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RC2 Corporation, Inc. (NASDAQ:RCRC)

Q4 2008 Earnings Call

February 18, 2009, 4:45 pm ET

Executives

Curtis Stoelting – Chief Executive Officer

Peter Nicholson – Chief Financial Officer

Peter Henseler - President

Analysts

Sean McGowan – Needham & Company

Linda Weiser – Caris & Company

Todd Schwartzman – Sidoti & Company

Timothy Condor – Wells Fargo

Gerrick Johnson – BMO Capital Markets

Anthony Gikas – Piper Jaffray

Operator

Welcome to the RC2 fourth quarter 2008 earnings release conference call. (Operator Instructions) At this time for opening remarks and introductions, I would like to turn the call over to Mr. Curt Stoelting.

Curtis Stoelting

Good afternoon and welcome to our 2008 fourth quarter conference call. As usual, I'm joined by Pete Henseler our President and joining me for the first time on the earnings call is Pete Nicholson, our Chief Financial Officer. On the call today, I will provide some overall comments followed by Pete Nicholson who will recap our fourth quarter and year end financial results. Pete Henseler will be available during the Q&A session that will follow the financial recap.

Before we get started, let me remind everyone that any forward-looking statements made on this call are subject to many uncertainties and the company's operation and business environment. I refer you all to our complete forward-looking disclosure in our fourth quarter release which is incorporated by references for purposes of this call. I also refer you to disclosures made in the company's quarterly and annual filings with the SEC.

A quick recap from my perspective, fourth quarter sales and profits were certainly negatively impacted by declines in holiday spending, conservative retail ordering throughout the quarter especially in the U.S. and U.K. and unfavorable foreign currency exchanges.

Our international sales increased by approximately 3% in local currencies but when stated in U.S. dollars declined by 15%. Foreign exchange had a 5% negative impact on Q4 consolidated net sales.

Looking at our sales by category, we're happy to report that comparable sales in our Mom, Infant and Toddler category increased by 3% in the quarter and was quite an accomplishment given the economic climate. Based on IRI data, we are performing better than the overall juvenile products industry which reported a U.S. industry wide sales decline for both the fourth quarter and the full year in 2008. In 2009, we expect that our Mom, Infant and Toddler category will continue to perform well, especially when compared to other consumer product categories.

Comparable sales in our Pre-School, Youth and Adults category declined by 15% in Q4. Softness across all product lines is reflective of the decline in overall holiday spending and conservative retail ordering during the holiday season. Two of our key play brands, Thomas Wooden Railway and John Deere replica toys performed well with shipments down only slightly from prior year comparison. Both of these brands exceeded our plans for retail sell through.

Also performing well was our newly launched Learning Curve Caring Corners interactive doll house line. Holiday retail sale through met or exceeded our plans in many of our play product lines and post holiday retail inventories are clean and unfortunately lower than we'd like.

In summary, our MIT business grew in the fourth quarter despite negative industry sales trends and the overall retail sales environment. Sale through data for our key play product lines indicates that although consumers spent less than normal on toys this holiday season, we earned our fair share at retail.

As expected, comparable gross profits were down in Q4. Pete Nicholson will provide additional detail later on the call. As we look to 2009 we expect higher product costs and unfavorable foreign exchange rates will continue to pressure margins, especially in the first half of 2009. We expect that product cost and currency trends will improve in the second half of 2009.

During the fourth quarter we implemented a company operating cost reduction plan which included head count reductions and tight controls on outside spending. This plan is expected to reduce our operating costs by over $10 million in 2009. Our number one focus is to maximize sales which is no easy task in today's environment while reducing our operating costs and preserving cash.

During Q4, we completed a very favorable refinancing of our senior credit facility which gives us the capital we need over the next three years to operate and organically grow our business. We aggressively paid down debt in Q4 and our net debt to adjusted EBITDA at year end is at one times leverage.

Consistent with our strategic plan, we continue to invest in innovative new products that make parenting easier and more fun for the entire family. Even with difficult economic conditions that we're expecting throughout 2009, we remain excited about launching our new Super WHY! product line, expanding our Caring Corners product line and extending our highly successful American Red Cross, Lamaze, John Deere and First Years product lines.

