Russ Berrie and Company, Inc. F2Q08 (Qtr End 06/30/08) Earnings Call Transcript

| About: Kid Brands, (KID)

Russ Berrie and Company, Inc. (RUS) Q2 2008 Earnings Call August 19, 2008 10:00 AM ET


Erica Pettit – Financial Dynamics

Bruce Crain – President &CEO

Anthony Cappiello – CAO & Interim CFO


Arnie Brief – Goldsmith & Harris

[Dan Kern] – Blue Sky Asset Management

Unidentified Analyst


Good morning ladies and gentlemen and welcome to the Russ Berrie and Company conference call. (Operator Instructions) I would now like to introduce your host for today’s conference, Ms. Erica Pettit of Financial Dynamics; please go ahead.

Erica Pettit

Good morning everyone and welcome to Russ Berrie’s second quarter 2008 conference call. If you have not viewed the press release issued this morning and would like to receive one by email or fax please call Financial Dynamics at 212-850-5600 and someone will send you one immediately.

As stated in the company’s earnings release this call is being webcast and can be accessed on the company’s website at The webcast of the call will be archived online shortly after the conference call for 90 days. A replay of the call will be available through August 26, 2008 by dialing 800-642-1687 access code 60012738.

We will begin the call with comments from management and then we will open up the line for questions. Before we begin we would like to remind everyone of the cautionary language regarding forward-looking statements contained in the press release. That same language applies to comments made on this morning’s conference call.

Now I would like to turn the call over to Bruce Crain, Chief Executive Officer and President of Russ Berrie.

Bruce Crain

Thanks Erica, good morning and thank you for joining everyone. I’m going to start with a review of recent performance and then Anthony Cappiello, our Chief Administrative Officer and Interim Financial Officer will provide a more detailed discussion of our financial results. Later I’ll come back and briefly discuss our plans going forward.

During the second quarter we achieved double-digit sales growth primarily due to the solid performance of LaJobi and CoCaLo which we acquired very early in the second quarter as well as sales growth in both our Kids Line and Sassy businesses.

However earnings results were very disappointing for us. Sales in our Gift segment were impacted by the overall difficult consumer and retail environment and this resulted in inventory adjustments from some of our retailers as well as weak sell-in during the quarter.

We experienced significant margin pressure particularly in our Infant and Juvenile business due to spikes of cost of goods. Although this is consistent with many consumer companies sourcing in US dollars, our cost of finished goods in the first half of 2008 escalated considerably given the weak US dollar Chinese Yuan exchange rate, compounded by higher raw material, labor and freight costs.

Combining these external factors have created a more challenging operating environment and affected our bottom line results. Additionally our results for the quarter were influenced by certain significant unusual and mostly non-cash financial items which we will discuss in more details when we review the performance of both of our segments.

All that said, we continue to implement appropriate strategies to assure the long-term success of each of our businesses and also take more time to discuss those strategies throughout this morning’s call.

Let me begin with a few second quarter highlights for our Infant and Juvenile segment. First, demand for Infant and Juvenile items remained really strong as the long-term favorable demographic trends in this recession resistant industry are very attractive. We believe that having a core business that can leverage these trends is extremely important during difficult economic times, and we’re pleased with our ability to continue to generate significant top line growth in this segment.

In fact, we’ve been able to protect our shelf space at our retail customers as we remain focused on leading with our innovative designs and well branded product lines and we have gained market share in some areas, even in the difficult macro environment.

This is especially encouraging given that our I and J retail customers have also been prudently managing their own inventory levels to appropriately address their views on consumer demand for 2008 and despite this, we grew our sales.

Beyond our organic business initiatives the important strategic and accretive acquisitions of LaJobi and CoCaLo that were completed during the quarter advanced our leadership position in the Infant and Juvenile market. In addition we were able to capture additional market share driven by their branded, trend light and quality products, we also benefit from their extremely high service level business models.

During the quarter we seamlessly completed the initial phase of integration of these businesses under the Russ Berrie Infant and Juvenile segments umbrella and are now deeply involved in helping them grow and drive synergies across the entire segment. I’m very encouraged by the progress across these new businesses as well as our ongoing progress of Kids Line and Sassy units.

Finally on the debt capital structure side of the I and J segment, we are pleased to amend our Infant and Juvenile credit facility early in the second quarter in order to finance the LaJobi and CoCaLo acquisitions and to support the overall growth of our I and J segment.

The facility now consists of a term loan in the amount of $100 million and a revolving credit facility up to $75 million. In connection with this change for our credit facility we did write-off [inaudible] financing expenses a portion of which were related to an earlier phase of the facility and as a result we recorded a non-cash charge of approximately $700,000 in Q2 for that.

