RC2 2007 Annual Report and Form 10-K

Delaware		36-4088307
(State or Other Jurisdiction of Incorporation or Organization)		(IRS Employer Identification No.)

1111 West 22nd Street, Suite 320, Oak Brook, Illinois		60523
(Address of principal executive offices)		(Zip Code)

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

Securities registered pursuant to Section 12(b) of the Exchange Act:

Title of each class		Name of each exchange on which registered
Common Stock, Par Value $0.01 Per Share		The NASDAQ Stock Market

Securities registered pursuant to Section 12(g) of the Exchange Act: None

Aggregate market value of the Registrant’s common stock held by non-affiliates as of June 29, 2007 (the last business day of the Registrant’s most recently completed second quarter): $824,795,547. Shares of common stock held by any executive officer or director of the Registrant have been excluded from this computation because such persons may be deemed to be affiliates. This determination of affiliate status is not a conclusive determination for other purposes.

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," "hope," "plan," "potential," "should," "estimate," "predict," "continue," "future," "will," "would" or the negative of these terms or other words of similar meaning. Such forward-looking statements are inherently subject to known and unknown risks and uncertainties. Our actual results and future developments could differ materially from the results or developments expressed in, or implied by, these forward-looking statements. Factors that may cause actual results to differ materially from those contemplated by such forward-looking statements include, but are not limited to, those described under the caption "Risk Factors" in Item 1A of this report. We undertake no obligation to make any revisions to the forward-looking statements contained in this filing or to update them to reflect events or circumstances occurring after the date of this filing.

We are a leading designer, producer and marketer of innovative, high-quality toys, collectibles and infant and toddler products. 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 thePooh, 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.

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 4 to our consolidated financial statements included elsewhere herein.

Our infant and toddler products category includes a wide range of products related to infant and toddler feeding, care, safety and play which are marketed under such brands as The First Years by Learning Curve and Lamaze. Some of the key product lines in this category include the Soothie™ bottle infant feeding system, the Take & Toss® toddler self-feeding system, the Lamaze infant development products and the American Red Cross health and wellness products. In 2007, we introduced a new look for Lamaze, which features new colors and patterns. We also introduced a full line of infant developmental play products featuring Winnie the Pooh licensed characters under The First Years by Learning Curve brand. Additionally, in 2007, we acquired the Compass Business, a privately-held, start-up developer and marketer of infant and toddler travel gear, including infant car and booster seats. In 2008, we plan to introduce the Magna Light Travel System™, a super light weight stroller with an innovative infant seat, as well as a convertible car seat with a removable headrest and a new booster seat that will be taller and deeper than our current booster seat. Additionally, in 2008, we plan to introduce a range of new products within our American Red Cross health and wellness product line, as well as in our Lamaze and Winnie the Pooh infant developmental play product lines.

Our preschool products category includes such brands as Play Town™ by Learning Curve and Take Along™ by Learning Curve and features products with such licensed properties as Thomas & Friends, Bob the Builder, John Deere and Nickelodeon. In 2007, we introduced the Play Town by Learning Curve product line which offers characters, vehicles, buildings and playsets for open ended, classic and creative play for toddlers and preschoolers, and we expanded our Take Along by Learning Curve product line to include popular Nickelodeon television characters such as Dora the Explorer, Go Diego Go!, The Backyardigans, Blues Clues and SpongeBob SquarePants. In 2008, we plan to introduce Caring Corners™, a product line featuring an interactive dollhouse and a full line of dolls and accessories, which will reward positive behaviors like caring, sharing and preparing for responsibility, both during play and real life. We also plan to add the licensed characters from Sesame Street into our Take Along by Learning Curve product line, as well as introduce a proprietary line of products that enhance the Take Along world.