Looking a little further forward in 2010, we anticipate improved economic conditions and we have exciting new product launches planed for Chunginton, Thomas & Friends Wooden Railway and Dinosaur Train which will be based on a new PBS kids pre-school television show scheduled to begin broadcasting in September of this year.

We look forward with a realistic yet optimistic view of the future. We now that the climate will be difficult throughout 2009 and we're planning for that. But we also believe that our strategic focus, our cost reduction plans, our low debt levels and experienced management team will allow RC2 to navigate these tough times while building toward sustainable growth in the future.

I want to personally thank all of our dedicated team members around the world who are working every day to improve our results and create new opportunities for RC2. With that, I'm going to turn it over to Pete Nicholson for the financial recap.

Peter Nicholson

Good afternoon. I recognize there are a number of GAAP to non-GAAP reconciling items in the earnings release, but for the most part these are consistent with the press release of January 15, 2009 which discussed preliminary results and the existence of these items. With that said, I will briefly walk through the impact of these items on the GAAP to non-GAAP reconciliation which is highlighted in the supplemental schedules to the earnings release.

Also, I will briefly review some of the discussion around certain statement of operations variances in the non-GAAP results both on a quarter and full year comparison. Finally, I will review some of the key balance sheet variances.

I will start with the Q4 2008 non cash impairment and write down charges in the reconciliation. Primarily driven by the decline in the company's market capitalization during the quarter, a pre-tax non cash impairment charge of $255.9 million was recorded in the quarter related to good will and certain intangible assets.

This was within the previously announced range and is separately identified on the face of the GAAP statement of operations. The charge results in a 100% reduction to good will with approximately $11.9 million of the pre-tax charge relating to certain other intangible assets.

It should be noted that the income tax benefit on this charge was less than the amount computed at the company's overall effective tax rate as the majority of the good will impairment related to non tax deductible good will.

Next, less significantly and as previously disclosed, including cost of sales, the company recorded a non cash write off of certain tooling assets on a pre-tax basis of $2.7 million. Finally, included in the quarter as previously disclosed, were severance and other related pre-tax charges of $2.2 million of which $.2 million impacted cost of sales with the rest impacting SG&A.

These charges result from the work force reduction which was implemented during Q4 of 2008 as part of the company's operational cost reduction plan. We do not currently anticipate material additional severance charges in 2009.

After considering those charges, gross margin for Q4 2008 decreased by approximately 5% primarily as a result of less favorable product mix, higher product cost and unfavorable foreign exchange rate fluctuations which more than offset cost improvement initiatives and price increases.

The unfavorable foreign exchange rate impacting our gross margin relates to our international subsidiaries which effective purchase products in U.S. dollars and sell these products to customers in various local currencies which are predominantly Australian dollar, Pound Sterling, Euro dollar and Canadian dollar. The weakening of those currencies to the U.S. dollar impacts the gross margins of our international subsidiaries as well as the translation of the results into U.S. dollars.

Interest expense for the fourth quarter 2008 was higher principally due to higher average borrowing in the quarter as well as a higher effective interest rate partially caused by an increase in amortization of debt costs.

Finally for the fourth quarter of 2008, other income was higher primarily as a result of favorable currency fluctuations impacting transaction gain recognition within our international subsidiaries which transact in multi-currencies. This affect acts as somewhat of a natural hedge to the above the line results and is only material when there are material swings in foreign currency rates in a period.

And example of this is the approximate 18% currency fluctuation change in December 2008 of the Euro to the Pound.

Before I discuss effective tax rate, I wanted to briefly touch upon the 2008 full year results. SG&A expense as a percentage of net sales increased by 2.7% primarily to reduced leverage due to lower sales volume. Most of these costs are not directly variable to sales. We anticipate that our cost reduction initiatives, including the Q4 2008 work force reduction will improve the company's SG&A expense leverage.

The interest expense increase in 2008 is principally related to the higher leverage modeling in 2008 over 2007.

