Recent Material Event

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

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Exchange Act Rule 12b-2.
 
Large accelerated filer [   ]  Accelerated filer [ X ]
Non-accelerated filer  [   ]  Smaller reporting company  [     ]
(Do not check if a smaller reporting company)  
 

 
 
 
 

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes___     No  X                                                                                                                                 

Aggregate market value of the Registrant’s common stock held by non-affiliates as of June 30, 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’s Winnie the Pooh, Princesses, Cars, Fairies and Toy 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.

 
 

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.

 
 

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.

 
 

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.


 
 

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.
 
We carry various product liability insurance policies with coverage in aggregate of over $75.0 million per occurrence.  Certain policies have coverage exclusions including, but not limited to, some policies that exclude claims related to lead.
 
Logistics.  We own a distribution facility in Dyersville, Iowa, lease distribution facilities in Rochelle, Illinois, and Australia, and use independent warehouses in California, Canada, the United Kingdom, Belgium and Germany.


 
 

Seasonality

We have experienced, and expect to continue to experience, substantial fluctuations in our quarterly net sales and operating results, which is typical of many companies in our industry.  Our 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.


 
 

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.


 
 

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 integration of acquired companies and their operations into our operations involves a number of risks, including:
 
  the acquired business may experience losses that could adversely affect our profitability;
     
  unanticipated costs relating to the integration of acquired businesses may increase our expenses;
     
  possible failure to obtain any necessary consents to the transfer of licenses or other agreements of the acquired company may decrease our net sales;
     
  possible failure to maintain customer, licensor and other relationships after the closing of the transaction of the acquired company may decrease our net sales;
 
 
 
 

 
  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.

 
 

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.


 
 

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.


 
 

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.

 
 

Item 2.  Properties
 
As of December 31, 2010, our facilities were as follows:
                                                                             
Description   Square Feet   Location    Lease Expiration
Corporate headquarters
27,050
 
Oak Brook, IL
 
April 2013
Learning Curve Brands, Inc. warehouse
400,000
 
Rochelle, IL
 
November 2019
Learning Curve Brands, Inc. office and warehouse
534,000
 
Dyersville, IA
 
Owned
JJCC, Inc. office and warehouse (1)
25,299
 
Logan, UT
 
March 2012
Learning Curve Brands, Inc. office
12,452
 
Canton, MA
 
August 2015
Learning Curve Brands, Inc. office
3,300
 
Bentonville, AR
 
October 2013
Learning Curve Brands, Inc. storage
1,875
 
Stoughton, MA
 
June 2011
Learning Curve Brands, Inc. office
1,455
 
Kettering, OH
 
April 2012
RC2 (H.K.) Limited quarters
68,230
 
Dongguan City, China
 
March 2012
RC2 (H.K.) Limited office, warehouse and storage
123,603
 
Dongguan City, China
 
March 2012
RC2 (H.K.) Limited office
7,563
 
Kowloon, Hong Kong
 
August 2012
RC2 (H.K.) Limited quarters
2,173
 
Weng Yuan, Shao Guan,
 
December 2011
     
China
   
RC2 (H.K.) Limited office
1,124
 
Weng Yuan, Shao Guan,
 
December 2011
     
China
   
Racing Champions International Limited office
8,512
 
Exeter, United Kingdom
 
October 2013
Racing Champions International Limited office
         
   and showroom
2,035
 
Thatcham, United Kingdom
 
August 2011
Racing Champions International Limited office
1,034
 
Lauren, Holland
 
December 2011
Racing Champions International Limited office
 
Marcq-En-Baroeul, France
 
September 2014
Racing Champions International Limited office
 
Barcelona, Spain
 
May 2013
RC2 Deutschland GmbH office
2,562
 
Koln, Germany
 
August 2013
RC2 Australia, Pty. Ltd. office and warehouse (2)
174,376
 
Dandenong South,
 
September 2019
     
Victoria, 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]


 
 

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
   
Low
 
First Quarter
  $ 10.73     $ 3.40  
Second Quarter
    15.07       5.40  
Third Quarter
    16.92       12.67  
Fourth Quarter
  $ 16.16     $ 12.46  
                 
2010:
 
High
   
Low
 
First Quarter
  $ 16.53     $ 14.11  
Second Quarter
    19.72       14.95  
Third Quarter
    20.95       14.80  
Fourth 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.


