RC2 Upgraded to Outperform

We are upgrading our rating on RC2 Corp. (RCRC), a leading designer, producer and marketer of innovative, high-quality toys, collectibles and infant and toddler products, to Outperform from Neutral.

The rating upgrade is based on second quarter 2010 earnings, which were well ahead of the Zacks Consensus Estimate, primarily driven by strong international sales. The company also raised the low end of its earnings guidance for fiscal 2010.

Moreover, we expect the company to benefit from its aggressive acquisition strategy and remain optimistic regarding its recent acquisition of privately held JJ Cole Collections for $40 million, a developer and marketer of travel products for mother, infant and toddler care. We consider the acquisition to be strategically sound for RC2, as it will expand the company’s mother, infant and toddler segment, which is less seasonal, generates higher margins and performs well in both strong and weak economic conditions. Also, JJ Cole has less exposure to international market, which provides significant sales growth opportunities in international markets.

Additionally, the company’s cost reduction initiatives should drive margins. Given the demographic trends, RC2’s focus on core early childhood also bodes well. Considering the company’s product line-up in the second half of 2010, we expect an improvement in the top line. Moreover, strong cash flow and modestly levered balance sheet offer a solid operating backdrop.

Second Quarter Results Ahead of Estimates

RC2’s second quarter earnings of 17 cents per share outdid the Zacks Consensus Estimate of 15 cents but were below 19 cents in the prior-year quarter.

Total revenue dropped 1.1% to $86.1 million due to a conservative ordering by retailers though consumer spending remained stable.

The company achieved a 12.8% growth in international sales, driven by solid international growth in the mother, infant and toddler products category, positive impact from currency exchange rates and shipments of the Chuggington product. However, North American sales were down 5.8% year over year.

Gross margin expanded 30 basis points year over year to 42.5%, driven by the elimination of unprofitable and low volume product line and favorable inventory absorption, partially offset by unfavorable product mix, higher input and labor cost and a rise in promotional allowances.

Outlook for 2010

For full-year 2010, RC2 has raised the low end of its earnings guidance range of $1.35, and now expects earnings in the range of $1.40 to $1.45 per share.

Management continues to invest in the Mother, Infant and Toddler Products categories and expects it to perform well relative to other consumer product categories in fiscal year 2010. The company expects input costs to increase in fiscal 2010.

Earnings Estimate Revisions: Overview

Following the second quarter earnings release, the Zacks Consensus Estimate for the company has increased, with the analysts remaining bullish on the stock. The earnings estimate details are discussed below.

Agreement of Estimate Revisions

From the table below, an optimistic inclination can be witnessed among the analysts. Revision trends in the last 30 days drifted toward the positive side. For fiscal 2010, 3 out of 7 analysts covering the stock raised their estimates and for fiscal 2011, all the 7 analysts increased their estimates. None of the analysts reduced their estimates. The analysts view the acquisition of JJ Cole Collection as a positive for the company and have increased their estimates based on the revenues and earnings contribution from the acquisition. The company expects the deal to increase its second half 2010 earnings per share by 5 cents, excluding the impact of transaction costs. In 2011, RC2 expects the deal to add 20 cents per share to 25 cents per share.

Magnitude of Estimate Revisions

The table below indicates that earnings estimates have climbed by 4 cents to $1.49 for fiscal year 2010 and by 22 cents to $1.87 for fiscal 2011, over the last 30 days. The upside in 2011 estimates is mainly based on earnings accretion from the deal.

RC2 CORP (RCRC): Free Stock Analysis Report

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