Finally, the effective tax rate for the fourth quarter 2008 was a by-product of a true up to a lower annualized 2008 effective tax rate than was previously estimated at September 30, 2008. The effective tax rate comparison on the full year non-GAAP statement of operations of 37.2% in 2007 versus 30.7% in 2008 was principally impacted mostly by an improved mix to more favorable tax rate jurisdictions.

Additionally, this effective tax rate comparison was impacted by a favorable shift in discrete tax items.

Looking ahead to 2009, we anticipate our mix of income between tax jurisdictions to be more consistent with the mix that occurred in 2007 than in 2008. As a result, we would anticipate a higher effective tax rate in 2009 more in the range of 35% to 36%. As such, when you apply the expected 2009 effective tax rate to the non recurring 2008 diluted earnings per share, the forward-looking base line for 2009 diluted earnings per share would be more appropriately compared to $1.35 per share.

Transitioning to the balance sheet, cash on hand was lower at December 31, 2008 versus prior year as the company focused on reduction of debt. As noted in the earnings release, debt was reduced by approximately $43 million during Q4 2008. As a result our December 31, 2008 outstanding debt was approximately $95 million.

When compared to the full year 2008 EBITDA of $62 million as outlined in the supplemental information in the earnings release, the company gross debt leverage ratio at December 31, 2008 is approximately one point five times. Because we have improved our leverage ratio, our borrowing rate will adjust down to LIBOR plus 2.75% during Q1 2009, an improvement of 25 basis points.

Additionally, on March 2, 2009 we anticipate we will have successfully met our annual clean down requirement under the credit facility, and we'll have $50 million of availability under our revolving credit agreement.

Looking at other key balance sheet items, accounts receivables was lower due to lower Q4 sales volumes as well as some impact of currency translation. Our consolidated day sales outstanding is approximately 73 days consistent with prior year.

Inventory terms were 2.2 times for 2008 versus prior years 2.6 times mostly due to higher inventory in the international business unit.

Finally, I just want to point out included in the supplemental schedules is a calculation of adjusted EBITDA which references depreciation, amortization and stock compensation for the 2008 fourth quarter and full year. Note that included in the depreciation amount of $5.9 million for the 2008 fourth quarter is the pre-tax non cash tooling write down of $2.7 million.

Our CapEx for the quarter was approximately $2.7 million bringing the total to $9.4 million for the year which is approximately $2 million less than 2007. Our capital expenditure plan for the full year 2009 looks to be approximately $11 million with depreciation estimated for 2009 at approximately $12 million. Amortization for 2009 is expected to be approximately $0.6 million.

Compensation expense related to equity awards is currently estimated to be approximately $5 million for 2009.

That concludes the financial information review. I'd like to turn the call back over to Curt.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Sean McGowan – Needham & Company.

Sean McGowan – Needham & Company

Could you comment on retail sale through of some of the key brands, John Deere and Thomas in the fourth quarter as well as what you're seeing so far this year?

Curtis Stoelting

Sean you obviously know we can't get into specific product lines or brands in terms of specific data but I'll let Pete give an overview in general of how he's tracked POS both in the quarter and as we started '09 here.

Peter Nicholson

The POS as Curt said in his comments, and we get our fair share, and fourth quarter was lumpy. It really picked up Thanksgiving and it was almost consistent with previous years once it got into the store. What's been good is we're seeing the POS remain pretty strong in the first six weeks of this year. It's still; it's somewhat flying in the face of the economic news out there.

The consumer hasn't quite quit. They'll be a little more discerning but you would think the POS would be not as good, so we've been pleased with what we're seeing and even some of the higher priced goods, we've actually have very nice sale through here in the first six weeks of the year.

Sean McGowan – Needham & Company

This credit facility, if you achieve that clean down, does that you a toe in the market for a possible acquisition or is that really left to what we should look forward to this year?

Curtis Stoelting

We're always working on the next acquisition, but we're not going to get locked into any timing on that. Right now we know that it's all about preserving cash and capital and that's what we're focused on so we're working hard to generate every incremental sales dollar we can. Like I said before, it's tough in this environment where the retailers are being very conservative, especially in the U.S.

