Rc2 Corp (RCRC) - Description of business

Symbol:	RCRC
Type:	NASDAQ
State location:	IL
State of Inc:	DE
Phone:	630-573-7200
Fax:	630-573-7575
Web Site:	www.rc2corp.com
Full Time Employees:	789
Business Address:	1111 WEST 22ND STREET, SUITE 320 OAK BROOK IL 60523 630-573-7200
Mailing Address:	1111 WEST 22ND STREET, SUITE 320 OAK BROOK IL 60523

Overview

We are a leading designer, producer and marketer of innovative, high-quality toys, collectibles, and infant products that are targeted to consumers of all ages. Our leadership position is measured by sales and brand recognition. Our infant, toddler and preschool products are marketed under our Learning Curve® family of brands which includes The First Years® by Learning Curve and Lamaze brands as well as popular and classic licensed properties such as Thomas & Friends , Bob the Builder , Winnie the Pooh , John Deere, Nickelodeon and Sesame Street . 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 and Asia Pacific.

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 and assets, see Note 5 to our consolidated financial statements included elsewhere herein.

Corporate History

We are a Delaware corporation that was originally formed in April 1996 as a holding company to combine the domestic operations of a privately held Illinois corporation formed in 1989 and the operations of four affiliated foreign corporations. We were originally named Collectible Champions, Inc. In 1997, we changed our name to Racing Champions Corporation before our initial public offering. In 2002, we changed our name to Racing Champions Ertl Corporation to reflect our integration of The Ertl Company, Inc. In 2003, following our acquisition of Learning Curve International, Inc. and certain of its affiliates (collectively, LCI), we changed our name to RC2 Corporation. In addition, we changed the name of our main domestic operating subsidiary to RC2 Brands, Inc.

On June 7, 2004, with an effective date of June 1, 2004, the Company acquired substantially all of the assets of Playing Mantis, Inc. (PM) primarily consisting of the Johnny Lightning® brand. Closing consideration consisted of $17.0 million of cash, excluding transaction expenses, and 91,388 shares of the Company’s common stock. This transaction has been accounted for under the purchase method of accounting, and accordingly, the operating results of PM have been included in our consolidated statements of earnings since the effective date of the acquisition.

On September 15, 2004, the Company acquired The First Years Inc. (TFY) for $156.1 million in cash, excluding transaction expenses. TFY is an international developer and marketer of infant and toddler care and play products sold under The First Years® brand name and under various licenses, including Disney’s Winnie the Pooh . This transaction has been accounted for under the purchase method of accounting, and accordingly, the operating results of TFY have been included in the accompanying consolidated statements of earnings since the effective date of the acquisition. The purchase was funded with a credit facility (see Note 8 to the consolidated financial statements).

On November 3, 2006, the Company announced the sale of RC2 South, Inc., its collectible trading card business, and substantially all of the assets relating to its die-cast sports collectibles product line. Closing consideration consisted of $6.9 million of cash, excluding transaction expenses. The sale was effective November 1, 2006 and the results of this sold business are presented as discontinued operations in the accompanying consolidated statements of earnings and consolidated statements of cash flows. The net proceeds of this transaction were used to pay down debt.

During December 2006, the Company made the decision to discontinue its Racing Champions®, JoyRide®, AMT® and certain Ertl® die-cast and model kit automotive collectible product lines. Discontinuing the automotive collectible product lines is consistent with the Company’s strategy to focus on sustainable, organic growth and on allocating resources to its higher growth infant and toddler products and preschool products categories. The Company plans to continue its agricultural collectibles business and continue to invest in its strategic long-term relationship with John Deere. Additionally, the Company plans to continue with its strategy to reposition its Johnny Lightning brand targeting younger consumers.

In January 2007, we changed the name of RC2 Brands, Inc., our main domestic operating subsidiary, to Learning Curve Brands, Inc., to better reflect our strategy of focusing on our Learning Curve family of infant, toddler and preschool brands.

Products

We group our products into three product categories: infant and toddler products; preschool products; and youth and adult products. During the fourth quarter of 2006, the Company reclassified its product categories and channels of distribution to be more closely aligned with its strategic direction and organization structure. This presentation is consistent with how we view our business. We provide a diverse offering of infant and toddler products, stylized toys and highly detailed, authentic replicas known for their quality workmanship. Our products currently retail from $1.79 to $599.99. We have successfully expanded our product offering, and by offering a wide range of products at varying price points, we believe our products appeal to a broad range of consumers.

