RC2 Third Quarter 2005 Form 10-Q

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

(Mark One)
x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the quarterly period ended September 30, 2005
	OR

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

Commission file number: 0-22635

RC2 Corporation

(Exact Name of Registrant as Specified in Its Charter)

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

1111 West 22^nd Street, Suite 320, Oak Brook, Illinois, 60523

(Address of principal executive offices)

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

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

Yes

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).

Yes

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

Yes

On November 1, 2005, there were outstanding 20,696,546 shares of the Registrant's $0.01 par value common stock.

RC2 CORPORATION

FORM 10-Q

SEPTEMBER 30, 2005

INDEX

PART I - FINANCIAL INFORMATION

		Page
Item 1.	Condensed Consolidated Balance Sheets as of September 30, 2005 and December 31, 2004	3
	Condensed Consolidated Statements of Earnings for the Three Months and Nine Months Ended September 30, 2005 and 2004	4
	Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2005 and 2004	5
	Notes to Condensed Consolidated Financial Statements	6
Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	19
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	27
Item 4.	Controls and Procedures	27

PART II - OTHER INFORMATION

Item 1.	Legal Proceedings	28
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	28
Item 3.	Defaults Upon Senior Securities	28
Item 4.	Submission of Matters to a Vote of Security Holders	28
Item 5.	Other Information	28
Item 6.	Exhibits	28
	Signatures	30

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

RC2 Corporation and Subsidiaries

Condensed Consolidated Balance Sheets

(In thousands)

	September 30, 2005		December 30, 2004
	(Unaudited)
Assets
Cash and cash equivalents	$	20,077	$	20,123
Accounts receivable, net		113,861		93,616
Inventory		88,097		55,023
Assets held for sale		5,115		4,186
Other current assets		12,782		21,432
Total current assets		239,932		194,380
Property and equipment, net		47,015		48,857
Goodwill		253,575		282,367
Intangible assets, net		100,028		58,243
Other non-current assets		2,161		1,901
Total assets	$	642,711	$	585,748

Liabilities and stockholders’ equity
Accounts payable and accrued expenses	$	85,495	$	64,040
Current maturities of term loan		21,250		16,562
Other current liabilities		880		847
Total current liabilities		107,625		81,449
Revolving line of credit		47,000		50,000
Non-current portion of term loan		48,750		64,688
Other non-current liabilities		56,516		42,849
Total liabilities		259,891		238,986
Stockholders’ equity		382,820		346,762
Total liabilities and stockholders' equity	$	642,711	$	585,748

See accompanying notes to condensed consolidated financial statements.

RC2 Corporation and Subsidiaries

Condensed Consolidated Statements of Earnings

(In thousands, except per share data)

	For the three months ended September 30,						For the nine months ended September 30,
	2005			2004			2005			2004
	(Unaudited)			(Unaudited)			(Unaudited)			(Unaudited)

Net sales	$	142,567		$	110,289		$	347,867		$	240,988
Cost of sales		72,833			54,283			176,267			117,235
Gross profit		69,734			56,006			171,600			123,753
Selling, general and administrative expenses		39,943			33,497			111,917			85,638
Amortization of intangible assets		845			---			1,095			---
Gain on sale of W. Britain product line		(1,953	)		---			(1,953	)		---
Operating income		30,899			22,509			60,541			38,115
Interest expense, net		1,522			1,011			4,557			2,465
Other expense (income)		4			(345	)		(347	)		(430	)
Income before income taxes		29,373			21,843			56,331			36,080
Income tax expense		11,113			7,864			20,480			12,989
Net income	$	18,260		$	13,979		$	35,851		$	23,091
Net income per share:
Basic	$	0.88		$	0.72		$	1.74		$	1.28
Diluted	$	0.85		$	0.68		$	1.67		$	1.20
Weighted average shares outstanding:
Basic		20,656			19,348			20,582			18,108
Diluted		21,594			20,443			21,525			19,205

See accompanying notes to condensed consolidated financial statements.

RC2 Corporation and Subsidiaries

Condensed Consolidated Statements of Cash Flows

(In thousands)

	For the nine months ended September 30,
	2005			2004
	(Unaudited)			(Unaudited)
Cash flows from operating activities
Net income	$	35,851		$	23,091
Depreciation and amortization		11,429			9,342
Amortization of deferred financing costs		362			709
(Gain) loss on sale of assets		(2,031	)		44
Changes in operating assets and liabilities		(25,253	)		979
Net cash provided by operating activities		20,358			34,165

Cash flows from investing activities
Purchase of property and equipment		(9,948	)		(10,955	)
Purchase of Playing Mantis, net of cash acquired		---			(17,238	)
Purchase of TFY, net of cash acquired		39			(155,745	)
Proceeds from disposal of property and equipment		608			92
Proceeds from sale of W. Britain product line		2,850			---
Investment in Meteor		(529	)		---
Increase in other non-current assets		(84	)		(16	)
Net cash used in investing activities		(7,064	)		(183,862	)

Cash flows from financing activities
Net proceeds from public offering of common stock		---			77,498
Proceeds from bank on credit facility		20,000			197,000
Payments to bank on credit facility		(34,250	)		(117,000	)
Issuance of common stock upon option exercise		1,349			1,590
Purchase of treasury stock		---			(822	)
Issuance of common stock for ESPP		139			104
Net cash (used in) provided by financing activities		(12,762	)		158,370
Effect of exchange rate changes on cash		(578	)		(126	)
Net (decrease) increase in cash and cash equivalents		(46	)		8,547
Cash and cash equivalents, beginning of year		20,123			16,548
Decrease in restricted cash		---			33
Cash and cash equivalents, end of period	$	20,077		$	25,128
Supplemental information:
Cash flows during the period for:
Interest	$	4,356		$	1,774
Income taxes	$	13,080		$	10,390
Income tax refunds received	$	4,997		$	216

Non-cash investing and financing activity during the period: 91,388 shares of stock issued for the purchase of Playing Mantis	$	---		$	2,868

See accompanying notes to condensed consolidated financial statements.

RC2 Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements

Note 1 - Basis of Presentation

The condensed consolidated financial statements include the accounts of RC2 Corporation and its subsidiaries (the Company or RC2). All intercompany transactions and balances have been eliminated.