But we're going to scratch and claw for every sales opportunity we can and we're going to likewise work really hard to hit our targets for operating cost savings and we're well on our way to doing that and even hopefully even a little bit more.

Sean McGowan – Needham & Company

Do you think the bank will kind of let you play a little bit if you come to a great idea?

Curtis Stoelting

I think there's always opportunities to get things done. I think in this environment with the way the capital markets are it's going to take a creative approach but we're going to keep looking for the right opportunity and the timing will take care of itself.

Operator

Your next question comes from Linda Weiser – Caris & Company.

Linda Weiser – Caris & Company

Your inventory was actually down on a dollar basis. How was it that the inventory was actually down year over year whereas your sales performance was so weak?

Curtis Stoelting

We planned, we were planning for a home run holiday and we certainly didn't get that so there was a couple of factors there. We probably ended up with a little more inventory than we would have liked to, especially in our international division mostly because they were, if you go back and look at the numbers, they were running sales comp gains in both local currencies right around 10% for most of the year, and they saw a significant slow down in the fourth quarter, especially in the U.K. and a little bit in Australia and Canada as well.

There is some translation impact. Obviously the inventories were holding in foreign subsidiaries. When we translate those back at the lower exchange rates or the average exchange rates for the quarter come back in dollar in a little lesser amount but there is real unit reduction in inventories and that's just trying to manage our resources and our capital.

Linda Weiser – Caris & Company

On the gross margin, I guess the decline in the quarter year over year was a little bit larger than maybe I would have thought, and it was bigger than the year over year decline in the third quarter. Is that largely the FX effect or, I think you said mix was unfavorable, but yet you've been reducing low margin SKU so you can give a little more color on that gross margin?

Curtis Stoelting

There's a couple of things to think about there. One is when we talk about mix; you have to remember that we have a combination of businesses that we're in. Our Mom and Toddler business has lower gross profit but generally has fewer licensing royalties associated with it and so it does impact the gross profit line when we have higher sales in MIT relative to our play business so that certainly had a significant impact in the quarter. Not a bad impact, because we kind of picked that back up with lower royalties in the SG&A expenses.

The other is just what we've been talking about all year. We kept talking about the cost increases that were coming that we were incurring throughout the year that really had to work their way through the supply chain into our inventory and then back out to the income statement as we sell that inventory. And that's what really caused some of that decline in gross profit in the quarter.

Peter Nicholson

And we'd expect to see the FX affect really more come through in the first quarter as really starting hitting us in the second half of the quarter and really as more on the balance sheet still. There's some of it but you'll see it come through in Q1.

Linda Weiser – Caris & Company

And why not the FX impact in 2Q '09 as well because you have a negative FX comparison there as well don't you? So it's the same phenomena throughout.

Peter Nicholson

A full quarter's worth. We're up against; the currencies are turning now throughout the first half whereas a year ago we had a tail wind for the next six months. For the first six months of '09 we'll be up against a pretty significant headwind.

Linda Weiser – Caris & Company

Can I just ask about, if you could give relative comparison between the sales potential of Dinosaur Train versus Super WHY!, is one of them thought to bigger than the other?

Curtis Stoelting

We love them all. We're working hard to diversify our pre-school play category and we're excited about those properties. Clearly Super WHY! has a lot more exposure. It's been on TV for almost two years now and we're able to measure consumer reaction to that and we're much further along in the development of the product. So we're launching that this year. We're real excited about it.

We like the Dinosaur train property. It's from a great outfit. Jim Henson's company is doing it and it will go on TV later this year. If I remember it's going to start on PBS Kids, and we think it brings two great classic play patterns together, dinosaurs which a lot of kids love dinosaurs and these are very friendly pre-school dinosaurs and fun.

And the train is not a big element in the share. The train is in the shell but it's more about the dinosaur than the train and we've got some work to do in terms of turning all that into great toys but our designers are coming up with great concepts every day. So I think we'll be further along on that probably middle of the year and we can give you a better idea of what we think the potential is.

Linda Weiser – Caris & Company

Could I ask one more about the pre-school use and adult segment? You mentioned that the sell through on Thomas Wood and John Deere is good and obviously there's a retail inventory reduction, but is the rest of the decline due to Bob and Take-Along Thomas?