 
 


   
Year Ended December 31,
 
   
   
   
   
   
 
Consolidated Statements of Operations:
 
(in thousands, except per share data)
 
Net sales (1)
  $ 518,829     $ 488,999     $ 437,029     $ 421,139     $ 427,343  
Cost of sales (2)
    275,754       270,059       246,301       236,243       246,637  
Restructuring 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       180,837  
Selling, general and administrative expenses (2)
    155,180       161,560       155,903       136,869       134,569  
Amortization
    1,149                         1,597  
Impairment 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             (247 )
Terminated acquisition costs
                1,399              
   Operating income (loss)
    72,243       33,795       (237,984 )     44,709       44,918  
Interest expense
    4,375       2,712       6,584       3,923       2,221  
Interest income
    (910 )     (1,197 )     (1,579 )     (546 )     (891 )
Write-off of investment
                2,057              
Other expense (income), net
          (1,768 )     (3,553 )           (718 )
   Income (loss) from continuing operations
                                       
      before income taxes
    68,248       34,048       (241,493 )     40,552       44,306  
Income tax expense (benefit)
    24,478       12,472       (35,741 )     13,590       14,522  
   Income (loss) from continuing operations
    43,770       21,576       (205,752 )     26,962       29,784  
(Loss) income from discontinued operations, net of tax
    (9,676 )                        
   Net income (loss)
    34,094       21,686       (205,752 )     26,962       29,784  
Less: net income attributable to non-controlling interest
                             
   Net income (loss) attributable to common stockholders
  $ 34,094     $ 21,686     $ (205,752 )   $ 26,962     $ 29,688  
                                         
Basic 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     $ 1.38  
Diluted 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     $ 1.34  
Weighted average shares outstanding:
                                       
   Basic
    20,884       20,395       17,406       19,014       21,564  
   Diluted
    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.

 
 


   
As of December 31,
 
Consolidated Balance Sheet Data: (in thousands)
 
   
   
   
   
 
Working capital
  $ 129,603     $ 67,128     $ 125,799     $ 188,433     $ 147,677  
Total assets
    614,640       650,245       336,650       375,785       415,957  
Total debt
    22,438       95,000       95,120       41,250       41,250  
Total 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.


 
 

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.

 
 

Results of Operations


   
Year Ended December 31,
 
   
   
   
 
(in thousands, except per share data)
 
Amount
   
Percent
   
Amount
   
Percent
   
Amount
   
Percent
 
Net 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       57.7  
Recall-related items
    (1,114 )     (0.3 )     (298 )     (0.1 )     (131 )      
   Gross profit
    191,842       43.9       185,194       44.0       180,837       42.3  
Selling, general and administrative expenses
    155,903       35.7       136,869       32.5       134,569       31.5  
Amortization
          0.2             0.2       1,597       0.4  
Impairment of goodwill and other intangible assets
    255,853       58.6       2,432       0.6              
Recall-related items
    15,782       3.6             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       10.5  
Interest expense
    6,584       1.5       3,923       0.9       2,221       0.5  
Interest 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 )           0.2       (718 )     (0.2 )
   (Loss) income before income taxes
    (241,493 )     (55.3 )     40,552       9.6       44,306       10.4  
Income tax (benefit) expense
    (35,741 )     (8.2 )     13,590       3.2       14,522       3.4  
   Net (loss) income
    (205,752 )     (47.1 )     26,962       6.4       29,784       7.0  
Less: net income attributable to non-controlling interest
                                   
   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             $ 1.38          
   Diluted
  $ (11.82 )           $ 1.39             $ 1.34          
                                                 
Weighted average shares outstanding:
                                               
   Basic
    17,406               19,014               21,564          
   Diluted
    17,406               19,362               22,113          



 
 

Calculation of Adjusted EBITDA (1)


   
Year Ended December 31,
 
(in thousands)
 
   
   
 
(Loss) income before income taxes and non-controlling interest
  $ (241,493 )   $ 40,552     $ 44,306  
Impairment of goodwill and other intangible assets
    255,853       2,432        
Depreciation and amortization
    16,279       12,058       11,148  
Compensation expense for equity awards
    6,078       6,298       4,997  
Sleep-related product costs
                2,045  
Acquisition and integration costs
                 
Litigation settlement costs regarding pre-acquisition intellectual property
                1,101  
Cash-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 )            
Interest expense
    6,584       3,923       2,221  
Adjusted 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.
 