The youth and adult product category includes such brands as Johnny Lightning and Ertl. In 2007, we introduced the radio-controlled combat Battle Wheels™ product line and the radio-controlled transforming robot and vehicle V-Bot™ product line, both of which are marketed under the Johnny Lightning brand name. In 2008, we plan to introduce the Double Duty™ product line which features the licensed John Deere property and includes transforming vehicles and accessories. We also plan to introduce new products within our John Deere toy and collectible product lines marketed under the Ertl brand.

In addition to our business in North America, in 2007 we operated in more than 50 other countries, selling a representative range of the infant and toddler, preschool and youth and adult product lines. The geographic regions in the International segment include Europe, Australia, Asia Pacific, South and Latin America. Key international brands for 2007 include Thomas & Friends Wooden Railway, Take Along Thomas, Bob the Builder, The First Years by Learning Curve and Lamaze.

We market a significant portion of our products with licenses from other parties. A significant element of our strategy depends on our ability to identify and obtain licenses for recognizable and respected brands and properties. Our licenses reinforce our brands and establish our products’ authenticity, credibility and quality with consumers, and in some cases, provide for new product development opportunities and expanded distribution channels. Our licenses are limited in scope and duration and authorize the sale of specific licensed products, generally on a nonexclusive basis.

We have entered into agreements to license such properties from, among others, Disney Consumer Products, Inc. (including Disney characters such as Winnie the Pooh), HIT Entertainment (relating to its Thomas & Friends and Bob the Builder properties), MTV Networks relating to its Nickelodeon properties (including Dora the Explorer, Go Diego Go!, The Backyardigans, Blues Clues and SpongeBob SquarePants), Sesame Workshop (relating to its Sesame Street properties), Lamaze International, Inc., and John Deere Shared Services, Inc.

We are a party to over 400 license agreements with terms generally of two to three years. Any termination of or failure to renew our significant licenses, or inability to develop and enter into new licenses, could limit our ability to market our products or develop new products and reduce our net sales and profitability. For the year ended December 31, 2007, 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, 2007. Over the next two years, license agreements in connection with several of our key licensed properties, including licenses for certain Nickelodeon and Bob the Builder 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.

As of December 31, 2007, approximately 42.0% of our licenses require us to make minimum guaranteed royalty payments, whether or not we meet specific sales targets. Aggregate future minimum guaranteed royalty payments as of December 31, 2007, are $36.2 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, 2007, was $26.2 million.

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 higher-priced products are typically sold in hobby, collector and independent toy stores, and through wholesalers and original equipment manufacturers (OEMs). We believe we have a leading position in multiple distribution channels and that this position extends the reach of our products to consumers and mitigates the risk of concentration by channel or customer.

Chain retailers. Our products marketed through this channel are targeted predominately at 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 include a wide range of retailers, such as book, farm and ranch, craft/hobby and juvenile products stores, as well as the national toy and discount retailers. Key customers in our chain retailer channel include Wal-Mart, Target, Toys "R" Us/Babies "R" Us, Tractor Supply Company and Kmart. Sales in 2007 to chain retailers were 68.3% of our net sales.

Specialty retailers, wholesalers and OEM dealers. We sell many of the products available at chain dealers retailers, as well as higher-priced products with special features, to specialty retailers, wholesalers and OEM dealers, which comprised 28.6% of our net sales in 2007. 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, our 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, Buy Buy Baby, Inc., John Deere and Case New Holland.

Corporate promotional and direct to consumers. We make certain products available to corporate promotional accounts and to consumers through a company store and our website located at 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 3.1% of our net sales in 2007.

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.

Our sales organization consists of an internal sales force and external sales representative organizations. Our internal sales force provides direct customer contact with nearly all of our chain retail and 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 specialty, regional and national retailers and supported 29.5% of our net sales in 2007. External sales representatives generally earn commissions of 1.0% to 10.0% 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.