Curtis Stoelting

Everything was down in toys. That's just the nature of the beast. So you kind of draw a line at some point and you say, "Okay, anything that was not down as much as medium point performed better than worse", and clearly we're moving out Bob the Builder. We're moving our some of our radio control products and we had planned those down anyway. So I think your assumptions on guidance is probably right.

Operator

Your next question comes from Todd Schwartzman – Sidoti & Company.

Todd Schwartzman – Sidoti & Company

Can you talk a little bit about product testing and other product costs during the quarter and more importantly what you're seeing thus far in Q1?

Curtis Stoelting

We've been very active in our multi-check quality and safety processes both here and in China and around the world and when the new legislation changed last year, we began implementing those new standards right away. We feel like we're in excellent shape in terms of complying with the new rules.

Yes, there's been probably more one time costs incurred in the second half of last year and in the first quarter of this year as we're just making sure and double and triple checking everything. But overall, it's not material to our results. It's not something we feel like we need to break out.

There will be ongoing components and I think we've said, we think that's probably less than 100 basis points of gross profit and we think it's a great investment.

Todd Schwartzman – Sidoti & Company

Regarding that revised Q4 2008 guidance you gave on January 15, $0.35 to $0.40, what was the source of the upside surprise? Was it the currency transaction gains? Was it something else?

Peter Nicholson

I think it's a combination of some transaction gain and the other in come line. I think certainly we didn't expect, you can't predict that, as well as I think our effective tax rate was more favorable than we though. So I think you can combine those two.

Todd Schwartzman – Sidoti & Company

If you X those items, roughly what would EPS have been?

Peter Nicholson

I think I tried to allude to that in guidance. If you look at what our effective tax rate was through Q3 and used that, apply that to the quarter and then shave some back on other income, I think you kind of get to the range that we thought we'd be at.

Todd Schwartzman – Sidoti & Company

Looking towards the back half of the year for improvement in FX translations, what gives you confidence that things will work in your favor in the back half?

Peter Nicholson

That's a great question. We really don't know. Obviously some people on the call maybe control foreign currency, but we don't. We're just assuming that the rates aren't going to change dramatically from where they are today. To some extent, we'd like them to back to where they were four months ago. We don't think that's likely right now. We don't really know, but all we're saying is the comparables will be better assuming things stay like they are today as we get into the second half of '09.

Todd Schwartzman – Sidoti & Company

Regarding Super WHY! can you give us some color if you happen to have the numbers of how has the program fared in the Neilson's and what kind of trend have you seen in the past 12 months. Are the ratings up, down, flat?

Peter Henseler

Super WHY! has far exceeded our expectations in terms of ratings. It is the number two show on PBS and continues to draw, not only which is important for our business, not only the kid viewership, but it's one of the most watched shows with moms which is important because she hold some veto power over watching the broadcast and the products she'll buy.

One of the things we purposely did from the beginning is we let almost two years of the show ramp up before the product is going to hit the market so we've really been able to saturate the market place with the program. The kids love it. Its Q scores. It one of the top Q scores with kids in our demo's so we're very pleased with where the programming and there's new programming coming, so a lot of programs in the schools, so awareness is very high and demand is we believe building.

Curtis Stoelting

A good early indicator is some of the published children's books went into the market place in January and the early sell throughs on those are fantastic. So that's a very good sign from our experience when the books are popular the toys generally follow.

Todd Schwartzman – Sidoti & Company

Sticking with the program ratings for just a minute, is that just the number two show on PBS kids, and if so, in what demo? How is that being spliced and diced.

Peter Henseler

We're looking at it in our demo, I think they go two to five and I believe overall network it's in the top five shows. Don't quote me on that but I can get that for you. But it's a top rated show.

Curtis Stoelting

It's better than we thought it would be frankly. We liked it because it had both toy aspects and early learning aspects. The fact that it's even more popular than we thought is a plus as far as we're concerned.

Todd Schwartzman – Sidoti & Company

Could you remind us what your acquisition strategy is, what you look for either in terms of complimentary products, size of the deal, distribution, perhaps impact on total market share?