The accompanying condensed consolidated financial statements have been prepared by management and, in the opinion of management, contain all adjustments, consisting of normal recurring adjustments, necessary to present fairly the financial position of the Company as of September 30, 2005 and December 31, 2004, the results of its operations for the three-month and nine-month periods ended September 30, 2005 and 2004, and its cash flows for the nine-month periods ended September 30, 2005 and 2004.

Certain information and note disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles have been omitted. It is suggested that these condensed consolidated financial statements be read in conjunction with the consolidated financial statements and related notes included in the Company's Form 10-K for the year ended December 31, 2004.

Due to the seasonality of our business, the results of operations for the interim periods ended September 30, 2005 are not necessarily indicative of the operating results for the full year.

Note 2 - Business Combinations

RC2 Corporation and The First Years Inc.

On September 15, 2004, the Company acquired The First Years Inc. (TFY) for approximately $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. TFY’s products are sold at toy, mass merchandising, drug and grocery chains, and at specialty retailers. This transaction has been accounted for under the purchase method of accounting and, accordingly, the operating results of TFY have been included in our consolidated statements of earnings since the effective date of acquisition. The purchase was funded with the Company’s credit facility (see Note 8 - “Debt”). The excess of the aggregate purchase price over the fair market value of net assets acquired of approximately $73.1 million and $97.6 million has been recorded as goodwill in the accompanying condensed consolidated balance sheets at September 30, 2005 and December 31, 2004, respectively. During the quarter ended September 30, 2005, the Company completed its valuation of the assets acquired in the TFY transaction. As a result, approximately $40 million in other intangible assets have been recorded on the balance sheet that previously were reflected in goodwill.

The purchase price was allocated to the net assets of TFY based on their estimated relative fair values as of September 15, 2004 as follows:

(In thousands)

Total purchase price, including expenses, net of cash acquired				$	154,528
Less:
Current assets	$	45,965
Property, plant and equipment		11,100
Intangible assets		58,238
Other long-term assets		175
Liabilities		(34,043	)		(81,435	)
Excess of purchase price over net assets acquired				$	73,093

See table following the discussion of Playing Mantis, Inc. for pro forma combined results.

RC2 Corporation and Playing Mantis, Inc.

On June 7, 2004, the Company acquired substantially all of the assets of Playing Mantis, Inc. (Playing Mantis) with an effective date of June 1, 2004. Closing consideration consisted of $17.0 million of cash (excluding transaction expenses) and 91,388 shares of the Company’s common stock. Additional cash consideration of up to $4.0 million may be earned in the transaction by Playing Mantis of which $2.0 million was based on achieving net sales and margin targets in 2004 and the remaining $2.0 million is based on achieving net sales targets for 2005. The contingent consideration for 2004 was not payable because the net sales and margin targets were not met in 2004. Playing Mantis designs and markets collectible vehicle replicas under the Johnny Lightning® and Polar Lights® brands and collectible figures under the Memory Lane™ brand. Playing Mantis’ products are primarily sold at mass merchandising, hobby, craft, drug and grocery chains. This transaction has been accounted for under the purchase method of accounting and, accordingly, the operating results of Playing Mantis have been included in our condensed consolidated statements of earnings since the effective date of the acquisition. The excess of the aggregate purchase price over the fair market value of net assets acquired of approximately $11.0 million and $14.1 million has been recorded as goodwill in the accompanying condensed consolidated balance sheets at September 30, 2005 and December 31, 2004, respectively. During the quarter ended June 30, 2005, the Company completed its valuation of the assets acquired in the Playing Mantis transaction. As a result, approximately $3 million in other intangible assets have been recorded on the balance sheet that previously were reflected in goodwill.

The purchase price was allocated to the net assets of Playing Mantis based on their estimated relative fair values as of June 1, 2004 as follows:

(In thousands)

Total purchase price, including expenses, net of cash acquired				$	20,106
Less:
Current assets	$	5,424
Property, plant and equipment		4,111
Intangible assets		3,314
Liabilities		(3,777	)		(9,072	)
Excess of purchase price over net assets acquired				$	11,034

The following table presents the unaudited pro forma combined results of operations for the three months and the nine months ended September 30, 2004 and assumes that the TFY and Playing Mantis acquisitions occurred as of January 1, 2004.

(In thousands, except per share data)

	Three Months Ended		Nine Months Ended
	September 30, 2004		September 30, 2004

Net sales	$	137,328	$	349,045

Net income	$	14,666	$	25,484
Net income per share:
Basic	$	0.76	$	1.40
Diluted	$	0.72	$	1.32

Pro forma data does not purport to be indicative of the results that would have been obtained had these acquisitions actually occurred at January 1, 2004 and is not intended to be a projection of future results.

RC2 Corporation and Learning Curve International, Inc.

On March 4, 2003, with an effective date of February 28, 2003, the Company acquired Learning Curve International, Inc. (Learning Curve) and certain of its affiliates (collectively, LCI) through the merger of a wholly owned subsidiary of RC2 with and into Learning Curve for approximately $104.4 million in cash (excluding transaction expenses) and 666,666 shares of the Company's common stock, including $12.0 million in escrow to secure Learning Curve’s indemnification obligations under the merger agreement. LCI develops and markets a variety of high-quality, award-winning children's and infant toys for every stage of childhood from birth through age eight. This transaction has been accounted for under the purchase method of accounting and, accordingly, the operating results of LCI have been included in our consolidated statements of earnings since the effective date of the acquisition. The purchase was funded with a credit facility (see Note 8 - “Debt”).

The escrow amount to secure Learning Curve’s indemnification obligations under the merger agreement was approximately $2.9 million at September 30, 2005. In the merger agreement, Learning Curve agreed to indemnify the Company for losses relating to breaches of Learning Curve’s representations, warranties and covenants in the merger agreement and for specified liabilities relating to Learning Curve’s historical business. The Company may make indemnification claims against the escrow account until the later of March 31, 2005 or the 10^th day following resolution of any tax audit or similar proceeding subject to potential indemnification under the merger agreement. Learning Curve is currently subject to a tax audit which is subject to potential indemnification under the merger agreement, and as a result, the escrow account will not close before the 10^th day following the resolution of this tax audit. In February 2005, the Company notified the representatives of the former Learning Curve shareholders of the tax audit and an additional indemnification claim, and in April 2005, the Company notified the representatives of the former Learning Curve shareholders of another indemnification claim.

