RC2 Runs Out of Steam

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As Dora the Explorer might say about RC2's (Nasdaq: RCRC) second-quarter earnings: Es muy mal.

The short-term effects of RC2's June toy recall were even more severe than the Street expected, and the stock is currently trading about 20% off yesterday's close. Here are a few of the quarter's low-lights:

•  Revenues, expected to be $108 million, came up 15% short at $92.2 million.

•  Gross margins decreased year over year from 47.3% in 2Q 2006 to 41% in 2Q 2007.

•  Quarterly earnings per share excluding retail costs and the tax benefit were $0.28, 20% short of the Street's estimates.

•  RC2 lowered 2007 EPS guidance to between $2.05 and $2.15 from a previous range of $2.60 to $2.75 per share.

As I mentioned in yesterday's pre-earnings report, RC2 investors need to pay close attention to the potential long-term effects of the recall. While those are yet to be seen, one thing is for sure -- the short-term effects are u-g-l-y ugly.

Going forward
On one hand, problems with Chinese manufacturing standards are not just an issue for RC2. Just today, in fact, one of RC2's competitors, Mattel (NYSE: MAT), announced that an internal probe had discovered excess levels of lead in some of its Big Bird and Elmo toys, which it is now in the process of recalling. Certainly, Hasbro (NYSE: HAS) and Jakks (Nasdaq: JAKK) are reviewing the quality of their Chinese-made products right about now. Or at least they should be.

The quality and safety of children's toys are paramount to parents. As we saw with the sharp drop in RC2 revenues this quarter, the backlash from questionable quality and safety can be swift and severe.

Long-term RC2 investors will want to keep a close eye on the issue of Chinese manufacturing standards and any reactionary legislation that might arise inside the Beltway.

RC2 is a Motley Fool Hidden Gems pick. Hasbro is a Stock Advisor choice. A free 30-day trial to either service is yours.

Todd Wenning does not own shares of any company mentioned.