 
 
 

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)
 
   
   
Difference
   
% Change
 
Preschool, 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.


 
 

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.


 
 

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.


 
 

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 and  
Contractual Obligations (2)
 
Total
   
      2012-2013       2014-2015    
beyond
 
Credit facility
  $ 41,250     $     $     $     $  
Estimated future interest payments on credit facility (1)
    1,130       1,130                    
Minimum guaranteed royalty payments
    23,085       4,255       18,670              
Operating leases
    28,896       4,531       7,559       6,194       10,612  
Unconditional purchase obligations
    3,148       2,169                    
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.


 
 

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.


 
 

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.


 
 

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.

 
 


   
Fiscal Year 2009
 
(in thousands, except per share data)
    Q1       Q2       Q3       Q4  
Net sales
  $ 86,268     $ 87,039     $ 126,507     $ 121,325  
Cost of sales (1)
    51,589       50,313       67,785       66,258  
   Gross profit
    34,679       36,726       58,722       55,067  
Selling, general and administrative expenses (1)
    29,703       30,134       36,757       40,851  
Amortization
                       
Impairment of intangible assets
                      2,432  
   Operating income
    4,780       6,427       21,812       11,690  
Interest expense
    1,177                    
Interest income
    (85 )     (106 )     (153 )     (202 )
Other expense (income), net
                (311 )      
   Income before income taxes
    2,965       5,359       21,457       10,771  
Income tax expense
    1,177       2,030       7,864       2,519  
   Net income
  $ 1,788     $ 3,329     $ 13,593     $ 8,252  
Earnings per common share:
                               
   Basic
  $ 0.10     $ 0.19     $ 0.68     $ 0.39  
   Diluted
  $ 0.10     $ 0.19     $ 0.66     $ 0.38  
Weighted average shares outstanding:
                               
   Basic
    17,248       17,290       20,078       21,383  
   Diluted
    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       Q4  
Net sales
  $ 88,083     $ 86,121     $ 128,974     $ 124,165  
Cost of sales (1)
    49,301       49,511       75,577       72,117  
   Gross profit
    38,782       36,610       53,397       52,048  
Selling, general and administrative expenses (1)
    32,607       30,341       34,747       36,627  
Amortization
                       
   Operating income
    5,956       5,960       18,215       14,787  
Interest expense
                       
Interest income
    (183 )     (289 )     (193 )     (226 )
Other expense (income), net
                (867 )     (239 )
   Income before income taxes
    5,558       5,344       18,716       14,688  
Income tax expense
    2,181       1,516       6,259       4,566  
   Net income
    3,377       3,828       12,457       10,122  
Less: net income attributable to non-controlling interest
                       
   Net income attributable to common stockholders
  $ 3,377     $ 3,828     $ 12,413     $ 10,070  
Earnings per share attributable to common stockholders:
                               
   Basic
  $ 0.16     $ 0.18     $ 0.57     $ 0.47  
   Diluted
  $ 0.15     $ 0.17     $ 0.56     $ 0.45  
Weighted average shares outstanding:
                               
   Basic
    21,405       21,561       21,636       21,651  
   Diluted
    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.

 
 

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.

 
 


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.


 
 

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
   
Weighted
       
   
Common Shares to Be
   
Average
   
Number of
 
   
Issued Upon Exercise
   
Exercise Price of
   
Common Shares
 
   
Of Outstanding
   
Outstanding
   
Available for Future
 
   
Options and
   
Options/
   
Issuance Under Equity
 
Plan Category  
SSARs
   
SSARs
   
Compensation Plans (1)
 
Equity compensation plans approved  by stockholders
    2,629,423     $ 16.01       1,157,845  
Equity compensation plans not approved by 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:


 
 

 
 
1.   Financial Statements
     
    The following consolidated financial statements of the Company are included in Item 8 of this report:
     
    Reports of Independent Registered Public Accounting Firm
     
    Consolidated Balance Sheets as of December 31, 2009 and 2010
     
    Consolidated Statements of Operations for the Years Ended December 31, 2008, 2009 and 2010
     