The following chart summarizes our current product categories:

Category	Key Licensed Properties	Key Brands	Retail Price Range
Infant and toddler products	Lamaze	Learning Curve	$1.79 - $149.99
	Winnie the Pooh	The First Years by Learning Curve
	Disney Princess
	Sesame Street
	American Red Cross
	Soothie

Preschool products	Thomas & Friends	Learning Curve	$4.99 - $599.99
	Bob the Builder	Take Along by Learning Curve
	John Deere
	Nickelodeon

Youth and adult products	John Deere	Johnny Lightning	$2.99 - $175.00
	Case New Holland	Ertl

Infant and toddler products. This category includes a wide range of infant and toddler products related to feeding, care, safety and play. Products in this category include:

·

Learning Curve's Lamaze infant toys with features that encourage developmental and interactive play; and

·

The First Years by Learning Curve, a full line of feeding, care, safety and play products for infants and toddlers, including the Take & Toss ® and Soothie product lines.

In 2006, we introduced the Soothie bottles product line under The First Years by Learning Curve brand. These bottles offer the same shaped, medical grade silicone nipple as those used on Soothie pacifiers. Additionally, we expanded the Take & Toss toddler self-feeding system under The First Years by Learning Curve brand. The Take & Toss product line includes sippy and straw cups, plates, bowls and feeding accessories. In 2006, we added licensed properties such as Thomas & Friends , Bob the Builder , The Wiggles , Barney , Sesame Street , Disney Princess, Winnie the Pooh, Spiderman, Finding Nemo and Cars to our Take & Toss product line . In late 2006, we introduced a line of The First Years by Learning Curve healthcare products associated with the American Red Cross licensed property.

In 2007, we plan to introduce a new look for Lamaze, featuring new colors and patterns. We also plan to launch a new play line featuring the Winnie the Pooh licensed property. Under The First Years by Learning Curve brand, we plan to expand distribution of our new Clean Air Odor Free ™ diaper disposal system which utilizes a carbon filter/fan system to both trap and eliminate odors. We also plan to introduce a portable infant glider and a retractable gate under The First Years by Learning Curve brand. Additionally, we plan to broaden our Take & Toss product line to include feeding sets featuring our most popular licensed properties.

Preschool products. This category includes product lines that are marketed to parents, grandparents, caregivers and giftgivers of preschool-aged children. Products in this category are marketed under our Learning Curve brand and include:

·

Thomas & Friends Wooden Railway, wooden engines, vehicles, destinations and playsets;

·

Bob the Builder Project: Build It characters, vehicles, playsets and role-play toys;

·

Take Along by Learning Curve die-cast vehicles and playsets designed around licensed properties such as Thomas & Friends , Bob the Builder , Big Foot Presents Meteor and the Mighty Monster Trucks , as well as several characters featured on popular Nickelodeon television shows;

·

Play Town classic wooden figures, vehicles, buildings and playsets;

·

John Deere farm, construction and role-play activity toys; and

·

Ride-ons featuring the John Deere, Thomas & Friends and Bob the Builder licensed properties.

In 2006, we expanded the distribution of our ride-ons . Additionally in 2006, we introduced new radio-controlled vehicles under the Bob the Builder and John Deere licensed properties.

In 2007, we plan to introduce our Play Town from Learning Curve product line which offers characters, vehicles, buildings and playsets for open-ended, classic and creative play for toddlers and preschoolers. We also plan to expand our Take Along by Learning Curve line to include popular Nickelodeon television characters such as Dora the Explorer , Go Diego Go! , The Backyardigans , Blue’s Clues and SpongeBob SquarePants.

Youth and adult products. This category includes product lines that are marketed to older boys and adult collectors. Products in this category include:

·

Johnny Lightning toy and radio-controlled vehicles; and

·

Ertl, collectible and toy vintage and modern tractors, farm implements and construction vehicles of major original equipment manufacturers (OEMs) such as John Deere and Case New Holland.