Turning now to our Gift segment I’d like to cover a number of internal and external challenges. Let me begin with a few general comments on this segment and the industry. We’ve made tremendous progress in restructuring the Russ Gift business over the last few years. We’ve been able to do so with great efforts by an entire team worldwide. Overall our core strategy remains strongly in place with Russ Gift which is globally led by first an extremely well recognized Russ and Applause brand portfolio, second innovative and fresh gift product together with an extensive plush offering and third a global sales forces and a growing multi channel approach to the market.

Despite our strategy and progress we’re not pleased with the current results and are working aggressively to continue to address the factors that are within our control in the Gift segment. The Gift industry especially in the US is continuing a multi year transformation as the retail mix evolves, consumer preferences go through fashion cycles, and sourcing costs and challenges escalate.

So while the industry and current gift market is troubled and challenging we are adapting as needed. We believe strongly that there is still a very large addressable gift market. We remain committed to adapting to it and returning Russ to be a profitable leader in the space.

Product remains key in the gift industry and at June and July tradeshows we introduced a full assortment of new products including hard goods gift products, along with our already strong plush offerings. In fact, we launched more new product at this summer’s US tradeshows then any other tradeshows we have recently had.

We featured new seasonal products for Valentine’s Day and Easter products for 2009 including PAAS and separately [Pete’s] branded lines of plush, and collectibles through new licensing agreements. We feel these offerings were well received and our sales teams are now busy getting orders placed.

Another particularly encouraging offering at SeaPals which is our new proprietary plush product that is a web play component and allows us to leverage our extensive Shining Stars experience. Its focus in on branded plush in a virtual world where a child can build an online aquarium where they are provided a host of play, social interaction, and educational opportunities where the child can also earn points.

Despite the encouraging product introductions and our core offerings, its important to note the attendance at the summer gift shows was lower than previous years which in our view reflects the soft current trends in the industry and weaker than expected product sell-in for Christmas to retailers.

Combined with our view on continued weak consumer demand this fall for discretionary consumer products we believe this indicates we may see continued pressure on this business in the near-term. Let me take a moment to discuss Shining Stars which was an important part of our 2007 sales.

As we anticipated and previously disclosed sales have slowed significantly year-to-date and we were faced with the anniversary of the strong sales and the launch of Shining Stars in the second quarter of 2007. To counter this we’ve been working on several key fronts to improve future opportunities for Shining Stars.

First we recently revised our licensing agreement for Shining Stars and transferred most of the joint equity ownership of the website we had as a result of our investment in the site last year, back to the licensors in exchange for more favorable operating economics going forward.

With our licensor site ownership consolidated our licensing partner intends to significantly further enhance the website and expand ways we can grow together with the well established international star registry franchise. The site is expected to expand its play and social interaction appeal and creating a three dimensional element for even better virtual experience.

Together our licensing partner and Russ Berrie also launched the Shining Stars website in Spanish, French and German languages and additional languages are forthcoming, all of which should help drive international sales.

Related to revising licensing agreement however we wrote off Shining Stars website development expenses and recorded a $1 million non-cash charge during the quarter in conjunction with the transfer of the ownership.

Second, we have developed a variety of incentive programs that allow our retail partners and our sales teams to promote products in fresh ways to help drive volume. Collectively we really are quite optimistic now about Shining Stars going forward but a lot of work to do.

During the quarter there were two unusual items also in the Gift segment, first we recorded a $70 million non-cash asset impairment charge based on the results of an evaluation of our fixed assets. Anthony will cover this in more detail later. Second, we recorded a $1.6 million charge taken in relation to a private label Christmas season product in the Gift segment that we shipped in Q2, but subsequently determined to be unacceptable from a quality standpoint.

We expect to be remaking the product and delivering the product in Q3. Before I turn the call over to Anthony to run through the details of our financial performance, I’d like to conclude by saying that while we were disappointed with both our Gift and I and J operating results, we remain confident that we have appropriate strategic and tactical action plans underway to improve our operating performance.

In addition we do think we are continuing to manage our capital structure and working capital well. For example, in the second quarter we amended our I and J lending facility as I mentioned earlier, paid down debt following the acquisitions, have been aggressively managing our accounts receivable to improve days outstanding and making good progress on working capital across the board.

Within Gift we have also been able to manage accounts receivable and inventory well despite difficult retailer credit markets and reduced sales levels. In summary we are committed to protecting our business in the near-term while maintaining our positive long-term outlook on the business. After Anthony, I’ll return briefly to discuss our plans moving forward in 2008.

Anthony Cappiello

Thanks Bruce, I’d like to address some of our financial highlights for the quarter. As you all know, the details of our results are available on our routine filed 10-K for the second quarter as well as the press release put out this morning, so I’ll keep my remarks relatively short.

Consolidated net sales for the second quarter increased 24.0% to $87.7 million compared to $70.7 million for the second quarter of 2007. This was primarily driven by sales of $22.2 million from LaJobi and CoCaLo which we acquired early in the second quarter of 2008, as well as an 8.7% sales growth at Sassy and Kids Line, partially offset by a 24.8% decrease in the Gift segment net sales.

