Company and Gregory J. Kilrea.21

Subsidiaries of the Company23.1

Consent of Independent Registered Public Accounting Firm.24

Power of Attorney (included as part of the signature page thereof).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 2, 2011


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 2, 2011Robert E. Dods/s/ Curtis W. Stoelting

Chief Executive Officer and
March 2, 2011Curtis W. Stoelting

Director (Principal Executive Officer)/s/ Peter A. Nicholson

Chief Financial Officer and Secretary
March 2, 2011Peter A. Nicholson

(Principal Financial and Accounting Officer)/s/ Peter J. Henseler

Director
March 2, 2011Peter J. Henseler/s/ Linda A. Huett

Director
March 2, 2011Linda A. Huett/s/ Paul E. Purcell

Director
March 2, 2011Paul E. Purcell/s/ John S. Bakalar

Director
March 2, 2011John S. Bakalar/s/ John J. Vosicky

Director
March 2, 2011John J. Vosicky/s/ Joan K. Chow

Director
March 2, 2011Joan K. Chow/s/ Thomas M. Collinger

Director
March 2, 2011Thomas M. Collinger/s/ Michael J. Merriman, Jr.

Director
March 2, 2011Michael J. Merriman, Jr.


35


REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM





The Board of Directors and Stockholders


RC2 Corporation:





Under date of March 2, 2011, we reported on the consolidated balance sheets of RC2 Corporation and subsidiaries (the Company) as of December 31, 2009 and 2010, and the related consolidated statements of operations, equity and cash flows for each of the years in the three-year period ended December 31, 2010.  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, such 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 2, 2011





Schedule II





Description


Valuation and Qualifying Accounts


(in thousands)


(Credited)Balance at


Charged to


Charged toBeginning of


Costs and


Other





Balance atDescription

Year


Expenses


Accounts


Deductions


End of YearAllowance for doubtful accounts:Year ended December 31, 2008

$
1,808


$
1,424


$
(221
)

$
(1,218
)

$
1,793Year ended December 31, 2009


1,793



558



48



(1,052
)


1,347Year ended December 31, 2010

$
1,347


$
41


$
(4
)

$
(421
)

$
963





36


RC2 CORPORATION AND SUBSIDIARIES


INDEX TO FINANCIAL STATEMENTS






Reports of Independent Registered Public Accounting Firm
F2Consolidated Balance Sheets as of December 31, 2009 and 2010
F4Consolidated Statements of Operations for the Years Ended December 31, 2008, 2009 and 2010
F5Consolidated Statements of Equity for the Years Ended December 31, 2008, 2009 and 2010
F6Consolidated Statements of Cash Flows for the Years Ended December 31, 2008, 2009 and 2010
F7Notes to Consolidated Financial Statements
F8













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 (the Company) as of December 31, 2009 and 2010, and the related consolidated statements of operations, equity and cash flows for each of the years in the three-year period ended December 31, 2010.  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, 2009 and 2010, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2010, 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, 2010, 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 2, 2011, expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.





/s/ KPMG LLP





Chicago, Illinois


March 2, 2011


F-2


REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM








The Board of Directors and Stockholders


RC2 Corporation:





We have audited RC2 Corporation and subsidiaries’ (the Company) internal control over financial reporting as of December 31, 2010, 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, 2010, 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, 2009 and 2010, and the related consolidated statements of operations, equity and cash flows for each of the years in the three-year period ended December 31, 2010, and our report dated March 2, 2011, expressed an unqualified opinion on those consolidated financial statements.





/s/ KPMG LLP





Chicago, Illinois


March 2, 2011


F-3


RC2 CORPORATION AND SUBSIDIARIES


CONSOLIDATED BALANCE SHEETS





December 31,(in thousands, except par value)

2009


2010AssetsCurrent assets:Cash and cash equivalents

$
88,049


$
58,768Accounts receivable, net of allowances for doubtful accounts of $1,347 and $963


88,905



94,342Inventory


65,888



90,833Deferred and prepaid taxes, net


6,223



4,677Prepaid expenses


6,600



6,204Other current assets


5,348



1,858Total current assets


261,013



256,682Property and equipment, net


28,073



29,753Goodwill


—



17,410Intangible assets, net


80,309



104,748Other non-current assets


6,390



7,364Total assets

$
375,785


$
415,957





Liabilities and equity


Current liabilities:Accounts payable

$
23,266


$
27,314Income taxes payable, net


—



384Accrued expenses


46,685



37,560Current maturities of bank term loan


—



41,250Other current liabilities


2,629



2,497Total current liabilities


72,580



109,005Bank term loan


41,250



—Deferred income taxes


7,741



9,670Other non-current liabilities


9,481



10,787Total liabilities


131,052



129,462


Commitments and contingenciesEquity:Common stock, voting, $0.01 par value, 28,000 shares authorized,24,277 shares issued and 21,384 shares outstanding at December 31, 2009,and 24,537 shares issued and 21,657 shares outstanding at December 31, 2010


232



235Additional paid-in capital


264,738



270,947Accumulated other comprehensive loss


(6,368
)


(4,182
)Retained earnings


64,194



93,882322,796



360,882Treasury stock, at cost, 2,893 shares at December 31, 2009 and 2,880 shares at December 31, 2010


(78,063
)


(77,848
)Total stockholders’ equity


244,733



283,034Non-controlling interest


—



3,461Total equity


244,733



286,495Total liabilities and equity

$
375,785


$
415,957





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)

2008


2009


2010Net sales

$
437,029


$
421,139


$
427,343Cost of sales, related parties


4,761



—



—Cost of sales other


241,540



236,243



246,637Recall-related items


(1,114
)