Note 3 - Intangible Assets and Goodwill

The components of intangible assets, net are as follows:

(In thousands)

	September 30, 2005		December 31, 2004
Carrying amount of amortizable intangible assets:
Customer relationships	$	8,703	$	---
Other		2,962		750
	$	11,665	$	750

Accumulated amortization of amortizable intangible assets:
Customer relationships	$	222	$	---
Other		966		94
	$	1,188	$	94

Intangible assets not subject to amortization:
Licenses and trademarks	$	89,380	$	57,416
Other		171		171
	$	89,551	$	57,587

Total intangible assets, net	$	100,028	$	58,243

Other amortizable intangible assets consist primarily of patents, non-compete agreements and licenses. The future quarterly amortization expense of amortizable intangible assets is approximately $0.3 million.

Goodwill consists of the following:

(In thousands)

	North America			International			Total
Balance as of January 1, 2005	$	267,362		$	15,005		$	282,367
Playing Mantis acquisition		(3,085	)		---			(3,085	)
TFY acquisition		(24,472	)		---			(24,472	)
Impact of currency exchange rate changes		---			(1,235	)		(1,235	)
Balance as of September 30, 2005	$	239,805		$	13,770		$	253,575

Note 4 - Accounting for Stock-Based Compensation

The Company accounts for stock-based compensation arrangements with employees in accordance with the provisions of Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees," and complies with the disclosure provisions of Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for Stock-Based Compensation." Under APB No. 25, compensation expense is based on the difference, if any, on the measurement date, between the estimated fair value of the Company's stock and the exercise price of options to purchase that stock. The compensation expense is amortized on a straight-line basis over the vesting period of the options. To date, no compensation expense has been recorded related to stock-based compensation agreements with employees.

If compensation costs for stock options issued, including options issued for shares under the employee stock purchase plan (ESPP), had been determined based on the fair value at their grant date consistent with SFAS No. 123, the Company's net income and net income per share would have been reduced to the following pro forma amounts:

	For the three months ended September 30,						For the nine months ended September 30,
	2005			2004			2005			2004
(In thousands, except per share data)	(Unaudited)			(Unaudited)			(Unaudited)			(Unaudited)

Net income as reported	$	18,260		$	13,979		$	35,851		$	23,091
Deduct: total stock-based employee compensation expense determined under fair value-based method for all awards, net of related tax effects		(541	)		(799	)		(1,527	)		(1,478	)

Pro forma net income	$	17,719		$	13,180		$	34,324		$	21,613
Basic net income per share
As reported	$	0.88		$	0.72		$	1.74		$	1.28
Pro forma	$	0.86		$	0.68		$	1.67		$	1.19
Diluted net income per share
As reported	$	0.85		$	0.68		$	1.67		$	1.20
Pro forma	$	0.82		$	0.64		$	1.59		$	1.13

The fair value of each stock option, excluding options issued for shares under the ESPP, is estimated on the date of grant based on the Black-Scholes option pricing model that assumes, among other things, no dividend yield, risk-free rates of return from 3.53% to 5.74%, volatility factors of 54.50% to 87.76% and expected life of 7 to 10 years. The weighted average fair value of options granted under the Company’s stock option plan during the nine months ended September 30, 2005 and 2004 was $18.69 and $19.39, respectively.

The fair value of each option issued under the ESPP was estimated using the Black-Scholes model with the following assumptions: risk-free rates of return from 0.93% to 3.17%, volatility factors of 29.79% to 79.16% and expected life of three months. The weighted average fair value of those purchase rights granted during the nine months ended September 30, 2005 and 2004 was $7.18 and $8.03, respectively.

During the first quarter of 2005, the Company evaluated the method that had historically been used to calculate the volatility factors used in valuing stock options issued, both under the stock option plan and the ESPP. The Company had been using historical Company results to compute the volatility used in valuing the stock options issued. As the Company’s business has changed significantly as a result of the acquisitions completed, the historical stock price movements are not a good indicator of expected future results. Therefore, the Company has changed the method used to calculate the volatility factor for those options issued under the stock option plan to correspond with the average volatility factor of those companies included in a recent peer group study. The Company also changed the method used to calculate the volatility factor for those options issued under the ESPP to that of the volatility during the most recent three month period, as it more accurately projects the expected volatility over the three month ESPP period being valued.

The pro forma disclosure is not likely to be indicative of pro forma results that may be expected in future years because of the fact that options vest over several years. Compensation expense is recognized as the options vest and additional awards may be granted.

Note 5 - Business Segments

The Company is a leading designer, producer and marketer of innovative, high-quality toys, collectibles, hobby and infant care products targeted to consumers of all ages, as measured by sales and brand recognition.

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

Segment performance is measured at the operating income level. Segment assets are comprised of all assets, net of applicable reserves and allowances.

Results are not necessarily those that would be achieved if each segment were an unaffiliated business enterprise. Information by segment and a reconciliation to reported amounts for the three months and nine months ended September 30, 2005 and 2004 are as follows:

	Three Months Ended September 30,
(In thousands)	2005			2004
Net sales:
North America	$	121,661		$	97,237
International		21,378			13,303
Sales and transfers between segments		(472	)		(251	)
Combined total	$	142,567		$	110,289

Operating income:
North America	$	24,079		$	19,916
International		6,820			2,593
Combined total	$	30,899		$	22,509

(In thousands)	September 30, 2005		December 31, 2004
Total assets:
North America	$	571,394	$	525,526
International		71,317		60,222
Combined total	$	642,711	$	585,748

	Nine Months Ended September 30,
(In thousands)	2005			2004
Net sales:
North America	$	299,704		$	206,998
International		49,264			34,628
Sales and transfers between segments		(1,101	)		(638	)
Combined total	$	347,867		$	240,988

Operating income:
North America	$	48,534		$	31,934
International		12,007			6,181
Combined total	$	60,541		$	38,115

Under the enterprise-wide disclosure requirements of SFAS No. 131, the Company reports net sales by each group of product categories and by distribution channel. With the acquisitions of Playing Mantis and TFY in 2004, the Company revised its product categories to reflect the Company’s three product platforms: collectible products, children’s toys and infant products. The presentation is consistent with how the Company views its business. The following tables present consolidated net sales by product category and by distribution channel for the three months and nine months ended September 30, 2005 and 2004:

	Three Months Ended September 30,
(In thousands)	2005		2004
Collectible products	$	34,862	$	51,505
Children’s toys		66,543		47,227
Infant products		41,162		11,557
Net sales	$	142,567	$	110,289

Chain retailers	$	88,901	$	57,969
Specialty and hobby wholesalers and retailers		34,252		31,710
OEM dealers		13,268		13,436
Corporate promotional		5,643		4,488
Direct to consumers		503		2,686
Net sales	$	142,567	$	110,289

	Nine Months Ended September 30,
(In thousands)	2005		2004
Collectible products	$	90,201	$	110,639
Children’s toys		140,121		109,281
Infant products		117,545		21,068
Net sales	$	347,867	$	240,988

Chain retailers	$	214,212	$	114,061
Specialty and hobby wholesalers and retailers		92,290		83,842
OEM dealers		27,084		24,690
Corporate promotional		12,575		11,405
Direct to consumers		1,706		6,990
Net sales	$	347,867	$	240,988

Note 6 - Comprehensive Income

The Company reports comprehensive income in accordance with SFAS No. 130, "Reporting Comprehensive Income." SFAS No. 130 requires companies to report all changes in equity during a period, except those resulting from investment by owners and distributions to owners, in a financial statement for the period in which they are recognized. Comprehensive income for the nine month periods ended September 30, 2005 and 2004 is calculated as follows:

(In thousands)	2005			2004
Net income	$	35,851		$	23,091
Other comprehensive (loss) income - foreign currency
translation adjustments		(3,742	)		45
Comprehensive income	$	32,109		$	23,136

Note 7 - Common Stock

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

	Authorized	Par	Shares Outstanding at	Shares Outstanding at
	Shares	Value	September 30, 2005	December 31, 2004
Voting Common Stock	28,000,000	$0.01	20,686,339	20,462,659

At December 31, 2004, the Company held 1,832,174 shares of its common stock in treasury. During the nine months ended September 30, 2005, the Company sold a total of 4,729 shares out of treasury to Company employees under the ESPP for $138,973. During the nine months ended September 30, 2004, the Company sold a total of 5,006 shares out of treasury to Company employees under the ESPP for $104,094.

In August 2004, the Company completed a public offering of 2,655,000 shares of common stock and certain selling stockholders sold 220,000 shares of common stock at a price of $31.00 per share. The Company received proceeds of $77.8 million from the offering, net of underwriting discount, and used $74.0 million of the proceeds to repay outstanding debt. Additionally, the Company incurred $0.3 million of costs associated with the offering and these costs have been reflected as a reduction of stockholders’ equity on the Company’s condensed consolidated balance sheets at September 30, 2005 and December 31, 2004.

As discussed in Note 2, the Company issued 91,388 shares of the Company’s common stock in June 2004 in connection with its acquisition of Playing Mantis.

Note 8 - Debt

Upon the closing of the acquisition of TFY on September 15, 2004, the Company entered into a new credit facility to replace its March 4, 2003 credit facility (see below). This credit facility is comprised of an $85.0 million term loan and a $100.0 million revolving line of credit, both of which mature on September 14, 2008 with scheduled quarterly principal payments ranging from $3.8 million to $6.9 million commencing on December 31, 2004 and continuing thereafter with a final balloon payment upon maturity. A portion of the term loan has an interest rate of 3.45% plus applicable margin through the first three years of the agreement. The remaining term loan and revolving loan bear interest, at the Company’s option, at a base rate or at a LIBOR rate plus applicable margin. The applicable margin is based on the Company’s ratio of consolidated debt to consolidated EBITDA (earnings before interest, taxes, depreciation and amortization) and varies between 1.00% and 1.75%. At September 30, 2005, the margin in effect was 1.25% for LIBOR loans. The Company is also required to pay a commitment fee of 0.30% to 0.45% per annum on the average daily unused portion of the revolving loan. Under the terms of this credit facility, the Company is required to comply with certain financial and non-financial covenants. Among other restrictions, the Company is restricted in its ability to pay dividends, incur additional debt and make acquisitions above certain amounts. The key financial covenants include minimum EBITDA and interest coverage and leverage ratios. The credit facility is secured by working capital assets and certain intangible assets. On September 30, 2005, the Company had $117.0 million outstanding on this credit facility and was in compliance with all covenants.

In conjunction with the new credit facility, the Company expensed approximately $0.5 million of deferred financing fees related to the Company’s March 2003 credit facility in interest expense during the third quarter of 2004. In addition, the Company incurred approximately $1.9 million in financing fees on the new credit facility, which is included in other non-current assets in the accompanying condensed consolidated balance sheets at September 30, 2005 and December 31, 2004 and is being charged to interest expense through September 2008.

Upon the closing of the acquisition of LCI on March 4, 2003, with an effective date of February 28, 2003, the Company entered into a credit facility to replace its previous credit facility. This credit facility was comprised of a $60.0 million term loan and an $80.0 million revolving loan, both of which were to mature on April 30, 2006. Thirty million dollars of the term loan had an interest rate of 2.61% plus applicable margin through the maturity of the agreement. The remaining term loan and revolving loan bore interest, at the Company's option, at a base rate or at a LIBOR rate plus applicable margin. The applicable margin was based on the Company's ratio of consolidated debt to consolidated EBITDA and varied between 0.75% and 1.75%. The facility was replaced with the September 2004 credit facility discussed above.

Note 9 - Net Income Per Share

The Company computes net income per share in accordance with SFAS No. 128, "Earnings Per Share." Under the provisions of SFAS No. 128, basic net income per share is computed by dividing net income for the period by the weighted average number of common shares outstanding during the period. Diluted net income per share is computed by dividing the net income for the period by the weighted average number of common and common equivalent shares outstanding during the period. Options to purchase 2,927 shares of common stock at $36.54 per share were outstanding during the nine months ended September 30, 2005, but were not included in the computation of diluted earnings per share because the options’ exercise price was greater than the average market price of the common shares. Options to purchase 851 shares of common stock at $34.65 per share were outstanding during the three months ended September 30, 2004, but were not included in the computation of diluted earnings per share because the options’ exercise price was greater than the average market price of the common shares. Options to purchase 82,192 shares of common stock at prices between $29.02 and $34.65 per share were outstanding during the nine months ended September 30, 2004, but were not included in the computation of diluted earnings per share because the options’ exercise price was greater than the average market price of the common shares.