The consolidated net loss was $12.1 million or $0.57 per basic and diluted share for the second quarter compared to a consolidated net income of $0.4 million or $0.02 per diluted share for the same period in 2007.

As Bruce mentioned, the second quarter 2008 results include certain unusual charges totaling approximately $10.4 million and I’ll review them in a moment, but excluding these unusual charges, the pre-tax net profit for the second quarter of 2008 was $0.03 million compared to $1.5 million in the second quarter of 2007.

The unusual charges consist of the following: an unusual cash charge of $1.6 million which was related to the quality of certain private label products in the Gift segment; a charge of $0.7 million related to the write-off of financing expenses in connection with the amendment of the company’s Infant and Juvenile credit facility as of April 2, 2008, about half of which is non-cash; a non-cash charge of $1 million related to the write-off of certain capitalized Shining Star website development expenses related to the revised license agreement that improves future cash ongoing operating economics; and a non-cash charge of $7 million related to the write-off of the value of long-term fixed assets related to the company’s Gift segment. As Bruce mentioned, I will go into more detail about this impairment charge.

In accordance with accounting standards, for the impairment of long-lived assets, we initiated an analysis of the carrying value of certain long-lived assets in the Gift segment because of current and projected cash flow shortfalls in the Gift segment and other gift industry trends. As a result of this review we determined that fixed assets in our Gift segment were impaired and that we needed to adjust the carrying value of long-lived fixed assets.

Let me briefly go through a few additional key line items from the income statement, consolidated gross profit in the second quarter was $28.5 million or 32.5% of net sales compared to $28.4 million or 40.1% of net sales for the second quarter of 2007. Infant and Juvenile segment margins were negatively impacted by competitive pricing constraints, increased raw material costs and product mix and a shift in product mix.

The decline in the Gift segment margin was primarily attributable to the mutual charges related to the website, private label product charge and a small portion of the gift impairment charge that was booked in cost of sales. Excluding these unusual items, gross profit for the Gift segment was $11.3 million or 43.4% of net sales, compared to $14.3 million or 42.3% of net sales in the prior year quarter.

All of this demonstrates that Gift has been able to maintain its margins despite other difficulties. Consolidated SG&A expenses for the second quarter was $36.3 million or 41.1% of net sales compared to $25.7 million or 36.3% of net sales in the second quarter of 2007.

The primary reason for this increase in both absolute and relative terms was the previously mentioned impairment charge of $7 million in the Gift segment attributed to the write-down of fixed assets of which $6.7 million was recorded in SG&A. Without such impairment charge, consolidated SG&A would have been $29.6 million or 33.8% of net sales for the second quarter. Again, we believe this shows that we’ve been able to maintain and adjust spending throughout these relatively weak markets. We did however experience a modest increase in SG&A expenses in our Infant and Juvenile segment as a result of our acquisitions of LaJobi and CoCaLo, increased product development and advertising costs.

Turning to the balance sheet, consolidated net inventories totaled $71.4 million for the second quarter which includes the acquisition of LaJobi and CoCaLo. Excluding the acquisition compared to December results, our inventory was essentially flat at $59.1 million. Importantly our inventory in the quarter was inline with our overall sales performance.

Specifically in our Infant and Juvenile businesses, inventories were $43.8 million, up from $28.6 million at December 31, due to our acquisition as well as our strategy to purchase inventory at current lower prices.

In our Gift business inventory was $27.6 million compared to $30.5 million at year end. In addition, property, [inaudible] and equipment is significantly lower due to the $7 million impairment charge I mentioned earlier.

The increase in goodwill, intangible assets and other debt reflects the acquisition of LaJobi and CoCaLo. Let me now turn the call back over to Bruce for his closing remarks.

Bruce Crain

Thanks Anthony, let me close this morning’s call by briefly discussing our plans moving forward. Despite the soft trends in the current consumer environment we continue to focus on executing our strategies for both Infant and Juvenile and the Gift segments.

For I and J segment we’re focused on improving operating results for the long-term and are continuing to work on three opportunity areas for this segment as we enter the second half of the year which include first, expanding market share, second offsetting cost increases and third maximizing synergy opportunities across what is now four businesses; I’ll briefly provide some more detail around these initiatives.

First we’re seeking to expand market share by growing and entering new product categories and channels. Importantly we believe the large opportunities for growth presented by some of these new areas will more then offset the related product mix shift to somewhat lower yet still attractive product gross margins.

While this mix shift will somewhat lower overall gross margins, it will help us drive operating results. Additionally that does not mean that we won’t continue to look for other ways to make the most of gross margins, which brings me to my next opportunity.

Specifically we’re looking to offset cost increases through a variety of measures. We’ve rigorously focused on optimizing tailored pricing strategies for our businesses and have analyzed price increases by retail channel and at the item level.

While we have implemented select price increases earlier this year, we have also negotiated certain additional increases with our retail partners which will begin at different times throughout the remainder of the year.