(298
)


(131
)Gross profit


191,842



185,194



180,837Selling, general and administrative expenses


155,903



136,869



134,569Amortization


889



608



1,597Impairment of goodwill and other intangible assets


255,853



2,432



—Recall-related items


15,782



576



(247
)Terminated acquisition costs


1,399



—



—Operating (loss) income


(237,984
)


44,709



44,918Interest expense


6,584



3,923



2,221Interest income


(1,579
)


(546
)


(891
)Write-off of investment


2,057



—



—Other (income) expense, net


(3,553
)


780



(718
)(Loss) income before income taxes


(241,493
)


40,552



44,306Income tax (benefit) expense


(35,741
)


13,590



14,522Net (loss) income


(205,752
)


26,962



29,784Less: net income attributable to non-controlling interest


—



—



96Net (loss) income attributable to common stockholders

$
(205,752
)

$
26,962


$
29,688





(Loss) earnings per share attributable to common stockholders:


Basic

$
(11.82
)

$
1.42


$
1.38Diluted

$
(11.82
)

$
1.39


$
1.34Weighted average shares outstanding:Basic


17,406



19,014



21,564Diluted


17,406



19,362



22,113





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


F-5


RC2 CORPORATION AND SUBSIDIARIES


CONSOLIDATED STATEMENTS OF EQUITY





Common Stock

Treasury Stock

Accumulated Other Comprehensive Income

Additional Paid-in

Retained


Non-Controlling

Total(in thousands)

Shares

Amount

Shares

Amount

(Loss)

Capital

Earnings


Interest

EquityBalance, 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 fromrestricted 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


$
—

$
244,733Net income


—


—


—


—


—


—


29,688



96


29,784Sale of subsidiary shares to non-controllinginterest


—


—


—


—


—


—


—



3,365


3,365Stock issued upon option exercise


227


3


—


—


—


916


—



—


919Tax benefit of stock option exercise


—


—


—


—


—


1,006


—



—


1,006Unrealized tax asset from unexercised options


—


—


—


—


—


(72
)

—



—


(72
)Stock issued under ESPP


13


—


(13
)

215


—


(32
)

—



—


183Deferred compensation fromrestricted stock awards


33


—


—


—


—


768


—



—


768Tax expense of restricted stock issuance


—


—


—


—


—


25


—



—


25Stock-based compensation expense


—


—


—


—


—


3,598


—



—


3,598Other comprehensive income:Foreign currency translation adjustments, net of tax


—


—


—


—


2,533


—


—



—


2,533Pension liability adjustment, net of tax


—


—


—


—


(347
)

—


—



—


(347
)Balance, December 31, 2010


21,657

$
235


2,880

$
(77,848
)
$
(4,182
)
$
270,947

$
93,882


$
3,461

$
286,495





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)

2008


2009


2010Operating activitiesNet (loss) income

$
(205,752
)

$
26,962


$
29,784Adjustments to reconcile net (loss) income to net cash provided by operating activities:Depreciation and amortization


16,279



12,058



11,148Impairment of goodwill and other intangible assets


255,853



2,432



—Write-off of investment


2,057



—



—Provision for uncollectible accounts


1,424



558



41Amortization and write-off of deferred financing costs


944



1,177



645Stock-based compensation and deferred compensation from restricted stock awards


6,078



6,298



4,997Excess tax benefit on stock option exercises


(182
)


(63
)


(828
)Deferred income taxes


(41,809
)


4,831



3,447Other


(51
)


141



21Changes in operating assets and liabilities (net of effects of acquisition):Accounts and other receivables


13,182



3,483



(5,619
)Inventory


(4,960
)


11,712



(22,028
)Prepaid expenses and other assets


(3,110
)


(1,379
)


(2,120
)Accounts payable and accrued expenses


(20,926
)


(3,391
)


(5,394
)Other liabilities


(1,490
)


(2,046
)


948Net cash provided by operating activities


17,537



62,773



15,042Investing activitiesPurchase of property and equipment


(9,422
)


(8,559
)


(10,966
)Proceeds from disposition of property and equipment


72



34



31Purchase price of acquisitions, net of cash acquired


13



270



(44,631
)(Increase) decrease in other assets


(141
)


(4,661
)


3,812Net cash used in investing activities


(9,478
)


(12,916
)


(51,754
)Financing activitiesNet cash proceeds from public stock offering


—



57,085



—Sale of subsidiary shares to non-controlling interest


—



—



3,959Stock option repurchase and cancellation


—



(106
)


(76
)Issuance of stock upon option exercises


956



185



919Excess tax benefit on stock option exercises


182



63



828Issuance of stock under ESPP


176



150



183Purchase of treasury stock


(24,660
)


—



—Borrowings on bank term loan


75,000



—



—Payments on bank term loan


—



(33,750
)


—Net payments on line of credit


(74,880
)


(20,120
)


—Financing fees paid


(2,792
)


(157
)


—Net cash (used in) provided by financing activities


(26,018
)


3,350



5,813Effect of exchange rate changes on cash


(7,755
)


2,747



1,618Net (decrease) increase in cash and cash equivalents


(25,714
)


55,954



(29,281
)Cash and cash equivalents, beginning of year


57,809



32,095



88,049Cash and cash equivalents, end of year

$
32,095


$
88,049


$
58,768Supplemental disclosure of cash flow information:Cash paid for interest during the period

$
5,393


$
2,842


$
1,289Cash paid for income taxes during the period


7,621



10,572



10,110Cash refunds received for income taxes

$
4,851


$
3,002


$
1,126





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®, Lamaze® and JJ Cole® Collections brands, as well as popular and classic licensed properties such as Thomas & Friends, Bob the Builder, Special Agent Oso, Chuggington, Dinosaur Train, John Deere, Disney’sWinnie the Pooh, Princesses, Cars, FairiesandToy Story, Ziploc 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 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 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, 2008, 2009 and 2010.