Note 10 - 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.

Note 11 - Use of Estimates

The preparation of the financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.

Note 12 - Reclassifications

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

Note 13 - Related Party Transactions

The Company purchased some of its product during the nine months ended September 30, 2005 and 2004, from a company in which a relative of one of the Company’s stockholders/directors has ownership interests. Additionally, in 2005, the Company began purchasing product from a second company in which the same relative of one of the Company’s stockholders/directors has a partial ownership interest.

Note 14 - Commitments and Contingencies

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

The Company markets a significant portion of its products under licenses from other parties. These licenses are generally limited in scope and duration and authorize the sale of specific licensed products on a nonexclusive basis. The Company has over 700 licenses with various vehicle and equipment manufacturers, race team owners, drivers, sponsors, agents and entertainment and media companies, generally for terms of one to three years. Many of the licenses include minimum guaranteed royalty payments that the Company must pay whether or not it meets specified sales targets. The Company believes it either achieved its minimum guarantees or has accrued for the costs related to these guarantees for the nine months ended September 30, 2005 and 2004.

In conjunction with the acquisition of TFY during the third quarter of 2004, the Company acquired purchase commitments with certain vendors relating to product and product components which are kept on hand to shorten lead times. In the event the product is discontinued, the Company would be required to reimburse the vendor for the cost of the products and product components on hand. At September 30, 2005, the total commitment to these vendors was approximately $45,000.

Note 15 - Insurance Recovery

During the nine months ended September 30, 2004, the Company received an insurance recovery of approximately $303,000 relating to the lost margin on product destroyed during a fire at the Company’s third-party warehouse in the United Kingdom in October 2003. This insurance recovery is included in the Company’s cost of sales for the nine months ended September 30, 2004.

Note 16 - Employee Benefit Plans

The Company maintains a funded noncontributory defined benefit pension plan that covers a select group of the Company’s workforce. The plan provides defined retirement benefits based on the employees’ years of service.

The components of net periodic benefit cost for the three months ended September 30, 2005 and 2004 are as follows:

(In thousands)	2005			2004
Service cost	$	27		$	27
Interest cost		192			172
Expected return on plan assets		(244	)		(216	)
Amortization of prior service costs		5			5
Amortization of net loss		93			45
Net periodic benefit cost	$	73		$	33

The components of net periodic benefit cost for the nine months ended September 30, 2005 and 2004 are as follows:

(In thousands)	2005			2004
Service cost	$	81		$	82
Interest cost		576			516
Expected return on plan assets		(734	)		(648	)
Amortization of prior service costs		15			15
Amortization of net loss		279			135
Net periodic benefit cost	$	217		$	100

The Company contributed $0.7 million to the pension benefit plan during the nine months ended September 30, 2005. The Company does not expect to make any additional contributions during the remainder of 2005.

Note 17 - Assets Held for Sale

During the second quarter of 2005, the Company accepted and signed a letter of intent related to the sale of the land and building located in Avon, Massachusetts. Assets held for sale in the amount of $5.1 million primarily represents the land and building at this location. The Company expects to close on the sale of the land and building during the fourth quarter of 2005.

Note 18 - Investment in Meteor The Monster Truck Company, LLC

In July 2005, the Company invested in Meteor The Monster Truck Company, LLC (Meteor). After recovery of its capital contributions and preferred returns, the Company will share in 7.5% of the profits and losses of Meteor. The Company has committed to contribute $750,000 to Meteor, of which approximately $530,000 has been funded. The Company determined that the investment in Meteor will be accounted for using the equity method of accounting based on the Company’s ability to exercise significant influence over the operating and financial policies of Meteor as a result of its representation on the board of directors. The investment in Meteor of $0.5 million is included in other non-current assets on the accompanying condensed consolidated balance sheet at September 30, 2005.

Subsequent to the third quarter-end, the Company funded the remainder of its commitment, bringing its total investment in Meteor to $750,000.

Note 19 - Sale of Product Line

During the third quarter of 2005, the Company completed the sale of its W. Britain product line of collectible pewter toy soldiers and accessories for $2.9 million in cash. The sale resulted in a gain of $2.0 million which is included in operating income on the accompanying condensed consolidated statements of earnings.

Item 2. Management's Discussion and Analysis of Financial

Condition and Results of Operations

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

RESULTS OF OPERATIONS

Operating Highlights

Net sales for the quarter ended September 30, 2005 increased approximately 29% primarily due to the addition of TFY. Gross margin decreased to 48.9% for the third quarter of 2005 from 50.8% for the third quarter of 2004 primarily due to the impact of the TFY acquisition which had historical gross margins lower than RC2’s historical gross margins, as well as a less favorable product mix and higher freight and product costs than that experienced in the third quarter of 2004. Selling, general and administrative expenses as a percentage of net sales decreased to 28.0% for the third quarter of 2005 from 30.4% for the third quarter of 2004. Operating income increased to $30.9 million for the third quarter of 2005 compared to $22.5 million for the third quarter of 2004. As a percentage of net sales, operating income increased to 21.7% for the third quarter of 2005 from 20.4% for the third quarter of 2004.

Net sales for the nine months ended September 30, 2005 increased approximately 44% primarily due to the addition of TFY. Gross margin decreased to 49.3% for the nine months ended September 30, 2005 from 51.4% for the nine months ended September 30, 2004 primarily due to the impact of the 2004 acquisitions which had historical gross margins lower than RC2’s historical gross margins, as well as a less favorable product mix and higher freight and product costs than that experienced in the first nine months of 2004. Selling, general and administrative expenses as a percentage of net sales decreased to 32.2% for the nine months ended September 30, 2005 from 35.5% for the nine months ended September 30, 2004. Operating income increased to $60.5 million for the nine months ended September 30, 2005 compared to $38.1 million for the nine months ended September 30, 2004. As a percentage of net sales, operating income increased to 17.4% for the nine months ended September 30, 2005 from 15.8% for the nine months ended September 30, 2004.