Through these efforts we believe we will be able to offset a portion of our cost increases and also retain most of our gross margin. However, it will be difficult to recoup all of our margins in this environment with pricing alone. Therefore we’re also focused on managing our product cost structures as well.

We have numerous prospects to further leverage our product costs by further improving sourcing in particular, which will help improve margins and through many other logistical consolidation and scale opportunities.

As an example, we have begun alternate sourcing operations beyond our core China factories into other parts of Asia and deeper into China. In particular we’ve already begun to leverage LaJobi’s Asian sourcing resources.

Our final tactic for offsetting cost increases and preserving margins has been through reengineering both new and existing product. We’ve also been working diligently to ensure that new and existing licensing relationships deliver appropriate returns on our investments.

As you know Sassy discontinued its [inaudible] distribution agreement earlier this year which involved predominately Euro sourced product which we no longer can make money on, although that relationship does not conclude until the end of this year.

On the other hand our licenses with Serta, Graco, and Carter’s are all growing nicely with attractive although relatively lower margins due to both the associated royalties and lower margins related to more entry level price points.

Finally with our four I and J businesses we plan to still retain the independence of the design, branding, marketing and sales groups of each. However we do believe there are opportunities to begin capitalizing on marketplace and cost synergies.

For example we are already working on joint retail customer sales relationship strategies to build market share with key accounts. Internationally we are beginning to develop key markets jointly and we believe we have significant opportunity to grow in select markets abroad.

At the upcoming ABC Kids Expo Show in Las Vegas in early September we’ll have separate but a significant collective presence and will be jointly highlighting our many [Ecco] product offerings. As I mentioned we are also actively working on specific initiatives for managing our cost structure and have already identified opportunities to leverage economies of scale.

For example we are already leveraging Kids Line factory base in China for CoCaLo. Additionally we are further reducing costs by collaborating on other operational areas such as freight and warehousing.

Now turning to our Gift business, we continue to focus on strengthening the core building blocks of this segment. As such, we are committed to first maintaining great product development under the Russ and Applause brand names and second balancing our sales resources and channel mix and geographies appropriately to the sizes and margins of various markets that we serve.

Specifically we are continuing to create and invest in new products including SeaPals mentioned earlier and extending the existing product lines while finding affective ways to further grow our licensed brands such as Corduroy, Raggedy Ann, Andy and The Simpsons.

You should note the Corduroy line in particular is part of the jump start the record campaign that’s going to kick off this fall and the plush product that we have will be associated with a book that will be read by Matt Lauer on The Today’s Show in September.

As part of our efforts to target our sales efforts appropriately, especially in the US market, we continue to have confidence in our key account sales teams can expand our relationships with mass retailers. At the same, through a combination of our field sales teams and B to B and telesales based selling organizations we’re adjusting our plans to be able to cost affectively service the needs of the specialty channel.

We’re also gaining traction with our FOB based group in Asia, which has created additional international opportunities to directly ship our products to key accounts globally.

In closing, we are confident we are taking the necessary steps to position our business for the long-term. While Russ and many consumer companies continue to be affected by the challenging macro environment the drivers of our business remain strong, we’re focused on leading industry performance in our respective segments.

Now we’ll turn the call over to your questions.

Question-and-Answer Session


(Operator Instructions) Your first question comes from the line of Arnie Brief – Goldsmith & Harris

Arnie Brief – Goldsmith & Harris

Could you give us some idea of the Shining Star inventory in the field; I’m guessing that you shipped 2.5 to 3 million units last year? How much of that is still lying around?

Bruce Crain

We certainly have inventory in-house that we’re still working through and our retailers we believe as sales slowed down in the early part of this year, we believe that they obviously had inventory and from a lot of the competitive landscape that you’re aware of, we know there was a lot of competitive product that was very similar out there that’s needed to work through the market.

We are actually seeing reorders from accounts that we hadn’t seen orders from that have had placements of late that we’re pretty encouraged by which suggest to us that the stuff that was in their backroom has now flowed through. But yes, I think there’s a general issue in the industry with a lot of product from our competitors. We believe a lot of our product was also out there.

The only thing I would remind you of, we still believe there are a lot of accounts that never got overloaded with product and we’re doing a lot of work to try to open up those accounts also.

Arnie Brief – Goldsmith & Harris

Do you see any results internationally that are encouraging?

Bruce Crain

We just launched all the new languages so there’s a whole effort now to gear up internationally where we were really not successful at having sufficient language translation stuff on the site throughout the last year and its just now in the last month that we’ve gotten new languages on so I would say we’re at the early stages of kind of reinvigorating those programs.

In particular in the UK, Canada, where we think French language stuff will be important. We also think that the Spanish language here in the US will be important given that demographic.

Arnie Brief – Goldsmith & Harris

Could you give me some idea, you mentioned there were product development expenses in the I and J area, were they completely expensed in the quarter or do they continue in the third quarter, could you give me some idea of magnitude?