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 certain of its domestic customers, and the amount of this insurance covers a limited portion 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.  Principally, 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, non-conforming 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, changes in regulatory requirements 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.





F-9


RC2 CORPORATION AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)




Other Non-Current Assets





Other non-current assets at December 31, 2009 and 2010, 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, 2008, 2009 and 2010, were $0.9 million, $1.2 million and $0.6 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 series through which the Company has a 50.0% interest in the related intellectual property rights, and bears an obligation to fund a portion of the development and production costs.  In 2010, the Company reported $4.0 million in income related to its interest in the Chuggington intellectual property, which is included in selling, general and administrative expenses on the accompanying consolidated statement of operations for the year ended December 31, 2010.  Net capitalized costs related to the development and production of the television series were $3.4 million and $5.2 million at December 31, 2009 and 2010, respectively.  These costs are being 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 related to these costs was $0.4 million for the year ended December 31, 2010, and is included in amortization expense in the accompanying consolidated statements of operations.  Amortization expense is expected to be approximately $0.8 million in 2011, with approximately 40% and 80% of the unamortized costs to be amortized in the next three years and five years, respectively.





Accrued Expenses





Accrued expenses consists primarily of accrued allowances of $15.6 million and $14.9 million, accrued royalties of $10.3 million and $9.3 million, and payroll-related accruals of $9.5 million and $5.0 million at December 31, 2009 and 2010, respectively.





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 estimated target for a participating customer requires adjustment, 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.





F-10


RC2 CORPORATION AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)




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, 2008, 2009 and 2010, have been recorded as components of accumulated other comprehensive income (loss) in 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, 2008 and 2010, were $2.8 million and $0.3 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 (benefit) expense related to the components of comprehensive income (loss) in 2008, 2009 and 2010, was $(1.8) million, $0.2 million and $(0.4) million, respectively.





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, 2008, 2009 and 2010, shipping and handling costs were $14.0 million, $11.8 million and $12.6 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, 2008, 2009 and 2010, was $17.2 million, $13.2 million and $16.0 million, respectively.  Advertising expense is included in net sales and selling, general and administrative expenses in the accompanying consolidated statements of operations.





F-11


RC2 CORPORATION AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)




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 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 2007 recalls (see Note 16 - 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 (SSARs) granted under the stock incentive plans is estimated on the date of grant based on the Black-Scholes option-pricing model.  The fair value of cash-settled stock appreciation rights (CSARs) is estimated on the last day of the reported period 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, SSARs and CSARs granted represents the period of time that stock options, SSARs and CSARs granted are expected to be outstanding.  The risk-free rate for the period within the contractual term of the stock option, SSAR or CSAR 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.  The fair value of performance-based restricted stock units (RSUs) granted under the stock incentive plan is calculated using the market price on the grant date.  The Company records stock-based compensation expense for performance-based RSUs based on its estimate of the amount of the performance-based RSUs to be earned upon completion of the performance period.





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.





F-12


RC2 CORPORATION AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)




Earnings (Loss) Per Share Attributable to Common Stockholders





The Company computes earnings (loss) per share attributable to common stockholders 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 (loss) per share attributable to common stockholders is computed by dividing net income (loss) attributable to common stockholders for the period by the weighted average number of common shares outstanding during the period.  Diluted earnings (loss) per share attributable to common stockholders is computed by dividing net income (loss) attributable to common stockholders 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 share attributable to common stockholders as required by this Topic:





Year Ended December 31,(in thousands, except per share data)

2008


2009


2010Net (loss) income attributable to common stockholders

$
(205,752
)

$
26,962


$
29,688Weighted average common and common equivalent shares outstanding:Weighted average common shares outstanding


17,406



19,014



21,564Add effect of diluted securities – assumed exercise of stock options and SSARs


—



348



549Weighted average common and common equivalent shares outstanding


17,406



19,362



22,113(Loss) earnings per share attributable to common stockholders:Basic

$
(11.82
)

$
1.42


$
1.38Diluted

$
(11.82
)

$
1.39


$
1.34





The computation of diluted earnings (loss) per share attributable to common stockholders excludes 1,921,142 shares, 1,266,956 shares and 1,436,859 shares in 2008, 2009 and 2010, respectively, because the options were anti-dilutive.  Because actual results for 2008 generated a loss, any potential common shares would be anti-dilutive, and accordingly, were excluded from the diluted loss per share attributable to common stockholders calculation.





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 40.1%, 43.5% and 38.9% of the Company’s net sales in 2008, 2009 and 2010, respectively.  Over the last three years each of these three customers accounted for between 11.8% 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, 2008, 2009 or 2010.





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, 2009 and 2010.  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’s purchases from one of its 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 suppliers was 11.4% of its total product purchases in 2009.  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, 2008, 2009 or 2010.





Recently Issued Accounting Codification





The Company did not implement any new recently issued accounting codifications during the year ended December 31, 2010.


F-13


RC2 CORPORATION AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)




3.  BUSINESS COMBINATIONS





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.