    Consolidated Statements of Equity for the Years Ended December 31, 2008, 2009 and 2010
     
    Consolidated Statements of Cash Flows for the Years Ended December 31, 2008, 2009 and 2010
     
    Notes to Consolidated Financial Statements
     
2.    Financial Statement Schedules
     
    Report of Independent Registered Public Accounting Firm
     
    Financial Statement Schedule for the Years Ended December 31, 2008, 2009 and 2010:
 
Schedule
   
Number
Description
Page
II
Valuation and Qualifying Accounts

 
    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.   Exhibits
     
3.1   Amended and Restated Certificate of Incorporation of the Company (incorporated by reference to Exhibit 3.1 of the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2002 (File No. 0-22635)).
     
3.2   First Amendment to Amended and Restated Certificate of Incorporation of the Company (incorporated by reference to Exhibit 3.2 of the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2002 (File No. 0-22635)).
     
3.3   Certificate of Ownership and Merger changing the Company’s name to Racing Champions Ertl Corporation (incorporated by reference to Exhibit 3.3 of the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2002 (File No. 0-22635)).
     
3.4   Certificate of Ownership and Merger changing the Company’s name to RC2 Corporation (incorporated by reference to Exhibit 3.4 of the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2003 (File No. 0-22635)).
     
3.5   Amended and Restated By-Laws of the Company (incorporated by reference to Exhibit 3.5 of the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2004 (File No. 0-22635)).
 

 
 
 

 
10.1*
  Employment Agreement, dated April 1, 2008, between the Company and Curtis W. Stoelting (incorporated by reference to Exhibit 10.1 of the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2008 (File No. 0-22635)).
     
10.2*
  Employment Agreement, dated April 1, 2008, between the Company and Peter J. Henseler (incorporated by reference to Exhibit 10.2 of the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2008 (File No. 0-22635)).
     
10.3*
  Employment Agreement, dated November 5, 2008, between the Company and Peter A. Nicholson (incorporated by reference to Exhibit 99.1 of the Company’s Current Report on Form 8-K dated November 5, 2008 (File No. 0-22635) filed by the Company with the Securities and Exchange Commission on November 10, 2008).
     
10.4*
  Employment Agreement, dated April 1, 2008, between the Company and Helena Lo (incorporated by reference to Exhibit 10.4 of the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2008 (File No. 0-22635)).
     
10.5*
  Employment Agreement, dated April 1, 2008, between the Company and Gregory J. Kilrea (incorporated by reference to Exhibit 10.5 of the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2008 (File No. 0-22635)).
     
10.6*
  RC2 Corporation 2005 Stock Incentive Plan, as amended (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 and Exchange 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 ended December 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 ended December 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 Exchange Commission 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 on May 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)).
 
 
 
 
10.16*
  RC2 Corporation Employee Stock Purchase Plan, as amended (incorporated by reference to Exhibit 99.1 of the Company’s Current Report on Form 8-K dated May 4, 2007 (File No. 0-22635) filed by the Company with the Securities 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 other lenders named therein (incorporated by reference to Exhibit 10.17 of the Company’s Annual Report on Form 10-K for 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 by reference 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.
     
  Subsidiaries of the Company
     
23.1   Consent of Independent Registered Public Accounting Firm.
     
  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.


 
 

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, 2011
Robert E. Dods
     
       
/s/ Curtis W. Stoelting
 
Chief Executive Officer and
March 2, 2011
Curtis W. Stoelting
 
Director (Principal Executive Officer)
 
       
/s/ Peter A. Nicholson
 
Chief Financial Officer and Secretary
March 2, 2011
Peter A. Nicholson
 
(Principal Financial and Accounting Officer)
 
       
/s/ Peter J. Henseler
 
Director
March 2, 2011
Peter J. Henseler
     
       
/s/ Linda A. Huett
 
Director
March 2, 2011
Linda A. Huett
     
       
/s/ Paul E. Purcell
 
Director
March 2, 2011
Paul E. Purcell
     
       
/s/ John S. Bakalar
 
Director
March 2, 2011
John S. Bakalar
     
       
/s/ John J. Vosicky
 
Director
March 2, 2011
John J. Vosicky
     
       
/s/ Joan K. Chow
 
Director
March 2, 2011
Joan K. Chow
     
       
/s/ Thomas M. Collinger
 
Director
March 2, 2011
Thomas M. Collinger
     
       
/s/ Michael J. Merriman, Jr.
 