Anthony Cappiello

We’re talking about probably $200,000 that was spent in Q1 and Q2 on development type related expenses that beefed up the development department a little bit in the sense of people and spending some money on some things going forward mainly continue to keep our margins inline and design product accordingly to right price points and things like that as an investment for the future. But nothing on a massive scale or whatever. Just $200,000 a quarter.

Bruce Crain

We see this as a bit of a permanent uptick maybe in that side of the investment part of the I and J business. We continue to be very profitable in those businesses even with that investment but we think it’s a prudent thing for the future as we try to grow. We’re doing a lot of work now outside the US for those businesses. All of those are somewhat step functions that are probably a little bit permanently part of the cost structure as we move forward in our I and J business and we’re happy to do so.

New product and design is really what keeps getting those guys new market share.

Arnie Brief – Goldsmith & Harris

Would it be fair to conclude, I know you don’t provide much guidance, but would it be fair to conclude that the margin pressure that we saw in the second quarter in I and J will continue but at a smaller magnitude?

Bruce Crain

I think again, the pressure on cost coming out of the Orient quite frankly surprised us a little bit. The magnitude of the spike that we saw earlier this year, I think we’re feeling okay that we’ve gotten quite a bit of price increase through already to our key retailers. As you can imagine, they don’t just take a price increase and put it out into retail, that has to be cycled in, so there’s a little bit of stickiness and delay factor. But we’re feeling quite good about that.

Generally there’s been okay reception across the retail base and we already have agreed to price increases that are going to hit throughout the rest of the year and actually into 2009, we’ve already had some of those negotiations.

I think as I said we don’t expect that just through price increases alone, we believe we can certainly pass the cost increase through, but we’re also trying to maintain margin which means you have to get more then the cost that you’re getting hit with pass through to the retailer and of course they’ve got to maintain margins also. So that’s why with equal focus above and beyond just price increases we’re really focused on cost of goods that we’re bringing in hence the new sources, reengineering product, taking things out of the product, really looking at reformatting a lot of it.

I think the other thing, this holds also true for the Gift segment, we really focus a lot on introducing as much as possible new product which gives us a real opportunity to just step price up to our historical margin structures. But its kind of the downside of having a successful product that’s out there in the market and that’s a little harder to change price on.

Arnie Brief – Goldsmith & Harris

If you look at trends in the Gift business on a monthly basis, May, June, July orders, and August, do you see any improvement in the trend?

Bruce Crain

I think as we mentioned Shining Stars makes some of those analytics a little bit difficult. Shining Stars was a big part of the business last year. In the core product I think we are somewhat, yes, encouraged on the core product I think would be a fair statement that we are running ahead and I think some of that’s both, there isn’t the Shining Stars to sell but we really again as I said, introduced a tremendous amount of product this year that we simply didn’t do last year.

And I think some of what we’re suffering through right now is the fact that we had such a success last year on a few items that we didn’t get enough new product out into the pipeline and we think we’ve remedied that in the last months and that’s now starting to flow through. I think we’re particularly encouraged by Valentine’s, Easter product that we should ship by the end of this year going into early 2009.

The design has gotten great reception and key accounts are picking that up nicely. I think the non-Shining Stars core stuff we’re feeling pretty good about but cautious because of the overall environment.


Your next question comes from the line of [Dan Kern] – Blue Sky Asset Management

[Dan Kern] – Blue Sky Asset Management

I see looking at your sales that the Infant and Juvenile segment is up 8.7%, the Gift business is down 25.4%, I wasn’t able to figure out how LaJobi and CoCaLo did versus 2007. Can you speak to that?

Bruce Crain

We don’t break that out at all in our disclosed numbers. We’re feeling, as I said, they’ve been accretive, they’re performing to our plans, we’re feeling good about those businesses. But we haven’t really been disclosing individual business numbers. As you may know, there is more detail disclosed on LaJobi in particular, but we don’t break out those numbers now individually. But I would say, a safe comment as in both cases, we’re feeling very good about sales and they’re running ahead of last year pretty meaningfully.

[Dan Kern] – Blue Sky Asset Management

Were they rolled up into the I and J numbers this year when you look at the 2008 versus 2007 comparison for Q2 or are they separate?

Anthony Cappiello

They are rolled up in the I and J component but the 8.7% is our existing Kids Line and Sassy business. So that percentage that’s referenced in the Q and the release is just on Kids Line and Sassy.

Bruce Crain

By implication you can back in, I don’t have the numbers right here, but in terms of what the growth is for those businesses separately. You look at the Q2 numbers last year for Kids Line and Sassy and grow that 8.7%, you’d have the residual.

[Dan Kern] – Blue Sky Asset Management

On the I and J business can you give me an idea of customer composition, what percentage of the total business are the top five or let’s say 10 customers make? Is it different then your Gift business in that a few accounts make up a large percentage of your sales?