White Pines, LLC





At the close of business on August 4, 2010, the Company acquired substantially all of the assets of White Pines, LLC (the JJ Cole Business), a Logan, Utah-based, privately-held, developer and marketer of mother, infant and toddler stylized travel, storage, comfort and convenience products marketed under the JJ Cole Collections brand.  The acquired brands and products and the new additions to the Company’s management team will allow the Company to rapidly expand its presence in stylized and fashion-driven mother, infant and toddler products.  Closing consideration consisted of $44.6 million of cash, of which $4.0 million was provided by the sale of a non-controlling interest, resulting in a net cash outlay by the Company of $40.7 million.





Concurrent with the acquisition of the JJ Cole Business, JJCC, Inc. (JJCC), a subsidiary of RC2 Corporation, was formed to acquire the assets of the JJ Cole Business.  RC2 Corporation holds an approximate 91.1% interest in JJCC.  At December 31, 2010, the fair value of the non-controlling interest in JJCC is $3.4 million.  The fair value of the non-controlling interest was determined by applying a discount for the lack of control and marketability to the proceeds received from the sale of the non-controlling interest of JJCC.





Transaction expenses of $0.3 million and integration costs of $0.2 million are included in selling, general and administrative expenses in the accompanying consolidated statement of operations for the year ended December 31, 2010.  The operating results of the JJ Cole Business have been included in the accompanying consolidated statements of operations since the acquisition date.  The excess of the aggregate purchase price over fair market value of net assets acquired of $17.0 million has been recorded as goodwill in the accompanying consolidated balance sheet at December 31, 2010, and is expected to be fully deductible for income tax purposes.  The goodwill arising from the acquisition consists of the expected synergies with the Company’s mother, infant and toddler products category.  All but $0.3 million of the goodwill has been recorded in the North America segment.





The following table summarizes the amounts of assets acquired and liabilities assumed at the acquisition date:





(in thousands)Total purchase price

$
44,631Portion paid by sale of non-controlling interest


3,95940,672Less:Current assets


1,710Property and equipment


175Intangible assets


25,700Other non-current assets


350Liabilities


(890
)Fair value of non-controlling interest


(3,365
)Total identifiable net assets


23,680Goodwill

$
16,992





Intangible assets acquired of $25.7 million have a weighted average amortization period of 23.6 years.  These intangible assets are comprised of (a) licenses and trademarks and (b) customer relationships of $18.8 million and $6.9 million, respectively, and have weighted average amortization periods of 25 years and 19.8 years, respectively.





The Company’s unaudited pro forma consolidated results of operations are not presented due to the immateriality of the JJ Cole Business results of operations to the Company’s consolidated results of operations.


F-14


RC2 CORPORATION AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)





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, 2008, 2009 and 2010, are as follows:




Year Ended December 31,(in thousands)

2008


2009


2010Net sales:North America

$
327,311


$
321,380


$
312,604International


110,451



100,648



115,467Sales and transfers between segments


(733
)


(889
)


(728
)Combined total

$
437,029


$
421,139


$
427,343Operating (loss) income:North America

$
(235,393
)

$
29,631


$
24,397International


(2,664
)


15,118



20,510Sales and transfers between segments


73



(40
)


11Combined total

$
(237,984
)

$
44,709


$
44,918Depreciation and amortization:North America

$
14,656


$
10,551


$
9,391International


1,623



1,507



1,757Combined total

$
16,279


$
12,058


$
11,148Capital expenditures:North America

$
7,758


$
7,046


$
9,890International


1,664



1,513



1,076Combined total

$
9,422


$
8,559


$
10,966December 31,(in thousands)






2009



2010Total assets:North America





$
258,815


$
281,094International






116,970



134,863Combined total





$
375,785


$
415,957





F-15


RC2 CORPORATION AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)





Under the entity-wide disclosure requirements of the Business Segments Topic of the FASB Accounting Standards Codification, the Company reports net sales by product category and by distribution channel.  The Company groups its products into two product categories: mother, infant and toddler products, and preschool, youth and adult products.  The Company groups its distribution channels into two categories:  chain retailers and specialty retailers, wholesalers, OEM dealers and other.  Amounts for the years ended December 31, 2008, 2009 and 2010, are as shown in the tables below:





Year Ended December 31,(in thousands)

2008


2009


2010Mother, infant and toddler products

$
178,548


$
183,335


$
195,464Preschool, youth and adult products


258,481



237,804



231,879Net sales

$
437,029


$
421,139


$
427,343Chain retailers

$
307,341


$
309,560


$
307,444Specialty retailers, wholesalers, OEM dealers and other


129,688



111,579



119,899Net sales

$
437,029


$
421,139


$
427,343





5.  PROPERTY AND EQUIPMENT





Property and equipment, net consist of the following:


December 31,(in thousands)

2009


2010Land

$
686


$
677Buildings and improvements


9,866



10,169Tooling


116,566



125,200Other equipment


24,245



26,041151,363



162,087Accumulated depreciation


(123,290
)


(132,334
)Property and equipment, net

$
28,073


$
29,753





Depreciation expense for the years ended December 31, 2008, 2009 and 2010, was $15.4 million, $11.5 million and $9.6 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 at that time.  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.





The carrying value of goodwill by reporting unit for the year ended 2010 is shown below:





(in thousands)

North America


International


TotalBalance at December 31, 2008 and 2009

$
—


$
—


$
—JJ Cole Business fair value allocation


16,692



300



16,992Other adjustments


418



—



418Balance at December 31, 2010

$
17,110


$
300


$
17,410





Other adjustments made during the year ended December 31, 2010, primarily relate to the final contingent purchase price on an acquisition purchased prior to the effective date of SFAS No. 141 (revised 2007), “Business Combinations,” as incorporated under the Business Combinations Topic of the FASB Accounting Standards Codification.