We support our product lines with various advertising and marketing promotions. Advertising takes place at varying levels throughout the year and peaks during the traditional holiday season. Advertising includes television commercials and print advertisements in magazines and other publications. Marketing includes, but is not limited to, digital media, including our websites www.learningcurve.com, www.johnnylightning.com and www.ertl.com, in-store displays, merchandising material and public relations. We also work closely with retail chains to plan and execute ongoing retailer-driven promotions and advertising. These programs usually involve promotion of our products in retail customers’ print circulars, mailings and catalogs, and sometimes include placing our products in high-traffic locations within retail stores.

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 toys, collectibles and infant and toddler products. Competition in the distribution of our products is intense, and the principal methods of competition consist of product appeal, ability to capture shelf or rack space, timely distribution, price and quality. Competition is also based on the ability to obtain license agreements for existing and new products to be sold through specific distribution channels or retail outlets. We believe that our competitive strengths include our knowledge of the markets we serve, our ability to bring products to market rapidly and efficiently, our dedicated and integrated suppliers, our multiple channels of distribution, our well-known brands supported by respected licenses, our diversified product categories, and our established and loyal consumer base. Many of our competitors have longer operating histories, greater brand recognition, and greater financial, technical, marketing and other resources than we have.

Far east product sourcing. We have operations in Kowloon, Hong Kong and in the RC2 Industrial Zone in Dongguan City, China, and employ 290 people in Hong Kong and China who oversee the sourcing of the majority of our products. This group assists our suppliers in sourcing raw materials and packaging, performs engineering and graphic art functions, executes the production schedule, provides on-site quality control, facilitates third-party safety testing and coordinates the delivery of shipments for export from China.

Far east production. All of our products are manufactured in China, except for certain plastic ride-ons and certain infant and toddler products. Our China-based product sourcing accounted for 88.2% of our product purchases in 2007. We primarily use six third-party, dedicated suppliers who manufacture only our products in six factories, three of which are located in the RC2 Industrial Zone. The RC2 Industrial Zone is the name of a factory complex developed in 1997 and located in Dongguan City, China, (approximately 50 miles from Hong Kong) where three of our third-party, dedicated suppliers operate freestanding factory facilities. Most of our third-party, dedicated suppliers have been supplying us for more than ten years. Third-party, dedicated suppliers produced 40.3% of our China-based product purchases in 2007. In order to supplement our third-party, dedicated suppliers, we use several other suppliers in China. All products are manufactured to our specifications using molds and tooling that we own. These suppliers own the manufacturing equipment and machinery, purchase raw materials, hire workers and plan production. We purchase fully assembled and packaged finished goods in master cartons for distribution to our customers. We enter into purchase orders with our foreign suppliers and generally do not enter into long-term contracts.

Domestic production. The production of certain plastic ride-ons and certain infant and toddler products is completed primarily by U.S.-based suppliers. We create the product design and specifications and coordinate the manufacturing activities. We generally prefer to coordinate the production of these products through a limited number of suppliers and believe that a number of alternate suppliers are available.

Tooling. To create new products, we continuously invest in new tooling. Tooling represents the majority of our capital expenditures. Depending on the size and complexity of the product, the cost of tooling a product generally ranges from $3,000 to $250,000. We own all of our tools and provide them to our suppliers during production. Tools are returned to us when a product is no longer in production and are stored for future use.

Product safety. Our products are designed, manufactured, packaged and labeled to conform with all safety requirements under U.S. federal and other applicable laws and regulations, industry developed voluntary standards and product specific standards. Additionally, following the June 2007 recall of certain Thomas & Friends Wooden Railway products, we established additional safeguards through our Multi-Check Safety System which includes:

We have experienced, and expect to continue to experience, substantial fluctuations in our quarterly net sales and operating results, which is typical of many companies in our industry. Our business is highly seasonal due to high consumer demand for our products during the year-end holiday season. Approximately 59.2% of our net sales for the three years ended December 31, 2007, were generated in the second half of the year, with August, September, October and November being the largest shipping months. As a result, consistent with industry practice, our working capital, mainly inventory and accounts receivable, is typically highest during the third and fourth quarters and lowest during the first and second quarters.

