Mattel, Inc. Q4 2008 Earnings Call Transcript

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 |  About: Mattel, Inc. (MAT)
by: SA Transcripts

Operator

Good day and welcome to the Mattel, Inc. fourth quarter 2008 earnings conference call. Today's conference is being recorded.

At this time I'd like to turn the conference over to Dianne Douglas. Please go ahead, ma'am.

Dianne Douglas

Thank you, Operator.

As you know, this morning we reported Mattel's fourth quarter and full year 2008 financial results. In a few minutes, Bob Eckert, Mattel's Chairman and CEO, and Kevin Farr, Mattel's CFO, will provide comments on the results and then the call will be opened for your questions.

Certain statements Bob and Kevin make during the call may include forward-looking statements relating to performance of our overall business, brands and product lines. These statements are based on currently available operating, financial, economic and competitive information, and they are subject to a number of significant risks and uncertainties which could cause our actual results to differ materially from those projected in the forward-looking statements.

We describe some of these uncertainties in the Risk Factors section of our Form 10-K and Form 10-Q, as well as in other filings we make with the SEC from time to time. Mattel does not update forward-looking statements and expressly disclaims any obligation to do so.

Information required by Regulation G regarding non-GAAP financial measures is available on the Investor and Media section of our corporate website, Mattel.com, under the subheading Financial Information and Earnings Releases.

Now, I'd like to turn the call over to Bob.

Bob Eckert

Thank you, Dianne.

While this isn't an audience that I have to remind about the tough economic conditions we weathered as a company and industry during the holiday season and continue to endure today, the myriad issues that affected the global economy and financial markets continue to touch the lives of everyone, including Mattel's investors, our employees, and the company's supply chain partners, toy vendors and retailers.

And the clouds of economic gloom persist. After the release of the U.S. Department of Labor's employment report, headlines across the country were dominated by the news that more jobs were lost in 2008 than in any other year since 1945. And unfortunately, that's not the worst news. About 75% of the 2.6 million jobs lost for the year were lost in the last four months, not a reassuring trend.

As it relates to toys, I recently read that during 2008 nearly 1,000 toy exporters shuttered their doors in southern China. And toy retailers weren't immune to the economic downturn, with significant toy sellers in the U.S., U.K., Mexico and other major markets either closing their doors or entering bankruptcy.

Against that backdrop, we underperformed for the quarter and ultimately the year due to a combination of lackluster sales, lower gross margins and higher expenses. On the encouraging side, it's likely the toy industry performed relatively well in 2008 compared to many other categories as it's done during previous times of economic recession. And in the allimportant holiday season, at least during the September through November period for which U.S. NPD data's available, Mattel outperformed the competition and gained share.

As a result of our ability to make terrific toys we've been awarded new toy licenses for the WWE Wrestling and Hit Entertainment's Thomas and Friends, which will help the company grow in 2010 and beyond.

Finally, as we close a most difficult, it's important to recognize a bright spot with the growth of American Girl. This team achieved record revenues despite the economic headwinds that we call encountered. American Girl's success in 2008's a testament to prudent retail expansion and terrific marketing, such as last summer's Kit Kittredge theatrical release.

As we look to 2009, we're preparing for a continuation of unfavorable economic conditions and the resulting challenging times. Our focus is both on weathering the storm by strengthening our balance sheet and controlling costs, as well as preparing for better times by developing new properties and rebuilding margins.

The coming year also brings an incredible milestone to celebrate at the Barbie brand marks its 50th year. From the tents of New York Fashion Week to Barbie's Malibu Beach House to the opening of House of Barbie in Shanghai, the brand is reaching girls of all ages around the world. We'll celebrate an industry changing toy that has become an iconic global lifestyle brand and honor the impact Barbie and her many accomplishments have had on girls through the decades.

In thinking about all these things and looking toward the coming year and beyond, it's clear that we have a year ahead that will have much excitement, but also some difficult challenges, including the contracting global economy, the credit crisis that our vendors and retail customers are still facing, and the headwinds we face in the movie tie-in portion of our portfolio.

As you know, we began to take action last year, first by streamlining our global professional work force by 8%. We also initiated a modest price increase for the spring 2009 line. And we're continuing to renegotiate products costs and reassess our advertising spend and strategy in light of current conditions.

Our goal in 2009 is to improve the profitability of the business by looking at all areas, from HR to marketing and all functions in between, with the relentless pursuit of cost reductions, including reducing the number of underperforming SKUs and tightening our infrastructure as we strive to improve efficiencies.