F-16





RC2 CORPORATION AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)





In the fourth quarter 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 was not renewed during 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)

2009


2010Gross amount of amortizable intangible assets:Licenses and trademarks

$
1,998


$
20,367Customer relationships


8,582



15,825Other


2,988



3,10213,568



39,294Accumulated amortization of amortizable intangible assets:Licenses and trademarks


897



1,514Customer relationships


1,172



1,643Other


2,919



3,0094,988



6,166Intangible assets not subject to amortization:Licenses and trademarks


71,729



71,620Total intangible assets, net

$
80,309


$
104,748





Other amortizable intangible assets consist primarily of patents and non-compete agreements and have estimated useful lives ranging from three to five years.  Customer relationships have useful lives from five 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 ranging up to 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 not subject to amortization is approximately two years.





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





(in thousands)2011

$
1,6132012


1,6002013


1,5212014


1,5092015

$
1,332





F-17


RC2 CORPORATION AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)




7.  INCOME TAXES





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





Year Ended December 31,(in thousands)

2008


2009


2010(Loss) income before income taxes:United States

$
(239,729
)

$
25,715


$
24,738Foreign


(1,764
)


14,837



19,568$
(241,493
)

$
40,552


$
44,306








The significant components of income tax (benefit) expense are as follows:





Year Ended December 31,(in thousands)

2008


2009


2010CurrentFederal

$
1,088


$
4,465


$
4,536State


(94
)


1,122



621Foreign


4,839



3,156



5,8905,833



8,743



11,047DeferredFederal


(36,690
)


3,821



2,863State


(4,119
)


334



(43
)Foreign


(765
)


692



655(41,574
)


4,847



3,475Income tax (benefit) expense

$
(35,741
)

$
13,590


$
14,522





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)

2008


2009


2010U.S. statutory rate


35.0
%


35.0
%


35.0
%State taxes, net of federal benefit


—



2.0



1.1Foreign


—



(2.8
)


(3.0
)Impairment


(20.5
)


(0.9
)


—Other


0.3



0.2



(0.3
)Effective rate


14.8
%


33.5
%


32.8
%





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)

2009


2010Deferred tax assets attributable toCapital loss carry-forward

$
5,856


$
5,793Stock-based compensation arrangements


4,713



5,966Inventory


3,563



4,324Sales allowances


1,677



1,402Federal credit carry-forwards (1)


1,875



80Net operating loss carry-forwards


1,773



1,393Accrued expenses


1,531



950Other


4,245



3,901Total deferred tax assets before valuation allowance


25,233



23,809Valuation allowance related to capital loss carry-forward


(5,856
)


(5,793
)Valuation allowance related to net operating loss carry-forwards


(873
)


(1,262
)Other valuation allowance


(125
)


(40
)Net deferred tax assets


18,379



16,714Deferred tax liabilities attributable toGoodwill and intangible assets


(16,873
)


(19,169
)Property and equipment


(1,398
)


(1,657
)Other


(2,036
)


(880
)Deferred tax liabilities


(20,307
)


(21,706
)Net deferred tax liability

$
(1,928
)

$
(4,992
)





(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 $52.6 million of accumulated and undistributed earnings of foreign subsidiaries at December 31, 2010, 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, 2009, were $0.4 million and net taxes payable at December 31, 2010, were $0.4 million.





The Company has a pre-tax capital loss of $15.6 million.  A valuation allowance of $5.8 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 wholly-owned 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 2010, the subsidiary generated a taxable loss and, as such, the valuation allowance was increased by $0.4 million.





F-19


RC2 CORPORATION AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)





The uncertain tax positions as of December 31, 2009 and 2010, totaled $2.8 million and $1.8 million, respectively.  The following table summarizes the activity related to the unrecognized tax benefits:





December 31,(in thousands)

2009


2010Unrecognized tax benefits, beginning of period

$
3,582


$
2,796Increases in positions taken in a prior period


—



65Decreases in positions taken in a prior period


(48
)


—Increases in positions taken in a current period


130



—Decreases due to positions taken in a current period


—



(376
)Decreases due to settlements


(339
)


—Decreases due to lapse of statute of limitations


(529
)


(658
)Unrecognized tax benefits, end of period

$
2,796


$
1,827





At December 31, 2009 and 2010, approximately $2.2 million and $1.8 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 concluded all U.S. federal income tax matters for years though 2008.  Substantially all material state and local and foreign income tax matters have been concluded for years through 2007.  The U.S. federal income tax return for 2009 is currently open for examination.  In the next twelve months, the Company expects to reduce the unrecognized tax position reserves by approximately $0.7 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, 2009 and 2010, the Company recorded adjustments for interest of $0.2 million in each year, and less than $0.1 million and $0.1 million, respectively, for potential penalties, related to these unrecognized tax benefits. In total, as of December 31, 2009 and 2010, the Company has recorded a liability for interest of $2.2 million and $2.4 million, respectively, and $0.4 million and $0.3 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, 2010, the applicable margins in effect were 2.25% for LIBOR borrowings and 1.25% 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, 2010, the commitment fee in effect was 0.45% 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.  During the fourth quarter of 2010, the credit facility was amended to remove the clean down provision which limited borrowings for a 60 day period.  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, 2010, the Company had $41.3 million outstanding on its bank term loan and no borrowings under its revolving line of credit.  At December 31, 2010, 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 $1.2 million and $0.5 million is included in other non-current assets in the accompanying consolidated balance sheets at December 31, 2009 and 2010, respectively.





The Company’s existing credit facility matures November 1, 2011, and the Company currently anticipates that it will refinance its credit facility during 2011.  There can be no assurance that financing will be available on terms acceptable to the Company, if at all.