Bruce Crain

It’s a very concentrated customer base in this world, that’s how retail really works out there. Not breaking down our customers, let me just tell you a little bit what goes on in the market today. You’ve got people like Wal-Mart, if there’s $11 billion of retail that goes on in this kind of product line; you’ve got Wal-Mart in there with $3.5 billion of it. Target is up there at a little under $2 billion. Baby’s R Us $1.5 billion. You’ve got to add some TRU back to that and probably get close to $2 billion for them.

So our mix is not too dissimilar from that. Our Wal-Mart number would be no where near that proportionately and TRU is clearly our leading account and it is a very large account. So collectively our top five would be well over 50% of our business.

[Dan Kern] – Blue Sky Asset Management

You had mentioned that Shining Stars was a big part of your business last year, and we all know that last year’s Q3 was very strong, with the loss of Shining Stars as being a top performer, how are you going to anniversary those sales in the upcoming quarter?

Bruce Crain

As I said I think that will be a challenge for us. We’ve got a lot of new product in the market that we did not have out there before. We’ve also introduced, we’re still selling a lot of Shining Stars, it’ll still be an important part of the year, and it just is not anniversarying anywhere near that same rate. We’ve also introduced SeaPals as I mentioned which is another web based product that will be a we believe a very strong performer. I don’t think it can be as big as the Shining Stars but we’re very excited by that. So I think its new product, generally our core product coming back quite strongly. Our international businesses are performing quite well in Gift in particular Australia which we talked about a few times in past calls, really had to struggle the last couple of years. We’re feeling very good about the turnaround that we’ve got going on there.

Also remember those markets have some additional advantages because of their relatively strong currencies buying in US dollars where most of our product is coming out of the PRC. So the international side I think is an uplift to it. But as I said it will be a challenging, especially Q3 because of the real strength of Shining Stars that began in Q2 last year and certainly continued in its peak quarter of Q3 last year.

[Dan Kern] – Blue Sky Asset Management

To clarify, the I and J numbers which show an 8.6% increase are Sassy and Kids Line 2008 versus Sassy and Kids Line 2007. The LaJobi and CoCaLo numbers would be part of your overall sales but you’re not showing it in either of the I and J or the Gift numbers, so we would have to basically back those sales numbers out of the total sales for the quarter, and you’re not giving us their 2007 performance?

Anthony Cappiello

We can’t report 2007 because it wasn’t part of our company in 2007 so we can only report it in 2008 and we gave you those numbers.


Your next question comes from the line of Unidentified Analyst

Unidentified Analyst

Isn’t it true that you’re going to have to provide I guess in the K in terms of the pro forma revenues for the company, as if, for 2007, isn’t that correct?

Anthony Cappiello

Yes, we’re required to provide that for LaJobi but not for CoCaLo and we did it. Its in the 8-K that we filed.

Unidentified Analyst

Obviously the consolidation of channels in the Gift area has been a real nightmare for the Gift companies which clearly we can see it in your numbers, and what happened to companies like [Anesco] what’s your view now of where we stand in that consolidation and how you’re adjusting to it and just some general thoughts about where your products can be put up for sale?

Bruce Crain

Let me focus on the US market, internationally I think we’ve got a different story but in the US market which I think is in particular sort of transitioned which has now been going on for a few years, remind everybody that we came off a world of a half dozen plus years ago in the Russ world with 70,000 accounts and numbers like that, with mom and pop gift stores lined Main Street, America, and the mass guys were not really in that channel. That has been a significant transformation where we had hundreds of people on the road calling on individual accounts; we now have less than 100 field sales people we think are quite good focused on those accounts that are still quite viable out there.

But you’re absolutely right that the bigger accounts have taken a big share of that and what we’ve done to adjust is a significant part of our business now in our US gift area is managed through our key account management structure where we call on all the biggest accounts, all the big type accounts and all the other national chains and department stores and everybody else. So I think we’ve built a nice team that’s going after that as part of the transition.

Separately to chase the specialty channel which has become less and less economical to reach especially the expense of gas prices for field sales people and all that, we’ve now built out a telesales and B to B operation that is chasing down the more rural and less economical to reach accounts. So we’re trying to not walk away from that account base, but reach them in a different way. So we think that’s important.

And then the other part that we’ve taken on that compliments the key account piece is an FOB approach to the market where we’re shipping a lot of the biggest accounts that have opportunities to go direct to Asia themselves, we’re trying to play a middle man there with branded product under both Russ, Applause and get that product directly shipped to not only our core account markets in Western Europe and North America but also the Brazils and the Russias and other parts of the world where we’re shipping those accounts.

So I think we’ve tried to change our mix structure of sales organizations. We’re trying to continue to have a branded strategy and we’re making offerings to the specialty guys in terms of certain SKUs or brand activity that we’re not offering to the larger guys in the same way as the way we’re trying to adapt and adopt. We’ve changed an awful lot of cost structures throughout this also again taking a lot of people out of the system.