We derive a significant portion of our sales from some of the world’s largest retailers. Our top three customers, Wal-Mart, Target and Toys "R" Us/Babies "R" Us, combined accounted for 42.6% of our net sales in 2007. Other than Wal-Mart, Target and Toy "R" Us/Babies "R" Us, no customer accounted for more than 10.0% of our net sales in 2007. Many of our retail customers generally purchase large quantities of our product on credit, which may cause a concentration of accounts receivable among some of our largest customers.

As of December 31, 2007, we had 832 employees, 43 of whom were employed part-time. We emphasize the recruiting and training of high-quality personnel, and to the extent possible, promote people from within RC2. A collective bargaining agreement covers 103 of our employees, all of whom work in the distribution facility in Dyersville, Iowa. We consider our employee relations to be good. Our continued success will depend, in part, on our ability to attract, train and retain qualified personnel at all of our locations.

We maintain our corporate website at www.rc2.com and we make available, free of charge, through this website our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports that we file with or furnish to the Securities and Exchange Commission (the Commission), as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Commission. Information on our website is not part of this report. This report includes all material information about the Company that is included on the Company’s website and is otherwise required to be included in this report.

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.

In June and September 2007, we announced the voluntary recall of certain Thomas & Friends Wooden Railway items. In December 2007, we announced the voluntary recall of certain products under our The First Years brand. Following the announcement of the June recall, a number of putative class action lawsuits were filed against us with respect to the products subject to the June and September recalls. In January 2008, we reached a settlement in Barrett v. RC2 Corporation with the plaintiffs in the various class action lawsuits filed in state courts. The proposed settlement, if approved, would resolve the class claims made by the members of the class in Barrett, namely persons in the United States who do not opt out of the class and who purchased or owned for purposes other than resale our Thomas & Friends Wooden Railway products which were recalled in June 2007 and September 2007. We recorded charges of $17.6 million, net of tax, or $0.84 per diluted share, for the year ended December 31, 2007, related to these recalls, based on the latest estimates of retailer inventory returns, consumer product replacement costs and shipping costs as of the date of this filing, as well as the additional replacement costs or refunds, donations, notice charges, claims administration and legal fees related to the settlement of the class action lawsuits. Since these charges are based on estimates, additional charges may be incurred based on a number of factors, many of which are outside of the Company’s control, including the amount of inventory of affected products at retailers, the amount of affected products that may be returned by customers, the cost of providing replacement products to consumers and retailers, and the final resolution of the lawsuits. Any increase in the costs relating to the recalls would further reduce our profitability and could reduce our net sales.

The 2007 recalls may harm our reputation and consumer acceptance of the affected products or our other products, which may have an adverse effect on our net sales. The recalls may also harm our relationships with our retail customers, including the willingness of those customers to purchase and provide shelf space for our products and to support retailer driven promotions and advertising for our products.

The June and September recalls may harm our relationship with the licensor (the Licensor) who has granted the licenses under which we market the property affected by those recalls (the Licenses). The Licenses give the Licensor the right to terminate, under certain circumstances, if we do not comply with a covenant relating to compliance with government and industry standards or under certain other conditions and to indemnification for certain damages arising out of our sales of products covered by the Licenses. The Licensor has sent a letter demanding that we indemnify it for certain costs in connection with the recalls and alleging that we have not complied with several provisions in the Licenses. We have responded to the Licensor's letter and are attempting to resolve these matters. Any termination of the Licenses, any adverse effect of the June and September recalls on our relationship with the Licensor and the terms of the Licenses or our other licenses with the Licensor, or any increase in the costs of the recalls for any indemnification or other payments to the Licensor, would likely have a material adverse effect on our business and prospects and would likely materially reduce our net sales and profitability.