The Company’s Hong Kong subsidiary maintains credit facilities with two banks providing for documentary and standby letters of credit of up to $5.0 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 and 2010, there were no amounts outstanding under these credit facilities.





Non-current debt consists of the following:





December 31,(in thousands)

2009


2010U.S. revolving line of credit

$
—


$
—Term loan payable to banks, bearing interest at 2.75% as ofDecember 31, 2009,

and 2.5625% as of December 31, 2010


41,250



41,250Less current maturities


—



41,250$
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)2011

$
4,2552012


9,2802013


9,3902014


1602015 and thereafter

$
—





Royalty expense for licenses, including any unearned guaranteed minimums, was $31.2 million, $29.9 million and $30.2 million for the years ended December 31, 2008, 2009 and 2010, respectively.





Rental expense for office and warehouse space and other equipment under cancelable and noncancelable operating leases amounted to $4.6 million, $4.7 million and $5.4 million for the years ended December 31, 2008, 2009 and 2010, 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, 2010, are as follows:





Year Ending December 31,


(in thousands)2011

$
4,5312012


4,0372013


3,5222014


3,1652015


3,029Thereafter

$
10,612





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 $4.3 million, $7.1 million and $20.0 million for the years ended December 31, 2008, 2009 and 2010, respectively.





Commitments for future minimum payments with terms extending beyond one year at December 31, 2010, for noncancelable unconditional purchase obligations are as follows:





Year Ending December 31,


(in thousands)2011

$
2,1692012


6392013


2952014


452015 and thereafter

$
—





Through 2013, the Company has a conditional obligation to purchase a minimum percentage of the total annual volume of purchases for certain products from one of its suppliers, provided that the supplier's costs are competitive as compared with costs from other suppliers.  The actual future amount of this obligation will vary based on the actual future purchases of the related products.





10.  LEGAL PROCEEDINGS





See Note 16 - 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:





Authorized


Par


Shares

Outstanding


Shares

Outstanding(in thousands, except par value)

Shares


Value


at December 31, 2009


at December 31, 2010Voting common stock


28,000


$
0.01



21,384



21,657





During the years ended December 31, 2009 and 2010, the Company sold a total of 23,449 shares and 12,510 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, 2010, 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.





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 year ended December 31, 2008, the Company repurchased 1.2 million shares for $24.7 million 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, 2010, the Company has two stock incentive plans, one which is 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, 2008, 2009 and 2010, are as follows:





Year Ended December 31,(in thousands)

2008


2009


2010Total expense recognized for stock-based payment plans

$
6,078


$
6,298


$
4,997Amount of related income tax benefit recognized in determining net income (loss)

$
2,291


$
1,965


$
1,845





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, 2008, 2009 and 2010.





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 416,846 shares remain available as of December 31, 2010.  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, 2008, 2009 and 2010, is estimated on the date of grant based on the Black-Scholes option-pricing model with the following assumptions:




2008


2009


2010Weighted average expected life

3 months

3 months

3 monthsWeighted average risk-free rate of return


1.8
%


0.1
%


0.1
%Weighted average expected volatility


76.7
%


120.2
%


41.7
%Weighted average dividend yield

None

None

None





The weighted average fair value of options granted under the ESPP during the years ended December 31, 2008, 2009 and 2010, was $7.70, $4.24 and $2.90, 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 Plans





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 vested over a five-year period.  These options generally 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, shares relating to 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.





During 2005, a new stock incentive plan was approved by the Company’s stockholders.  Under this plan, restricted stock awards, restricted stock units (RSUs), options to purchase stock, SSARs and CSARs may be granted for up to 3,180,000 shares of common stock.  Options, SSARs and CSARs granted generally vest over a three to five-year period.  These options, SSARs and CSARs generally 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, shares relating to cancelled options or forfeited awards revert back into the plan and are available for future issuance.  Restricted stock awards generally vest over a two to three year period.  At December 31, 2010, there were 740,999 shares of common stock available for future grants under the 2005 Stock Incentive Plan.





The fair value of stock options and SSARs granted under the 2005 Stock Incentive Plan during the years ended December 31, 2008, 2009 and 2010, is estimated on the date of grant based on the Black-Scholes option-pricing model with the following assumptions:





2008


2009


2010Weighted average expected life

7 years

6 years

6 yearsWeighted average risk-free rate of return


2.9
%


2.2
%


2.5
%Weighted average expected volatility


40.5
%


59.0
%


60.0
%Weighted average dividend yield

None

None

None





The fair value of CSARs granted under the 2005 Stock Incentive Plan during the year ended December 31, 2010, is estimated on the last day of the reported period based on the Black-Scholes option-pricing model with the following assumptions: weighted average expected life of 5 years, weighted average risk-free rate of return of 2.0%, weighted average expected volatility of 48.0% and no dividend yield.