Europe is a little different for us; we’re still mostly focused on smaller accounts over there. The hyper market world of Europe is a very challenging place. We have not found a business model to chase the German hypermarkets in the really lower price point world over there and really have chosen not to.

Unidentified Analyst

In the I and J arena, you mentioned mix shift, can you give us a little more commentary on that? What exactly is a mix shift that’s impacted you?

Bruce Crain

I’ll give you a specific example that might be helpful, in the Kids Line world for example, they continue to be on a nice growth trajectory and they took on the Carter’s license now a couple of years ago. That’s become quite a significant part of their sales activity, very successful out there but two things come with Carter’s. One is they are relatively lower retail price points at times, very well known brand so it moves very well off the shelf, great velocity.

But its lower pricing a little bit to the retailer, a little bit to us. But separately it also comes with a royalty agreement. So we’re happy to chase that business, we’ll take that market share, but between the royalties and the lower margins, it lowers our overall mix of margin that we’re getting. So that would be a Kids Line example I think that talks about the mix shift.

We’re also looking at a lot of other product categories where we think we can be relevant and not all of those have the same dynamics as some of our categories today that have very, very attractive margins historically. So we’re certainly preserving all of our core business to the extent we can and then we’re trying to chase a lot of new categories and I just think prudently as we look forward not all of those can be quite as sort of juicy margin wise as some of the other ones.

Unidentified Analyst

Are there other areas like Carter’s where you’ve got that lower, just the structure would deliver less margin?

Bruce Crain

Take an example over in the world of LaJobi, its been a great acquisition for us. One of the most successful areas of LaJobi these days is their Graco license and we do Graco cribs and so what we’ve been trying to do with LaJobi is preserve all of the LaJobi brands that are more higher positioned in the market and what we’re using Graco for is our opening price point activity in the marketplace.

So again slightly lower margin structures but also with a royalty. Each one of our businesses has a version of that so that we can de-multi channel and capture as much market share. I think in today’s environment we’re pretty pleased with that actually. Look across the landscape today with people like Wal-Mart and others actually having a fairly good uptick from the consumer trading down, we’ve been able to participate in that consumer kind of shift that’s going on currently.

Unidentified Analyst

We’re hearing that the cost of doing business in China is up and people are looking for new sourcing areas, but we also hear that although the cost of doing business in China is up, generally they tend to be very, very efficient, productive, their change times are very short and its nice to say let’s move somewhere else, but you may lose on productivity what you pick up in labor, I’m just wondering what your take on that is.

Bruce Crain

I agree with you. In my most recent trip over there earlier this year, I think a lot of the trends; China is an extraordinary production engine. One of the things that we’re doing a lot is we’re shifting a little bit more inland to other factory bases within China that can still leverage all the logistics and the attitude and work mindset of the Chinese. A lot of those are owned by the same factory owners that are simply moving their factory operations.

So we’re doing a lot of that. For certain product categories though I think we are being successful outside. LaJobi has a very nice business in their wood product in Thailand, Vietnam; they also do a lot of their lower price point stuff still in China where they need the efficiencies. So we’re dabbling and I think we’re going to dabble a lot more to make sure that we’re diversified both cost wise and quite frankly its probably a little bit geopolitically too, to have a little bit more going on in some other places.

I agree with your point, the Chinese operation is amazing. I spent time in India and a lot of other places trying to get product in and out of ports, corruption levels, red tape, all the ancillary things that you need, packaging, transportation, are not anywhere near as developed in most other places.


Your final question is a follow-up from the line of Arnie Brief – Goldsmith & Harris

Arnie Brief – Goldsmith & Harris

You discussed this a little bit in the 10-Q but I just want to be sure, is there any financial, any problem financing the Gift business seasonally in the third quarter?

Bruce Crain

No I think we are confident the business is well covered. Moving forward in the near future I think as we say in the Q, if we do a long-term outlook based on current trends it does get more tenuous if we don’t turn around some of the underlying margin structures and sales trends.

Anthony Cappiello

We will not have any problems between now and year end for sure. We are positioned well. We have adequate cash and adequate borrowing capability.

Arnie Brief – Goldsmith & Harris

I detect some concern, I don’t normally do this on a conference call but if the people who are looking at LaJobi and CoCaLo and trying to figure out the company did provide an 8-K in June, and the Orange County newspaper provides some numbers, and my numbers indicate that those two acquisitions had sales of $74 million in 2007 and if you look at the 8-K, the first quarter on LaJobi which is in the 8-K, and the June quarter numbers which the company gave you in the release for those two acquisitions, they seem to be running at a run rate of about $85 million, so they’re showing nice increases.

The other comment I have to make because there’s a lot of concern obviously about the third quarter which was so good last year with Shining Stars is that that third quarter also included an inventory write-down of and substantial advertising expenses which hopefully neither will repeat this year so there’s some relief on the margin side to the lower Shining Stars sales.