Curtis Stoelting

I'm sure there's some competitors on the line so we're not going to get into the exact criteria, but we certainly have a very disciplined approach about how we look at things and we run everything through our strategic sales force and measure that really statistically to make sure that what we're going after is the right fit.

Todd Schwartzman – Sidoti & Company

So you don't necessarily say for this product category within X number of years we want to be number one, two or three or we're not going to build up that business.

Curtis Stoelting

Again, we have lots of different ways we look at it. We think it's a good process. There's some rigor and some discipline to it. We're not going to get into specifics on an open conference call, but if you want to call Pete offline, I'm sure he can give you a little more detail.

Operator

Your next question comes from Timothy Condor – Wells Fargo.

Timothy Condor – Wells Fargo

I think in your guidance with the tax rate guidance, you said more sales coming from higher tax jurisdictions. Are you looking at that from a constant dollar basis, maybe the international sales not growing as much as you anticipate relative to domestic sales or is that factoring in as you translate that back for U.S. taxes?

Curtis Stoelting

Tax rates are driven on profit not sales.

Timothy Condor – Wells Fargo

Right, but as it flows through.

Curtis Stoelting

I understand. One of the issues is going to be as we have with currency, we expect that mix to occur and some of the blend of where some of our non recurring expenses and other expenses occurred this year versus where we think they're going recur, and much of the significant cost reduction is in the U.S. as opposed to international, so we see some of our cost reduction improvement and the headwinds for currency will give a better mix on U.S. based profits than international.

Timothy Condor – Wells Fargo

In you commentary regarding the fourth quarter and in your expectations primarily for the first quarter here, mark downs over all, I didn't hear any comments about that, but how are those year over year in the fourth quarter? Did you do anything there to push that sell through? Could that be also part of the gross margin question that was asked earlier?

Curtis Stoelting

That's a good question, but R&A actually wasn't abnormal. It was just kind of in the normal range for the fourth quarter. And frankly, most fourth quarter R&A are driven off of inventory over stocks which drive those mark downs. And like I said, we came through very clean in terms of inventory. It really wasn't a big impact in terms of the gross margin decline in the fourth quarter.

Timothy Condor – Wells Fargo

Would you expect that to be similar or given your inventory position maybe a little bit better even on a year over year basis in the first quarter?

Curtis Stoelting

It's not really a big issue in the first quarter. We're in very good shape across all of our product lines whether it's MIT or our flight product lines. We think one of the few benefits when the retailers aren't ordering much, is you get less exposure from mark down. If we ship them more, we have a little more exposure to mark down because I think we'd sell a lot more that way.

Timothy Condor – Wells Fargo

On the cost input perspective, some of our competitors have commented that maybe things could start flowing in the back part of the year, they're working with their vendors very closely and you may see some abatement. You've already seen a little bit of that in some of the commodity side, a little bit and that could flow through more so in the back half of the year.

What type of pricing number one are you looking at here for the spring line and then maybe for the fall line and then how are you thinking about the cost inputs for the back half of the year. You already stated that you thought those would not be as aggressive, but could we actually see some abatement come in the back half of the year year over year?

Curtis Stoelting

I think if commodities stay where they are now that we'll start to see some positive trends in the second half of the year.

Timothy Condor – Wells Fargo

Labor and transportation also?

Curtis Stoelting

Labor, transportation and some inputs. But even though, for instance resins have come off their peak, they still haven't dropped dramatically from where we set prices back at the beginning of 2008 and we didn't true up our vendors dollar for dollar for those increases and so we aren't going to, if you can't pick the top of the chart and expect to get that all back day one.

I do think there will be improvements. We always work very closely with our vendors and we are getting selective cost reductions right now and I think those will become more meaningful later in the year.

On the pricing side, obviously we build in new pricing on all the new products for 2009 and we've got carry over price increases that went into effect July 1, 2008 which incrementally will provide a little bit of additional pricing in the first half. But with everything going on with the consumer and the economic conditions, we did not go out with a spring price increase, and I think that was the right move. Likewise we don't expect to go backward on price either.