At December 31, 2007, we have intangible assets not subject to amortization of $33.1 million relating to the Licenses. These intangible assets are not subject to amortization because they have indefinite useful lives. As of the date of this report, we have determined that there is no impairment of these intangible assets or charge to the indefinite useful lives. However, we will continue to monitor these intangible assets for impairment or a change in the indefinite useful lives in light of the status of the recalls and related events, including the class action litigation. Termination of the Licenses would result in an impairment and a write-off of the full value of these intangible assets. Any impairment or change in the useful lives of the intangible assets would increase our expenses and reduce our profitability.

Other product recalls or 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, under certain circumstances, if any products marketed under the license are subject to a product liability claim, recall or similar violations of product safety regulations, or if we breach covenants relating to the safety of the products or their compliance with product safety regulations. A termination of a license 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.

The introduction of new products is critical in our industry and to our growth strategy. Our business depends on our ability to continue to conceive, design and market new products and upon continuing market acceptance of our product offerings. Rapidly changing consumer preferences and trends make it difficult to predict how long consumer demand for our existing products will continue or what new products will be successful. Our current products may not continue to be popular or new products that we introduce may not achieve adequate consumer acceptance for us to recover development, manufacturing, marketing and other costs. A decline in consumer demand for our products, our failure to develop new products on a timely basis in anticipation of changing consumer preferences or the failure of our new products to achieve and sustain consumer acceptance could reduce our net sales and profitability.

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, 2007, 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 the Company’s total net sales. Over the next two years, license agreements in connection with several key licensed properties, including licenses for certain Nickelodeon and Bob the Builder 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.

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, increase 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. For example, increase in the price of zinc, a key component in die-cast products, and increased costs in China, primarily for labor, reduced our gross margins in 2006 and 2007 and may continue to reduce our gross margins in 2008.

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 toys, collectibles and infant and toddler products. Many of our competitors have longer operating histories, greater brand recognition, and greater financial, technical, marketing and other resources than we have. In addition, we may face competition from new participants in our markets because the 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.

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. (Learning Curve) and certain of its affiliates (collectively, LCI) effective February 28, 2003, Playing Mantis, Inc. (PM) effective June 1, 2004, The First Years Inc. (TFY) effective September 15, 2004, Angels Landing, Inc. (Angels Landing) effective May 24, 2007, and Mother’s Intuition Inc. (MI) effective November 30, 2007. The integration of acquired companies and their operations into our operations involves a number of risks, including:

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. All of our borrowing capacity is also subject to fluctuations in interest rates.

In 2007, approximately 68.3% of our net sales were to chain retailers. Our success depends upon the continuing willingness of these retailers to purchase and provide shelf space for our products. We do not have long-term contracts with our customers. In addition, our access to shelf space at retailers may be reduced by store closings, 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.

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 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, 2006 and 2007, our credit insurance covered 6.3% and 7.9%, respectively, of our gross accounts receivable. Insurance coverage for future sales is subject to reduction or cancellation.

We rely on six third-party, dedicated suppliers in China to manufacture a significant portion of our products in six 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 88.2% of our product purchases in 2007. Third-party, dedicated suppliers who manufacture only our products accounted for 40.3% of our China-based product purchases in 2007. 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. Any of these risks could increase our expenses or reduce our net sales.

Our net sales are primarily denominated in U.S. dollars, with 19.4% of our net sales in 2007 denominated in British pounds sterling, Australian dollars, Euros or Canadian dollars. Our purchases of finished goods from Chinese manufacturers are primarily denominated in Hong Kong dollars. Expenses for these manufacturers are primarily denominated in Chinese Renminbi. As a result, any material increase in the value of the Hong Kong dollar or the Renminbi relative to the U.S. dollar 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.

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.

Our existing credit facility matures on September 14, 2008, and we currently anticipate that we will refinance during the second quarter of 2008. We may not be able to refinance on acceptable terms given the current conditions of credit markets in the United States. The terms of any refinancing may be less advantageous to us than our existing credit facility, including with respect to the amount of credit available, interest rates and the terms of restrictive debt covenants. A refinancing on less advantageous terms may adversely affect our business and may reduce our profitability.