The fair value of stock options and SSARs granted under the 2005 Stock Incentive Plan is estimated on the date of grant based on the Black-Scholes option-pricing model.  The fair value of CSARs is estimated on the last day of the reported period 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, SSARs and CSARs granted represents the period of time that stock options, SSARs and CSARs granted are expected to be outstanding.  The risk-free rate for the period within the contractual term of the stock option, SSAR or CSAR 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 SSAR activity for the Company’s stock incentive plans for the years ended December 31, 2008, 2009 and 2010, is as follows:





Weighted


Aggregate

WeightedAverage


Intrinsic

AverageExercise


Value

RemainingShares


Price


(in 000s)

Contractual LifeOutstanding as of December 31, 2007


1,491,390


$
24.272008Granted


639,500



19.44Exercised


82,118



11.64Forfeited


115,600



29.93Expired


12,030



33.53Outstanding as of December 31, 2008


1,921,142



22.802009Granted


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



14.762010Granted


360,000



17.04Exercised


248,182



5.07Forfeited


12,400



8.04Expired


4,000



18.69Outstanding as of December 31, 2010


2,629,423


$
16.01

$
20,616

6.7Exercisable and vested as of December 31, 2010


1,260,434


$
19.89

$
7,195Expected to vest at December 31, 2010


1,363,694



12.46


13,354Total vested and expected to vest


2,624,128


$
16.03

$
20,549

6.7





The following table summarizes information about stock options and SSARs outstanding at December 31, 2010:





Outstanding


ExercisableWeightedRange of





Average Remaining


Weighted Average





Weighted AverageExercise Prices


Number


Contractual Life


Exercise Price


Number


Exercise Price$
5.11 - $15.10



1,325,840



7.1


$
7.45



500,025


$
8.17$
16.59 - $24.78



906,199



7.0


$
20.50



406,025


$
21.97$
28.87 - $43.06



397,384



4.8


$
34.36



354,384


$
34.05











F-25


RC2 CORPORATION AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)





A summary of CSAR activity under the 2005 Stock Incentive Plan for the year ended December 31, 2010, is as follows:





Weighted Average


Weighted Average


Aggregate

IntrinsicNumber of


Grant Date


Remaining


ValueShares


Fair Value


Contractual Life



(000s)Outstanding as of December 31, 2009


—


$
—2010Granted


207,000



16.03Forfeited


8,500



14.90Outstanding as of December 31, 2010


198,500


$
16.08



9.2


$
1,129Exercisable and vested as of December 31, 2010


—


$
—Expected to vest at December 31, 2010


195,698



16.10Total vested and expected to vest


195,698


$
16.10



9.2


$
1,110





The weighted average fair value of options, SSARs and CSARs granted under the 2005 Stock Incentive Plan for the years ended December 31, 2008, 2009 and 2010, was $9.00, $2.63 and $9.54 per share, respectively.  The total intrinsic value of options and SSARs exercised during the years ended December 31, 2008, 2009 and 2010, was $1.0 million, $0.3 million and $3.0 million, respectively.





As of December 31, 2010, there was $7.6 million of total unrecognized compensation cost related to nonvested stock-based compensation arrangements granted under the 2005 Stock Incentive Plan.  That cost is expected to be recognized over a weighted average period of 2.0 years.  The total fair value of options and SSARs vested during the year ended December 31, 2010, was $3.0 million.





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 under the 2005 Stock Incentive Plan for the years ended December 31, 2008, 2009 and 2010, is as follows:




Weighted Average

Weighted AverageNumber of


Grant Date

RemainingShares


Fair Value

Contractual LifeUnvested 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



14.442010Granted


32,800



18.29Vested


49,866



16.19Unvested restricted stock awards as of December 31, 2010


74,170


$
14.97

1.9





As of December 31, 2010, there was $0.8 million of total unrecognized compensation cost related to nonvested stock-based compensation arrangements granted under the 2005 Stock Incentive Plan for restricted stock awards.  That cost is expected to be recognized over a weighted average period of 1.9 years.






F-26





RC2 CORPORATION AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)





During the year ended December 31, 2010, performance-based RSUs were granted to employees, which entitle the holder to receive one share of common stock for each performance-based RSU which is earned.  The performance goals require compounded annual growth in the Company’s EBITDA (as defined in the grant agreements) over a three-year period ending December 31, 2012.  If the minimum threshold is not achieved, none of the performance-based RSUs will be earned.  If the minimum threshold amount of cumulative three-year EBITDA exceeds the minimum threshold, additional performance-based RSUs will be earned above 37.5% on a pro-rata basis up to the maximum number of performance-based RSUs granted, which is 140,000 performance-based RSUs.  Stock-based compensation expense has been recognized during the year ended December 31, 2010, based upon an estimate of 52,500 performance-based RSUs expected to be earned at the end of the three-year measurement period.  The weighted average fair value at the date of grant for these performance-based RSUs is $18.29.  As of December 31, 2010, there was $0.7 million of total unrecognized compensation cost related to nonvested stock-based compensation arrangements expected to be vested under the 2005 Stock Incentive Plan for performance-based RSUs.  That cost is expected to be recognized over a weighted average period of 2.0 years.





13.  COMPREHENSIVE INCOME (LOSS)





Comprehensive income (loss) for the years ended December 31, 2008, 2009 and 2010, is calculated as follows:





Year Ended December 31,(in thousands)

2008


2009


2010Net (loss) income

$
(205,752
)

$
26,962


$
29,784Foreign currency translation adjustments, net of tax


(23,084
)


7,946



2,533Pension liability adjustment, net of tax


(2,508
)


(365
)


(347
)Comprehensive (loss) income


(231,344
)


34,543



31,970Less: Comprehensive income attributable to non-controlling interest


—



—



96Comprehensive (loss) income attributable to common stockholders

$
(231,344
)

$
34,543


$
31,874





14.  RELATED PARTY TRANSACTIONS





In 2008, the Company purchased $4.8 million of product from a company in which a relative of a Company stockholder and former director of the Company had an ownership interest.  These purchases were made through May 2008, at which time the former director completed his board of directors tenure.





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 during 2009.  In 2010, the Company paid the investment banking firm fees of $0.2 million for services rendered in the JJ Cole Business acquisition.