Could you comment on that at all in terms of the outlook for margins in the third quarter for the Gift business?

Anthony Cappiello

We’ve been maintaining our margin rate all along. In fact I think we were one point better year-on-year as we said in the Gift segment. We don’t expect to erode in the third quarter. We have very strong expense control in our Gift segment and very good margin control in our Gift segment. So we don’t expect any major changes there going forward.

Arnie Brief – Goldsmith & Harris

Are you shipping animals now?

Anthony Cappiello

We’re just starting to, yes.

Bruce Crain

We think we have a whole good pipeline of that stuff.

Arnie Brief – Goldsmith & Harris

You’ve indicated on a couple of occasions, that you recognize the need for getting the revenue side of the Gift business up or the cost structure down or doing something more dramatic in terms of easing that burden all together, could you give us some idea at this point are you actively looking at acquisitions to the Gift business? Is it still a question of getting it to perform better operationally? Is there any effort to really leverage up the revenue side?

Bruce Crain

Our focus and the team’s focus, clearly all the time whether its I and J, Gift, our responsibility is to be looking strategically at different businesses, but 99.9% of what we’re doing within Gift is focused on the operational side and yes, many of those issues have to do with getting leverage across our infrastructures that we’ve got. We’ve got a tremendous organization in the Far East and we’re trying to push a lot of new product development activities through there. We’ve got sales organizations that are geared up to sell stuff so as you’ve seen at several of the shows and other events, we’re really trying to push new product initiatives through what we think is a really well developed pipeline and a great brand group and that’s where we’re getting our leverage from and execute within that. We’re pretty happy with our margin structures.

Our key challenge is sales and that’s what we’re spending the most time on is developing new sales initiatives and programs. Its just hard, that none of the tides or the oceans are really helping us out right now in the gift industry but I’m not going, at this point that’s where the focus is but clearly on the strategic front, that is something that a few of us spend a lot of time on also and not appropriate for this call.

Arnie Brief – Goldsmith & Harris

Was the weakness in the core business in the June quarter across all the product lines, i.e. Applause and Russ and [Yokimo] was it across all channels, mom and pop and mass? Were there any specific areas of weakness?

Anthony Cappiello

The erosion in the second quarter, a good piece of it was in our Shining Stars business. The rest of our business, some categories were a little bit up some categories were a little bit down.

Bruce Crain

Q2 I think industry wide we really saw a downdraft, as I mentioned, the show traffic in June I think was really indicative of what’s going on in the Gift trade. I heard quotes out of some of the marks that were down 30%, 40% in some of their traffic numbers which is really pretty concerning. That means that’s when the last buys would be happening for Christmas product; you had gas prices, travel costs for all these retailers and things like that.

So that’s our concern, its more the outside external factor which we really can’t influence that well. But within our product we’re pretty pleased with what we’ve got out in the market for new products and we’ve got reception on it. What will be telling is over the next months as we get back on the road and are really pushing our key accounts, is what we can now push for the balance of the year and especially into the early part of 2009 for our big programs, Easter, Mother’s Day, Valentine’s Day and those kind of programs which we’re spending a lot of time on selling activity for now.

Arnie Brief – Goldsmith & Harris

Was there any way in the quarter of differentiating between retailers adjusting inventories down and sell-through at the consumer level?

Bruce Crain

I think we saw more of that in the I and J side then we saw it in the Gift side and on the I and J side despite those adjustments which were pretty pronounced, I think it was pretty prevalent in the press that that was going on throughout retail, I think we did quite a good job of having increases in sales despite that on our I and J front. I think it is a trend and I think another open question will be does the consumer come out to shop over the next months and we feel we’re adequately supplied with inventory that we can take care of some of those orders without being excessively ready for that.

Arnie Brief – Goldsmith & Harris

Is it fair to say that in I and J since demand for the product is reasonably stable, and parents got to outfit a baby, since demand is reasonably stable, that the inventory adjustments at retail tend to be short-term?

Bruce Crain

Yes, it think they are somewhat, I think its also by product category. As I said, on customer concentration, there are about six accounts that sort of determine a tremendous amount of the activity in the channel depending on what they do on their own logistics and adjustments. But yes, generally one of the things we like about the business also on the I and J front in particular, is that it isn’t particularly seasonal and is not dependent on Christmas either so these adjustments will flow through; they’re not necessarily driven by seasonal Christmas kind of stuff. And there are several of these retailers that have their own issues internally on how they run their logistics and yes, I think its one-time adjustments then; we’re feeling pretty confident that we’ve got plans that might get pushed out that we’re not losing placements.


There appear to be no further questions at this time; I will now turn it back over to management for any closing remarks.

Bruce Crain

Thank you everybody for questions. Look forward to coming back to you with some hopefully more upbeat news as the further quarters come in and look forward to keeping you up to date on the Q3 call which will be coming up in two-and-a-half months or so. Thanks very much; have a good day.

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