Director
March 2, 2011
Michael J. Merriman, Jr.
     

 
 

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 to              
   
Beginning of
   
Costs and
   
Other
         
Balance at
 
Description
 
Year
   
Expenses
   
Accounts
   
Deductions
   
End of Year
 
Allowance for doubtful accounts:
                             
Year ended December 31, 2008
  $ 1,808     $ 1,424     $ (221 )   $ (1,218 )   $ 1,793  
Year ended December 31, 2009
    1,793                   (1,052 )     1,347  
Year ended December 31, 2010
  $ 1,347     $     $ (4 )   $ (421 )   $  


 
36 
 

RC2 CORPORATION AND SUBSIDIARIES
INDEX TO FINANCIAL STATEMENTS
 
 
Reports of Independent Registered Public Accounting Firm F2
   
Consolidated Balance Sheets as of December 31, 2009 and 2010  F4
   
Consolidated Statements of Operations for the Years Ended December 31, 2008, 2009 and 2010 F5
   
Consolidated Statements of Equity for the Years Ended December 31, 2008, 2009 and 2010 F6
   
Consolidated Statements of Cash Flows for the Years Ended December 31, 2008, 2009 and 2010  F7
   
Notes 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)
 
   
 
             
Assets
           
Current assets:
           
   Cash and cash equivalents
  $ 88,049     $ 58,768  
   Accounts receivable, net of allowances for doubtful accounts of $1,347 and $963
    88,905       94,342  
   Inventory
    65,888       90,833  
   Deferred and prepaid taxes, net
    6,223       4,677  
   Prepaid expenses
    6,600       6,204  
   Other current assets
    5,348       1,858  
      Total current assets
    261,013       256,682  
Property and equipment, net
    28,073       29,753  
Goodwill
          17,410  
Intangible assets, net
    80,309       104,748  
Other non-current assets
    6,390       7,364  
         Total assets
  $ 375,785     $ 415,957  

Liabilities and equity
Current liabilities:
           
   Accounts payable
  $ 23,266     $ 27,314  
   Income taxes payable, net
           
   Accrued expenses
    46,685       37,560  
   Current maturities of bank term loan
          41,250  
   Other current liabilities
    2,629       2,497  
      Total current liabilities
    72,580       109,005  
Bank term loan
    41,250        
Deferred income taxes
    7,741       9,670  
Other non-current liabilities
    9,481       10,787  
      Total liabilities
    131,052       129,462  
Commitments and contingencies
           
Equity:            
   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
           
   Additional paid-in capital
    264,738       270,947  
   Accumulated other comprehensive loss
    (6,368 )     (4,182 )
   Retained earnings
    64,194       93,882  
      322,796       360,882  
    Treasury 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       283,034  
   Non-controlling interest
          3,461  
      Total equity
    244,733       286,495  
         Total 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)
 
   
   
 
Net sales
  $ 437,029     $ 421,139     $ 427,343  
Cost of sales, related parties
    4,761              
Cost of sales other
    241,540       236,243       246,637  
Recall-related items
    (1,114 )     (298 )     (131 )
   Gross profit
    191,842       185,194       180,837  
Selling, general and administrative expenses
    155,903       136,869       134,569  
Amortization
                1,597  
Impairment of goodwill and other intangible assets
    255,853       2,432        
Recall-related items
    15,782             (247 )
Terminated acquisition costs
    1,399              
   Operating (loss) income
    (237,984 )     44,709       44,918  
Interest expense
    6,584       3,923       2,221  
Interest income
    (1,579 )     (546 )     (891 )
Write-off of investment
    2,057              
Other (income) expense, net
    (3,553 )           (718 )
   (Loss) income before income taxes
    (241,493 )     40,552       44,306  
Income tax (benefit) expense
    (35,741 )     13,590       14,522  
   Net (loss) income
    (205,752 )     26,962       29,784  
Less: net income attributable to non-controlling interest
                 
      Net (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     $ 1.38  
   Diluted
  $ (11.82 )   $ 1.39     $ 1.34  
                         
Weighted average shares outstanding:
                       
   Basic
    17,406       19,014       21,564  
   Diluted
    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 thousan