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 $1.0 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 2008, the Company made matching contributions of 100.0% on the first 4.0% of employees’ annual wages and 50.0% on the next 6.0% of employees’ annual wages.  In 2009 and 2010, 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, 2008, 2009 and 2010, the Company’s contributions were $1.1 million, $0.7 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.


F-27


RC2 CORPORATION AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)





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)

2008


2009


2010Change in benefit obligationBenefit obligation at beginning of year

$
13,415


$
13,214


$
15,107Service cost


101



125



168Interest cost


854



891



885Actuarial (gain) loss


(563
)


1,584



1,246Benefits paid and plan expenses


(593
)


(707
)


(757
)Benefit obligation at end of year

$
13,214


$
15,107


$
16,649Change in plan assetsFair value of assets at beginning of year

$
13,281


$
9,000


$
11,422Actual return on plan assets


(3,688
)


1,629



1,534Employer contributions


—



1,500



—Benefits paid and plan expenses


(593
)


(707
)


(757
)Fair value of assets at end of year

$
9,000


$
11,422


$
12,199Funded Status at End of Year

$
(4,214
)

$
(3,685
)

$
(4,450
)Amounts Recognized in the Consolidated Balance SheetsOther non-current liabilities

$
4,214


$
3,685


$
4,450Accumulated other comprehensive loss

$
7,253


$
7,929


$
8,497Amounts Recognized in Accumulated Other Comprehensive LossPrior service cost

$
95


$
76


$
57Actuarial loss


7,158



7,853



8,440Accumulated other comprehensive loss

$
7,253


$
7,929


$
8,497Information for Pension Plans with an Accumulated Benefit Obligation in Excess of Plan AssetsProjected benefit obligation

$
13,214


$
15,107


$
16,649Accumulated benefit obligation


13,214



15,107



16,649Fair value plan assets

$
9,000


$
11,422


$
12,199








F-28


RC2 CORPORATION AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)





Year Ended December 31,(in thousands)

2008


2009


2010Components of Net Periodic Benefit CostService cost

$
101


$
125


$
168Interest cost


854



891



885Expected return on plan assets


(1,110
)


(971
)


(1,037
)Amortization of prior service cost


19



19



19Amortization of net loss


190



231



162Net periodic benefit cost

$
54


$
295


$
197




Other Changes in Plan Assets and Projected Benefit Obligation

as Other Comprehensive LossNet actuarial loss

$
4,234


$
926


$
749Amortization of net actuarial gain


(190
)


(231
)


(162
)Amortization of prior service cost


(19
)


(19
)


(19
)Total other comprehensive loss

$
4,025


$
676


$
568





Estimated Items That Will Be Amortized from Accumulated Other Comprehensive

Loss into Net Periodic Benefit Cost During 2011Prior service cost

$
19Actuarial loss


236Expected recognition of expense

$
255





During 2010, only 7% of the Plan’s participants remained active.  As such, the Company concluded that the Plan’s participants were mostly inactive and revised its method for amortizing the accumulated other comprehensive loss over the average remaining life expectancy of the inactive participants rather than the average remaining service period of the active participants which had previously been used.





Year Ended December 31,Reconciliation of Funded Status


2008



2009



2010Funded status

$
(4,214
)

$
(3,685
)

$
(4,450
)Unrecognized net actuarial loss


7,158



7,853



8,440Unrecognized prior service cost


95



76



57Prepaid benefit cost

$
3,039


$
4,244


$
4,047





Estimated Future Benefit Payments2011

$
6872012


6932013


7512014


7892015


8272016 to 2020

$
5,496





Assumptions

2008


2009


2010Weighted Average Assumptions Used to Determine Benefit Obligations

at December 31Discount rate


6.89
%


5.98
%


5.51
%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


6.50
%


6.89
%


5.98
%Expected return on plan assets


8.50
%


7.75
%


7.75
%Rate of compensation increase


N/A



N/A



N/A





F-29


RC2 CORPORATION AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)





The discount rate is supported by the Hewitt Top Quartile yield curve, which is developed using yields of various bonds rated A 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 7.88% 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


-0.84
%


7.88
%


17.38
%5 years


3.89



7.88



12.0310 years


5.05



7.88



10.8020 years


5.87
%


7.88
%


9.94
%





Plan Assets





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




Percentage of Plan AssetsTarget


December 31,Asset Category

Allocation


2009 (1)


2010Large cap domestic equity securities


24
%


24
%


25
%Mid cap domestic equity securities


11



11



12Small cap domestic equity securities


6



6



7International equity securities


14



14



14Commodities


5



5



8Fixed income securities


40



40



34Total


100
%


100
%


100
%





(1)  The allocation of assets as of December 31, 2009, excludes the contribution made on December 29, 2009.





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.








F-30


RC2 CORPORATION AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)





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, 2010:





(in thousands)

Level 1


Level 2


Level 3


TotalCash equivalents

$
210


$
-


$
-


$
210Mutual fundsBond funds


4,104



-



-



4,104Equity funds


7,885



-



-



7,885Total assets at fair value

$
12,199


$
-


$
-


$
12,199





Employer Contributions





During the year ended December 31, 2010, the Company did not make any contributions to the Plan and does not expect to make any contributions to the plan during 2011.  There are no minimum required contributions to the Plan for fiscal year 2011.  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.  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 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 sheet at December 31, 2009, and was paid in 2010.





The Company recorded charges related to the 2007 recalls of $14.3 million, $0.2 million and $(0.4) million for the years ended December 31, 2008, 2009 and 2010, respectively.  The Company had $2.7 million of accrued recall-related items included in accrued expenses in the accompanying consolidated balance sheet at December 31, 2009, principally all of which were settled in 2010.




F-31