Three Months Ended September 30, 2005 Compared to Three Months Ended September 30, 2004

Net sales. Net sales for the third quarter of 2005 increased $32.3 million, or 29%, to $142.6 million from $110.3 million for the third quarter of 2004. The sales increase was primarily attributable to the addition of TFY which is reflected in the significant increase in our infant products category. Net sales also increased in our children’s toys product category, but these increases were partially offset by a decrease in our collectible products category.

Net sales in our infant products category increased approximately 256% primarily due to the addition of TFY. Net sales in our children’s toys category increased approximately 41% primarily driven by Thomas & Friends and John Deere toy vehicles and our ride-on products, as well as sales of our new Bob the Builder product line. Net sales in our collectible products category decreased approximately 32% primarily due to the continued tough comparisons with both The Fast and The Furious and Orange County/American Chopper product lines in the third quarter of 2004, the discontinuance of the Memory Lane seasonal figures which primarily shipped during the second half of 2004, lower overall NASCAR product sales and the discontinuance of distribution at NASCAR trackside events in 2005.

Actual net sales for the third quarter of 2005, excluding $0.8 million in net sales of previously discontinued product lines, increased 8% when compared to the third quarter of 2004 pro forma net sales excluding $6.5 million in net sales from these same discontinued product lines. The pro forma net sales assume that the Playing Mantis and TFY acquisitions occurred as of January 1, 2004.

Gross profit. Gross profit increased $13.7 million, or 25%, to $69.7 million for the third quarter of 2005 from $56.0 million for the third quarter of 2004. The gross profit margin (as a percentage of net sales) decreased to 48.9% in the third quarter of 2005 compared to 50.8% in the third quarter of 2004 primarily due to the impact of the TFY acquisition which had historical gross margins lower than RC2’s historical gross margins, as well as a less favorable product mix and higher freight and product costs than experienced in the third quarter of 2004. Our quarterly gross margins can be affected by the mix of product that is shipped during each quarter. Historically, all of our product categories approximated a similar gross margin; however, individual product lines within a category carried gross margins that varied significantly and caused quarterly fluctuations, based on the timing of these individual shipments throughout the year. Due to the 2004 acquisition of TFY, which has higher sales of non-licensed products that carry lower selling prices and gross margins than the Company has had historically, our quarterly gross margins could not only significantly fluctuate, but could be lower than those historically reported. There were no major changes in the components of cost of sales.

Selling, general and administrative expenses. Selling, general and administrative expenses increased $6.4 million, or 19%, to $39.9 million for the third quarter of 2005 from $33.5 million for the third quarter of 2004. As a percentage of net sales, selling, general and administrative expenses decreased to 28.0% for the third quarter of 2005 from 30.4% for the third quarter of 2004. The decrease in selling, general and administrative expenses as a percentage of net sales was primarily due to operating leverage gained from increased sales and integration cost savings from the 2004 acquisitions and disciplined control over discretionary operating costs.

Operating income. Operating income increased to $30.9 million for the third quarter of 2005 from $22.5 million for the third quarter of 2004. As a percentage of net sales, operating income increased to 21.7% of net sales in the third quarter of 2005 from 20.4% in the prior year third quarter. Operating income for the third quarter of 2005 includes $2.0 million in gain on the sale of assets related to the sale of our W. Britain product line. Operating income also includes $0.8 million in amortization expense, $0.6 million of which is “catch-up” amortization for the period September 16, 2004 through September 30, 2005 recorded in the third quarter related to the completion of the valuation of the assets acquired in the TFY transaction.

Net interest expense. Net interest expense of $1.5 million for the third quarter of 2005 and $1.0 million for the third quarter of 2004 relates primarily to bank term loans and lines of credit. The increase in net interest expense was primarily due to the increase in average outstanding debt balances.

Income tax. Income tax expense for the third quarter of 2005 and 2004 includes provisions for federal, state and foreign income taxes at an effective rate of 37.8% and 36.0%, respectively. During the third quarter of 2005, the Company changed its tax rate to 37.1% based on updated estimates of projected state tax costs.

Nine Months Ended September 30, 2005 Compared to Nine Months Ended September 30, 2004

Net sales. Net sales for the nine months ended September 30, 2005 increased $106.9 million, or 44%, to $347.9 million from $241.0 million for the nine months ended September 30, 2004. This sales increase was primarily attributable to the addition of TFY which is reflected in the significant increase in the infant products category. Net sales also increased in our children’s toys category, but these increases were partially offset by a decrease in our collectible products category.

Net sales in our infant products category increased approximately 458% primarily due to the addition of TFY. Net sales in our children’s toys category increased approximately 28% primarily driven by strong performance of Thomas & Friends and John Deere toy vehicles and our ride-on products, as well as sales of our new Bob the Builder product line. Net sales in our collectible products category decreased approximately 19% primarily due to the continued tough comparisons to both The Fast and The Furious and Orange County/American Chopper product lines in the first nine months of 2004, the discontinuance of the Memory Lane seasonal figures, lower overall NASCAR product sales and the discontinuance of distribution at NASCAR trackside events in 2005.

Actual net sales for the nine months ended September 30, 2005, excluding $2.5 million in net sales of previously discontinued product lines, increased 4% when compared to the nine months ended September 30, 2004 pro forma net sales, excluding $17.4 million in net sales from these same discontinued product lines. The pro forma net sales assume that the Playing Mantis and TFY acquisitions occurred as of January 1, 2004.

Gross profit. Gross profit increased $47.8 million, or 39%, to $171.6 million for the nine months ended September 30, 2005 from $123.8 million for the nine months ended September 30, 2004. The gross profit margin (as a percentage of net sales) decreased to 49.3% in the nine months ended September 30, 2005 compared to 51.4% in the nine months ended September 30, 2004 primarily due to the impact of the TFY acquisition which had historical gross margins lower than RC2’s historical gross margins, a less favorable product mix and higher freight and product costs than that experienced in the first nine months of 2004. There were no major changes in the components of cost of sales.

Selling, general and administrative expenses. Selling, general and administrative expenses increased $26.3 million, or 31%, to $111.9 million for the nine months ended September 30, 2005 from $85.6 million for the nine months ended September 30, 2004. As a percentage of net sales, selling, general and administrative expenses decreased to 32.2% for the nine months ended September 30, 2005 from 35.5% for the nine months ended September 30, 2004. The decrease in selling, general and administrative expenses as a percentage of net sales was primarily due to operating leverage gained from the increased sales from the 2004 acquisitions and disciplined control over discretionary operating expenses.