And a message to Mattel employees worldwide this morning. I told them that I'm not pessimistic, but I am realistic. Therefore, our guiding principals for 2009 are to reduce spending in all areas of the business, work smarter and more effectively, and extract every efficiency we can out of the supply chain in order to deliver improved profitability, better execution, and a stronger, well positioned Mattel for 2010 and beyond.

I'll now turn the call over to Kevin Farr, Mattel's CFO, who will provide more detail on our financial results.

Kevin Farr

Thank you, Bob, and good morning, everyone.

As you heard from Bob, we were not immune from the challenging global economic environment in 2008, particularly retail weakness in the all-important fourth quarter. We experienced widespread sales decline in the fourth quarter as retailers tightly managed their inventory risk given the challenging economic environment. I'll discuss worldwide gross sales shown on Exhibit 2 of today's press release, starting with a review of sales for the fourth quarter.

Total worldwide gross sales for the quarter were down 12%, including a 5 percentage point negative impact from changes in currency exchange rates. U.S. sales were down 6%, while international sales were down 20%, including an 11 percentage point negative impact from changes in currency exchange rates.

On a regional basis, sales in Europe were down 24%, including a 9 percentage point negative impact from exchange rates.

Sales in Latin America were down 12%, including an 11 percentage point negative impact from foreign exchange.

And sales in Asia-Pacific were down 12%, including a 12 percentage point negative impact from changes in exchange rates.

I will now review our core categories and brands for the fourth quarter.

Mattel Girls and Boys Brands. Worldwide sales for Mattel Girls and Boys brands segment were down 17%, including a 6 percentage point negative impact from changes in currency exchange rates.

Worldwide, Barbie sales were down 21%, including a 7 percentage point negative impact from changes in currency exchange rates. Barbie sales in the U.S. were down 6% and Barbie sales in international markets decreased 28%, including a 9 percentage point negative impact from changes in currency exchange rates.

Worldwide sales of other girls brands were down 8%, including a 7 percentage point negative impact from changes in exchange rates. Sales in the U.S. were up 4%, while international sales of other girls brands were down 16%, including a 12 percentage point negative impact in changes in currency exchange rates.

Sales in the Wheels category, which include Hot Wheels, Speed Racers, Matchbox and Tyco R/C decreased 19%, including a 6 percentage point negative impact from changes in currency exchange rates.

Sales in our Entertainment business, which include games and puzzles, were down 17%, including a 6 percent point negative impact from changes in foreign exchange.

FisherPrice Brands. Worldwide sales for Fisher-Price brands were down 10% for the fourth quarter, including a 4 percentage point negative impact from changes in currency rates.

On a regional basis, international sales of Fisher-Price brands decreased 13%, including an 11 percentage point negative impact from foreign exchange, while sales in the U.S. declined 9%.

Worldwide, core Fisher-Price was down 9%, including a 5 percentage point negative impact from changes in currency exchange rates. U.S. sales of Fisher-Price core were down 7% and international sales were down 11%, including an 11 percentage point negative impact from changes in foreign exchange rates.

Worldwide, Fisher-Price Friends sales declined 12%, including a 4 percentage point negative impact from changes in currency exchange rates. Sales of Fisher-Price Friends in the U.S. were down 10%, and international sales were down 16, including a 10 percentage point negative impact from changes in foreign exchange.

American Girl Brands. For the fourth quarter consecutive quarter, American Girl brands delivered sales growth of 5% this quarter.

I'll now review sales for the full year.

Worldwide gross sales were down 2% for the full year, with zero impact from changes in currency exchange rates. On a regional basis, sales in Europe were down 6% compared to the prior year, including a 2 percentage point benefit from changes in foreign exchange rates. Sales in Latin America were up 7%, including a benefit of 2 percentage points from changes in currency exchange rates, and sales in Asia-Pacific were up 4%, with zero impact from changes in foreign currency.

I will now review our core categories and brands for the full year.

Mattel Boys and Girls Brands. Worldwide sales for Mattel Boys and Girls brands decreased 2%, which included zero impact from changes in currency exchange rates. The sales decrease reflected a 2% decrease in international sales, which included a benefit from changes in the currency exchange rates of 2 percentage points and a U.S. sales decline of 1%.

Worldwide Barbie sales were down 9%, including zero impact from changes in currency exchange rates. Barbie sales in the U.S. were down 7%, while in international markets Barbie sales were down 9%, including a 2 percentage point benefit from changes in currency exchange rates.

The primary drivers of the global decline were last year's Barbie Girls mp3 player, lower international sales of MyScene, and the fact that this year's fall Entertainment segment, Diamond Castle, did not perform as well as last year's [Island] Princess, particularly in international markets.