Timothy Condor – Wells Fargo

Then in the first half of the year, what type of on average, letting that flow through would you expect a low single digit, mid single digit price increase in the first half of the year until you anniversary the July increase?

Curtis Stoelting

I'm not going to speculate on that. I think what we know is true, is that we achieved price increases mostly that went into effect mid year '08 somewhere in the 4% to 6% range. So if you just play that out, you would think that would play into first half.

Now the problem is, it's not as easy as just doing that because as we talked about, there's mix, there's currency and there's other factors that are going to play into margins.

Timothy Condor – Wells Fargo

Could you just remind us of the timing of your wholesale shipments and when we should see the products on retail of Super WHY! and the Dinosaur Train and Chuggington I think is just international for '09, but each of those primary categories for '09 and 10.

Curtis Stoelting

We tried to be real clear on the release on what's when.

Peter Henseler

Super WHY!, there will be a little bit of shipment here at the second quarter, but primarily most of it is going to flow in the third and fourth quarter and we'll see it on the retail shelves in late spring in select retailers. Dino Trains as Curt said, we're going to let the TV show get well established. Dino Train, you'll be seeing product again in the second half of 2010 and the Chuggington, the same thing. We're going to let the TV show get well established in the international markets and we'll begin distributing product in 2010 market by market depending on when the TV show airs.

Curtis Stoelting

The U.K. show will have been on 12 months by the time we get to spring of 2010 so we might put some product into the U.K. in the first half. And then we'll just look at each market and we're in discussion with retailers about that and we'll decide when the timing is right. But now Chuggington Train until 2010. We want the programming to do the job on the marketing side and right now it is doing the job. The ratings have been very strong on BBC. It's been on for about four and a half months. It just went on Super RTL in Germany and a lot of other networks here in the first quarter and early ratings are strong there as well. So we're very happy where that show is tracking right now.

We've got a long way to go. We've got a lot more international markets that are going to be opening up throughout the first half of this year in terms of the media and at the same time, I think our team here has developed a fantastic pre-school play line behind it that will really be kind of Train play plus and we'll be happy to share that with you later in the year.

Operator

Your next question comes from Gerrick Johnson – BMO Capital Markets.

Gerrick Johnson – BMO Capital Markets

Obviously a big launch here in 2010 with these licensed properties, so as it relates to Chuggington and Dinosaur Train, what kind of R&D expense should be modeling in 2009 and how is that incrementally changed from 2008?

Curtis Stoelting

We are obviously spending time on those new product lines and we obviously won't be earning any sales profits until next year, but that's kind of a normal process for us. We're always in development. We're always working 12 to 18 to 24 months ahead, so I don't think the dynamic will be much different than what it's been in the past.

Peter Nicholson

We wouldn't anticipate the incremental.

Curtis Stoelting

The great thing is with both of those properties we have plenty of time to plan and we're doing it in a very orderly fashion so it's very efficient.

Gerrick Johnson – BMO Capital Markets

Are there any outstanding litigation left? Anything that we have to be concerned about?

Curtis Stoelting

It's pretty well behind us. There's a few little nits and gnats out there but nothing material.

Gerrick Johnson – BMO Capital Markets

What's the definition of a nits or a gnat?

Curtis Stoelting

We're still dealing with CPSC in terms of if there's going to be some sort of fine. That's bureaucratic process that we don't control the timing of, and there's a couple of other immaterial law suits that really have nothing to do with the primary products that were part of the recall but some of the smaller products.

Peter Nicholson

The only lingering effect should be our legal costs as we defend some of those cases, because if you look at our footnotes of our financials, we don't accrue for the cost to defend those cases. But certainly if you look at the footnotes, you'll see that we do have accruals in place for estimates for any fines that may still be out there.

Curtis Stoelting

We don't anticipate breaking anything out in terms of 2009 as a recall because it's not going to be material.

Operator

Your next question comes from Anthony Gikas – Piper Jaffray.

Anthony Gikas – Piper Jaffray

Could you give me in the relatively flat EPS guidance you've given for the year, what are you assuming for interest expense net of interest income for the year?