Operating income. Operating income increased to $60.5 million for the nine months ended September 30, 2005 from $38.1 million for the nine months ended September 30, 2004. As a percentage of net sales, operating income increased to 17.4% of net sales in the nine months ended September 30, 2005 from 15.8% in the nine months ended September 30, 2004. Operating income for the nine months ended September 30, 2005 includes $2.0 million in gain on the sale of assets related to the sale of our W. Britain product line. Operating income also includes $1.1 million in amortization expense, $0.6 million of which is “catch-up” amortization for the period September 16, 2004 through September 30, 2005 recorded in the third quarter related to the completion of the valuation of the assets acquired in the TFY transaction.

Net interest expense. Net interest expense of $4.6 million for the nine months ended September 30, 2005 and $2.5 million for the nine months ended September 30, 2004 relates primarily to bank term loans and lines of credit. The increase in net interest expense was primarily due to the increase in average outstanding debt balances and an increase in the Company’s incremental borrowing rate.

Income tax. Income tax expense for the nine months ended September 30, 2005 and 2004 includes provisions for federal, state and foreign income taxes at an effective rate of 36.4% and 36.0%, respectively. During the third quarter of 2005, the Company changed its tax rate to 37.1% based on updated estimates of projected state tax costs. Additionally during the second quarter of 2005, the Company released approximately $0.7 million, or $0.03 per diluted share, of income tax accruals stemming from the resolution of specific outstanding state and foreign tax issues.

Related Party Transactions

The Company purchased some of its product during the nine months ended September 30, 2005 and 2004 from a company in which a relative of one of the Company’s stockholders/directors has ownership interests. Additionally, in 2005 the Company began purchasing product from a second company in which the same relative of one of the Company’s stockholders/directors has a partial ownership interest.

LIQUIDITY AND CAPITAL RESOURCES

The Company’s operations provided net cash of approximately $20.4 million during the nine months ended September 30, 2005. Inventory increased approximately $33.0 million and accounts receivable increased approximately $20.0 million during the nine months ended September 30, 2005 and were two of the primary uses of cash from operations. Capital expenditures for the nine months ended September 30, 2005 were approximately $9.9 million, of which approximately $8.3 million was for molds and tooling. Payments on the Company’s credit facility were approximately $34.3 million for the nine months ended September 30, 2005. Borrowings on the Company’s credit facility were $20.0 million during the nine months ended September 30, 2005. Cash and cash equivalents remained relatively constant during the nine months ended September 30, 2005.

During the nine months ended September 30, 2005, the Company made total payments of $23.0 million on its line of credit and $11.3 million on its term loan and borrowed $20 million on its line of credit. At September 30, 2005, the Company had $52.2 million available on its line of credit.

The Company has met its working capital needs through funds generated from operations and available borrowings under the credit agreement. The Company’s working capital requirements fluctuate during the year based on the seasonality related to sales. Due to seasonal increases in demand for the Company’s products, working capital financing requirements are usually highest during the third and fourth quarters. The Company expects that capital expenditures during 2005, principally for molds and tooling, will be approximately $15.0 million.

The Company believes that its cash flows from operations, cash on hand and available borrowings will be sufficient to meet its working capital and capital expenditure requirements and provide the Company with adequate liquidity to meet anticipated operating needs for 2005. However, if the Company’s capital requirements vary materially from those currently planned, the Company may require additional debt or equity financing. There can be no assurance that financing, if needed, would be available on terms acceptable to the Company, if at all.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

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

Allowance for Doubtful Accounts. The allowance for doubtful accounts represents adjustments to customer trade accounts receivable for amounts deemed uncollectible. The allowance for doubtful accounts reduces gross trade receivables to their net realizable value. The Company's allowance is based on management's assessment of the business environment, customers' financial condition, historical trends, customer payment practices, receivable aging and customer disputes. The Company has purchased credit insurance that covers a portion of its receivables from major customers. The Company will continue to proactively review its credit risks and adjust its customer terms to reflect the current environment.

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

Impairment of Long-Lived Assets, Goodwill and Other Intangible Assets. Long-lived assets have been reviewed for impairment based on Statement of Financial Accounting Standards (SFAS) No. 144, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of." This statement requires that an impairment loss be recognized whenever the sum of the expected future cash flows (undiscounted and without interest charges) resulting from the use and ultimate disposal of an asset is less than the carrying amount of the asset. Goodwill and other intangible assets have been reviewed for impairment based on Statement No. 142, "Goodwill and Other Intangible Assets." Under SFAS No. 142, goodwill and other intangible assets that have indefinite useful lives are not amortized, but rather are tested at least annually for impairment. The Company's management reviews for indicators that might suggest an impairment loss could exist. Testing for impairment requires estimates of expected cash flows to be generated from the use of the assets. Various uncertainties, including changes in consumer preferences, deterioration in the political environment or changes in general economic conditions, could impact the expected cash flows to be generated by an asset or group of assets. Intangible assets that have finite useful lives will continue to be amortized over their useful lives.

Income Taxes. The Company records current and deferred income tax 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. In determining the required liability, management considers certain tax exposures and all available evidence. However, if the available evidence were to change in the future, an adjustment to the tax-related balances may be required.

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

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

Recently Issued Accounting Pronouncements

In December 2004, the FASB issued SFAS No. 123R, “Share-Based Payment.” This statement is a revision of SFAS No. 123, “Accounting for Stock-Based Compensation” and supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees.” This statement establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services and also addresses transactions in which an entity incurs liabilities in exchange for goods and services that are based on the fair value of the entity’s equity instruments or that may be settled by the issuance of those instruments. This statement applies to all awards granted after the required effective date and to awards modified, repurchased, or cancelled after that date. This statement is effective as of the beginning of the first annual period beginning after June 15, 2005. The Company will adopt this statement for the quarter beginning January 1, 2006. We believe the best indication of the approximate impact on net income of adopting the provisions of this revised Statement may be determined by reviewing the table provided under Note 4 - Accounting for Stock-Based Compensation. We plan to use the prospective method and accordingly will not be restating prior periods upon adoption of SFAS No. 123R.

