| RC2 CORP 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 |
| 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 offering |
| 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 |
| 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 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 |
| 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 |
| 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, 2005, net sales of the Company’s products with the licensed properties of Thomas & Friends and John Deere each accounted for more than 10dtta0prca of our net sales |
| Over the next two years, license agreements in connection with several key licensed properties, including licenses for certain Thomas & Friends, Winnie the Pooh, Disney Princess, Finding Nemo 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 |
| 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 |
| 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 infant products, toys and collectibles |
| 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 collectible, toy and infant product industries have limited barriers to entry |
| We experience price competition for our products, competition for shelf space at retailers and competition for licenses, all of which may increase in the future |
| If we cannot compete successfully in the future, our net sales and profitability will likely decline |
| 10 _________________________________________________________________ We may experience difficulties in integrating strategic acquisitions |
| 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 |
| We acquired Learning Curve International, Inc |
| effective February 28, 2003, Playing Mantis, Inc |
| effective June 1, 2004 and The First Years Inc |
| effective September 15, 2004 |
| The integration of acquired companies and their operations into our operations involves a number of risks including: · the acquired business may experience losses which 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 agreements of the acquired company; · possible failure to maintain customer, licensor and other relationships after the closing of the transaction of the acquired company; · 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; 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 |
| This debt leverage could adversely affect our profit margins and limit our ability to capitalize on future business opportunities |
| A portion of this debt 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 2005, we sold 62dtta3prca of our products 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, 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 |
| 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 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 only maintain credit insurance for some of our major customers and the amount of this insurance generally does not cover the total amount of the accounts receivable |
| At December 31, 2004 and 2005, our credit insurance covered approximately 8dtta4prca and 7dtta2prca, respectively, of our gross accounts receivable |
| Insurance coverage for future sales is subject to reduction or cancellation |
| We rely on a limited number of foreign suppliers in China to manufacture a majority of our products |
| We rely on seven third-party, dedicated suppliers in China to manufacture a majority of our products in eight factories, three of which are located in close proximity to each other in the RC2 Industrial Zone manufacturing complex in China |
| Our China-based product sourcing accounted for approximately 91dtta6prca of our product purchases in 2005 |
| The seven third-party, dedicated suppliers who manufacture only our products accounted for approximately 48dtta4prca of our China-based product purchases in 2005 |
| We enter into purchase orders with our foreign suppliers and generally do not enter into long-term contracts |
| Because we rely on these suppliers for flexible production and have integrated these suppliers with our development and engineering teams, if these suppliers do not continue to manufacture our products exclusively, our product sourcing would be adversely affected |
| Difficulties encountered by these suppliers such as fire, accident, natural disaster or an outbreak of a contagious disease at one or more of their facilities, could halt or disrupt production at the affected facilities, delay the completion of orders, cause the cancellation of orders, delay the introduction of new products or cause us to miss a selling season applicable to some of our products |
| 11 _________________________________________________________________ Increases in the cost of the raw materials used to manufacture our products could increase our cost of sales and reduce our gross margins |
| Since our products are manufactured by third-party suppliers, we do not directly purchase the raw materials used to manufacture our products |
| However, the prices we pay our suppliers may increase if their raw materials, labor or other costs increase |
| We may not be able to pass along such price increases to our customers |
| As a result, increases in the cost of raw materials, labor or other costs associated with the manufacturing of our products could increase our cost of sales and reduce our gross margins |
| Currency exchange rate fluctuations could increase our expenses |
| Our net sales are primarily denominated in US dollars, with approximately 14dtta1prca of our net sales in 2005 denominated in British pounds sterling, Australian dollars, Euros or Canadian dollars |
| Our purchases of finished goods from Chinese manufacturers are denominated in Hong Kong dollars |
| Expenses for these manufacturers are denominated in Chinese Renminbi |
| As a result, any material increase in the value of the Hong Kong dollar or the Renminbi relative to the US dollar or the British pounds sterling would increase our expenses and therefore could adversely affect our profitability |
| We are also subject to exchange rate risk relating to transfers of funds denominated in British pounds sterling, Australian dollars, Canadian dollars or Euros from our foreign subsidiaries to the United States |
| Historically, we have not hedged our foreign currency risk |
| Because we rely on foreign suppliers and we sell products in foreign markets, we are susceptible to numerous international business risks that could increase our costs or disrupt the supply of our products |
| Our international operations subject us to risks including: · economic and political instability; · restrictive actions by foreign governments; · greater difficulty enforcing intellectual property rights and weaker laws protecting intellectual property rights; · changes in import duties or import or export restrictions; · timely shipping of product and unloading of product through West Coast ports, as well as timely rail/truck delivery to the Company’s 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 |
| The costs 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 |
| Product liability, product recalls and other claims relating to the use of our products could increase our costs |
| Because we sell infant products, toys and collectibles to consumers, 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 |
| If we fail to comply with these regulations 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 |
| In addition, substantially all of our licenses give the licensor the right to terminate 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 could 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 |
| 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 |
| 12 _________________________________________________________________ Our debt covenants may limit our ability to complete acquisitions, incur debt, make investments, sell assets, merge or complete other significant transactions |
| Our credit agreement includes 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 certain investments or loans; · pay dividends; or · dispose of or sell assets or enter into a merger or similar transaction |
| 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 in the second and third quarters and may tend to depress our stock price during the first and second quarters |
| 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; · fluctuation in our quarterly operating results; · substantial sales of our common stock; · general stock market conditions; or · other economic or external factors |
| You may be unable to sell your stock at or above your 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 |
| A securities class action lawsuit was filed against us in 2000 following a decline in the trading price of our common stock from dlra17dtta00 per share on June 21, 1999 to dlra6dtta50 per share on June 28, 1999 |
| We settled this lawsuit in 2002 with a dlra1dtta8 million payment, covered by insurance, after incurring legal costs of dlra1dtta0 million that were not covered by insurance |
| Future volatility in the price of our common stock may result in additional 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 which 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 1/3prca or more of our outstanding common stock; and · the Delaware anti-takeover statute contained in Section 203 of the Delaware General Corporation Law |
| 13 _________________________________________________________________ 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 15prca or more of our voting stock for a period of three years after the stockholder acquires 15prca or more of our voting stock, unless (1) the transaction is approved by our board of directors before the stockholder acquires 15prca or more of our voting stock, (2) upon completing the transaction the stockholder owns at least 85prca 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 2/3prca of our voting stock excluding shares of our voting stock owned by the stockholder |