In 2007, we plan to reposition the Johnny Lightning product line featuring a new logo, packaging and product design targeting younger consumers. Under the Johnny Lightning brand, we plan to introduce Lightning Wheels, a line of fantasy vehicles with tires that illuminate. Additionally, we plan to introduce two new radio-controlled product lines, V-Bot ™ and Battle Wheels ™ . The V-Bot product line features a fully funtional radio-controlled vehicle that transforms into a robot. The Battle Wheels product line features radio-contolled battling action figures on wheels.

Licenses

We market a significant portion of our products with licenses from other parties. We have license agreements with entertainment, publishing and media companies; automotive and truck manufacturers; agricultural and construction vehicle and equipment manufacturers; among others. 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’ authenticity, credibility and quality with consumers, and in some cases, provide for new product development opportunities and expand distribution channels. Our licenses are limited in scope and duration and authorize the sale of specific licensed products generally on a nonexclusive basis. For the year ended December 31, 2006, net sales of the Company’s products with the licensed properties of 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, 2006. As of December 31, 2006, approximately 69.7% of our licenses required 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, 2006, are $50.7 million, with the individual license minimum guarantees ranging from $1.00 to $20.9 million. Royalty expense related to licenses with minimum guarantees for the year ended December 31, 2006 was $32.6 million. We are a party to over 500 license agreements, approximately 400 of which are actively used in our current product lines, 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. Over the next two years, license agreements in connection with several of our key licensed properties, including licenses for certain Winnie the Pooh , Disney Princess, Finding Nemo, Bob the Builder , Ford Motor Company and DaimlerChrysler Corporation products, are scheduled to expire. 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.

Channels of Distribution

Our products are available through more than 25,000 retail outlets located in North America, Europe, Australia and Asia Pacific. 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 products with higher prices are typically sold in hobby, collector and independent toy stores and through wholesalers and OEM dealers. 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 price conscious end-users. As a result, the majority of our products marketed through this channel are designed to span lower price points and generally retail for less than $30.00. Customers included in this channel have more than ten retail locations and can include a wide range of retailers, such as book, farm and ranch, automotive and craft/hobby stores, as well as the national discount retailers. Key customers in our chain retailer channel include Wal-Mart, Toys “R” Us/Babies “R” Us, Target, Kohl’s, Tractor Supply Company and Michaels Stores, Inc. Sales in 2006 to chain retailers were 68.0% of our net sales.

Specialty retailers, wholesalers and OEM dealers. 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 29.2% of our net sales in 2006. 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 (generally 90 to 360 days) before the products become available through other distribution channels. We reach these customers directly through our internal telesales group and business-to-business website located at www.myRC2.com and through specialty sales representatives. Key customers in our specialty retailers, wholesalers and OEM dealers channel include Learning Express, All Aboard Toys, Horizon Hobby, John Deere and Case New Holland.

Corporate promotional, direct to consumers and other. We make certain products available to corporate promotional accounts and to consumers through company stores and our websites located at www.diecastexpress.com and www.learningcurveshop.com . Individual products sold directly to consumers sell at prices similar to those found at retailers, hobby stores and OEM dealers. Sales through this channel constituted 2.8% of our net sales in 2006.

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® and Take & Toss®. 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 retail chain and key wholesale accounts. A number of accounts are designated as “house accounts” and are handled exclusively by our internal sales staff. Our inside sales and customer service groups use telephone calls, mailings, faxes and e-mails to directly contact OEM dealers and smaller volume customers such as collector, hobby, specialty and independent toy stores.

Our internal sales force is supplemented by external sales representative organizations. These external sales representative organizations provide more frequent customer contact and solicitation of the national, regional and specialty retailers and supported 30.2% of our net sales in 2006. External sales representatives generally earn commissions of 1.0% 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. This 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.

Our marketing programs are directed toward adult collectors, parents and children, current consumers and potential new consumers who fit the demographic profile of our target market. Our objectives include increasing awareness of our product offerings and brand names, as well as executing consumer promotions. We utilize the following media vehicles in our marketing plans:

·

Advertising. We place print advertisements in publications with high circulation and targeted penetration in key vertical categories such as parenting, gift and hobby. We run commercials on a selective basis on television programs that target key consumers.