In December 2004, the FASB issued FASB Staff Position (FSP) 109-2, “Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004.” This FSP was issued to provide accounting and disclosure guidance for the repatriation provision of the American Jobs Creation Act of 2004 (the Act) which was signed into law on October 22, 2004. This FSP was effective upon issuance. Pursuant to the Act, the Company is in the process of evaluating those provisions relating to the repatriation of certain foreign earnings that are repatriated, as defined in the Act. The Company expects to complete its evaluation during the fourth quarter of 2005 and anticipates that any repatriation of funds will occur during the fourth quarter, at which time the Company will incur an additional tax charge. Currently, the range of possible amounts the Company is considering repatriating is between zero and $10.0 million.

FORWARD-LOOKING STATEMENTS

Certain statements contained in this report are considered "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. These statements may be identified by the use of forward-looking words or phrases such as "anticipate," "believe," "could," "expect," "intend," "may," "planned," "potential," "should," "will," "would" or the negative of those terms or other words of similar meaning. Such forward-looking statements are inherently subject to known and unknown risks and uncertainties. The Company's actual results and future developments could differ materially from the results or developments expressed in, or implied by, these forward-looking statements. Factors that may cause actual results to differ materially from those contemplated by such forward-looking statements include, but are not limited to, the following: the Company may not be able to manufacture, source and ship new and continuing products on a timely basis; the Company is dependent upon timely shipping of product and unloading of product through West Coast ports as well as timely rail/truck delivery to the Company's warehouse and/or customers' warehouses; increases in the cost of raw materials used to manufacture the Company’s products and increases in freight costs could increase the Company’s cost of sales and reduce the Company’s gross margins; currency exchange rate fluctuations, particularly in the Chinese Renminbi or the Hong Kong dollar, could increase the Company’s expenses; customers and consumers may not accept the Company's products at prices sufficient for the Company to profitably recover development, manufacturing, marketing, royalty and other costs; the inventory policies of retailers, together with increased reliance by retailers on quick response inventory management techniques, may increase the risk of underproduction of popular items, overproduction of less popular items and failure to achieve tight shipping schedules; competition in the markets for the Company's products may increase significantly; the Company is dependent upon continuing licensing arrangements with vehicle manufacturers, agricultural equipment manufacturers, major race sanctioning bodies, race team owners, drivers, sponsors, agents and other licensors; the Company may experience unanticipated negative results of litigation; the Company relies upon a limited number of independently owned factories located in China to manufacture a significant portion of its vehicle replicas and certain other products; the Company is dependent upon the continuing willingness of leading retailers to purchase and provide shelf space for the Company's products; and general economic conditions in the Company's markets. The Company undertakes no obligation to make any revisions to the forward-looking statements contained in this report or to update them to reflect events or circumstances occurring after the date of this report.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

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

Based on the Company's interest rate exposure on variable rate borrowings at September 30, 2005, a one-percentage-point increase in average interest rates on the Company's borrowings would increase future interest expense by approximately $70,049 per month and a five-percentage point increase would increase future interest expense by approximately $350,245 per month. The Company determined these amounts based on approximately $84.1 million of variable rate borrowings at September 30, 2005, multiplied by 1% and 5%, respectively, and divided by 12. 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.

During July 2005, China revalued the Chinese Renminbi, abandoning the former method of pegging the Chinese Renminbi to the U.S. dollar. As expenses for the Company’s Chinese manufacturers are primarily denominated in Chinese Renminbi, a material increase in the value of the Chinese Renminbi relative to the U.S. dollar would increase the Company’s expenses and therefore could adversely affect the Company’s profitability.

Item 4. Controls and Procedures

As of the end of the period covered by this report, the Company carried out an evaluation, under the supervision and with the participation of the Company's management, including the Company's Chief Executive Officer and Chief Financial Officer, of the Company's disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended). Based on this evaluation, the Company's Chief Executive Officer and Chief Financial Officer concluded that, as of the end of such period, the Company's disclosure controls and procedures were effective in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by the Company in reports that the Company files with or submits to the Securities and Exchange Commission. It should be noted that in designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. The Company has designed its disclosure controls and procedures to reach a level of reasonable assurance of achieving the desired control objectives and based on the evaluation described above, the Company's Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures were effective at reaching that level of reasonable assurance.

There was no change in the Company's internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, as amended) during the Company's most recently completed fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings.

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

(a)

Not applicable.

(b)

Not applicable.

(c)

Not applicable.

Item 3. Defaults Upon Senior Securities.

Not applicable.

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

Not applicable.

Item 5. Other Information.

Not applicable.

Item 6. Exhibits.

3.1

Amended and Restated Certificate of Incorporation of the Company (incorporated by reference to Exhibit 3.1 of the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 2002 (File No. 0-22635) filed by the Company with the Securities and Exchange Commission on May 14, 2002).

3.2

First Amendment to the Amended and Restated Certificate of Incorporation of the Company (incorporated by reference to Exhibit 3.2 of the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 2002 (File No. 0-22635) filed by the Company with the Securities and Exchange Commission on May 14, 2002).

3.3

Certificate of Ownership and Merger changing the Company's name to Racing Champions Ertl Corporation (incorporated by reference to Exhibit 3.3 of the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 2002 (File No. 0-22635) filed by the Company with the Securities and Exchange Commission on May 14, 2002).

3.4

Certificate of Ownership and Merger changing the Company's name to RC2 Corporation (incorporated by reference to Exhibit 3.4 of the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 2003 (File No. 0-22635) filed by the Company with the Securities and Exchange Commission on May 14, 2003).

3.5

Amended and Restated By-Laws of the Company (incorporated by reference to Exhibit 3.5 of the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2004 (File No. 0-22635) filed by the Company with the Securities and Exchange Commission on May 10, 2004).

31.1

Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2

Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1*

Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 (Section 906 of the Sarbanes-Oxley Act of 2002).

_______________________

*This certification is not "filed" for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, or incorporated by reference into any filing under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

Dated this 9th day of November 2005.

RC2 CORPORATION

By /s/ Curtis W. Stoelting

Curtis W. Stoelting,

Chief Executive Officer

By /s/ Jody L. Taylor

Jody L. Taylor,

Chief Financial Officer and Secretary