Peter Nicholson

We'd expect our average borrowing to increase slightly over our December 31 point as we grow working capital a little bit, so if you kind of look at our historical growth in working capital for the year that we've had seasonally throughout previous years, and as you can see we're at LIBOR plus 2.75 so today we're borrowing at a half a percent for LIBOR.

We'd like to think that we're not the best predictors of that, but we gave ourselves some cushion on where LIBOR is today.

Anthony Gikas – Piper Jaffray

Do you have a dollar amount for the year?

Curtis Stoelting

You can do the math.

Anthony Gikas – Piper Jaffray

Is there anything in the Mother, Infant, Toddler product line item that you haven't released? Is that all First Year or is there anything else that's comingled in that line now?

Curtis Stoelting

Comingled is so inappropriate. But yes, there is. Lamaze is in there which is a great brand as you know. You buy it a lot for gifts and whatnot. But it's predominantly First Year. There is our Lamaze brand as well and obviously we've rebranding our car seat and booster seat business, our travel gear business, so that's in the First Year's as well. That would be in those categories. First Year is the vast majority of that business.

Anthony Gikas – Piper Jaffray

Were there any expense associated with the abandoned acquisition of children's publishing division last year? Any expenses there that you won't incur? Any one time items in 2008?

Curtis Stoelting

We broke those out in the third quarter, about $1.3 million to $1.4 million pre-tax, so obviously we're not going to incur those this year. But we did break those out and they're part of our non recurring analysis.

Anthony Gikas – Piper Jaffray

Are they included in the cost savings or would that be incremental?

Curtis Stoelting

We didn't include those there. Anything that's non recurring, we're not double counting. It's not in our cost saving estimate. The pre-tax before acquisitions were $1.4 million. And yes, those were included in the cost savings.

Anthony Gikas – Piper Jaffray

Do you ever revisit that transaction?

Curtis Stoelting

I think a lot of things in the back of my head before I go to bed at night, but we're moving forward now. The world's changed quite a bit since we negotiated that deal and we still like that category, and I think there will be a time to think about revisiting that, but right now I think we want to get through this consumer cycle, focus on the things I talked about earlier on the call, driving every incremental sales dollar, managing our operating costs and achieving our cost reduction plan and exceeding it hopefully and really preserving our capital until we see some light at the end of the tunnel.

Operator

Your next question comes from Linda Weiser – Caris & Company.

Linda Weiser – Caris & Company

A follow up on your American Red Cross line, it looked like Safety First really had that whole space at Wal Mart when we were checking the stores. Were you ever in Wal Mart with American Red Cross or is that predominantly other retailers and is that an opportunity for you to gain some space at Wal Mart or not?

Peter Henseler

I asked Pete this very question just a few days ago. Your perception is correct. We are actively working on that to expand distribution. We did take about a year and a half to make sure it was going to be the right mix with consumers. We feel very good about that and now I think Curt mentioned in his comments, we are actively looking to expand that line out.

Curtis Stoelting

We've never had it at Wal Mart in the past. We think it's an opportunity. The other thing American Red Cross, what we've had in the market the last two to three years is the Health and Wellness products that are associated with that brand. We've been very successful with that.

In December and January, we started shipping our Safety component under American Red Cross so all the great safety items that you need when babies arrive are now available under that brand as well so there's expansion in terms of product range and we're looking at distribution expansion as well. But at this point it would be late '09 into 2010 is where we would go into the next cycle on that.

Linda Weiser – Caris

Have you lost any major retailers that you originally launched it into?

Curtis Stoelting

No. We've expanded space. We launched initially BRU. We expanded it into other high quality retailers and we've done the work and we're very confident that program will be effective at other retailers like Wal Mart and K-Mart for instance. So we're broadening distribution which is always our strategy as we kind of put together a three to five year product line plan.

Operator

We have no further questions in the queue. I'll turn it back over to the Mr. Stoelting for any additional or closing remarks.

Curtis Stoelting

I want to thank everybody for their participation on the call today. We look forward to speaking to you throughout 2009. Have a good day.

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Source: RC2 Corporation, Inc. Q4 2008 Earnings Call Transcript

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