Worldwide sales of other girls brands were up 11%, which included a 1 percentage point benefit from changes in currency exchange rates. The sales increase is primarily driven by strong sales of High School Musical, Little Mommy, Hannah Montana in international markets, and Disney Princess, partially offset by sales declines in PixelChix and Polly Pocket.

Worldwide sales for the Wheels business were up 4%, including a benefit from changes in currency exchange rates of 1 percentage point. The U.S. Wheels business experienced double-digit sales growth driven primarily by the Hot Wheels portion of the Speed Racer business.

Sales in our Entertainment business, which include games and puzzles, were down 4%, with a 1 percentage point benefit from changes in currency exchange rates. The decline in sales worldwide was driven primarily by declines in the sales of the Cars property, interactive games, and Radica, partially offset by growth in Batman: The Dark Knight.

Fisher-Price Brands. Worldwide sales for Fisher-Price brands were down 3%, with a 1 percentage point benefit from changes in foreign exchange rates. U.S. sales were down 6%, while international sales were up 1%, including a zero impact from changes in currency exchange rates.

Worldwide sales of core Fisher-Price were up 1%, including a 1 percentage point positive impact from currency exchange rates. U.S. sales were down 4%, and international sales increased 8%, including a benefit of 1 percentage point from changes in currency exchange rates.

Worldwide sales of Fisher-Price Friends were down 16%, including a 1 percentage point negative impact from currency exchange rates. U.S. sales declined 15 percent, while international sales were down 17%, including a 1 percentage point negative impact from changes in foreign exchange.

American Girl Brands. Sales of American Girl brands were up 7% versus the prior year, driven primarily by strong sales of historical dolls tied to the Kit Kittredge movie, with double-digit increases in the retail channels.

Now let's review the P&L, which is shown on Exhibit 1. For the fourth quarter, gross margin was 46%, down 200 basis points from 48% for the fourth quarter last year. Gross margin benefited from price increases, favorable foreign exchange rates, and product recall related costs included in last year's fourth quarter. These gains were more than offset by external cost pressures, mix, and cost of distribution.

For the year, gross margin was 45.4%, down 110 basis points from 46.5% in 2007. Compared with the prior year, gross margin benefited from price increases, favorable foreign exchange, and product recall costs in last year which were more than offset by external cost pressures, distribution, and mix.

For the fourth quarter, advertising expense was $275.6 million or 14.2% of net sales versus 13% for the fourth quarter of 2007, reflecting lower than expected sales volume. For the year, advertising expense was $719.2 million or 12.2% of net sales compared to 11.9% last year. Last year's advertising expense included product recall related costs of approximately $1 million in the fourth quarter and $5 million for the full year.

For the quarter, selling, general and administrative expenses decreased approximately $20 million to $384.2 million. As a percentage of net sales, SG&A expenses increased 140 basis points to 19.8%. Lower fourth quarter SG&A expenses were driven primarily by a lower incentive cost and favorable foreign exchange, partially offset by severance charges and legal settlement related costs.

For the full year, SG&A expense was $1.42 billion, an increase of $85 million from 2007 and as a percentage of net sales, it increased 170 basis points to 24.1%. Fiscal year 2008 SG&A expenses include approximately $52 million of incremental legal and settlement related costs. The remaining increase in SG&A was driven by the negative impact of foreign exchange and bad debt charges.

For the year, overall equity compensation expense was $36 million compared to $22 million in 2007.

Operating income in the fourth quarter was $232.4 million or 12% of net sales, down 450 basis points compared with last year's fourth quarter due primarily to lower gross margins, higher advertising expenses, and higher SG&A costs as a percentage of net sales, all impacted by lower sales.

For the year, operating income was $541.8 million or 9.2% of net sales, down 300 basis points from the prior year, reflecting lower gross margins, higher advertising expenses, and higher SG&A costs, all impacted by lower sales.

For the fourth quarter, interest expense was $28.9 million, up slightly from the prior year fourth quarter. For the full year, interest expense increased from $71 million in 2007 to $81.9 million in 2008 due to higher average borrowings, partially offset by lower average rates.

Interest income for the quarter was $3.2 million versus $4.7 million in 2007, reflecting a lower yield and a higher average cash balances in the fourth quarter of 2008. For the year, interest income decreased from $33.3 million to $25 million.

In the fourth quarter, non-operating income net was $19 million versus $2.8 million in 2007. For full year 2008, other non-operating income net was $3.1 million versus $11 million in 2007. The current year income relates primarily to currency exchange gains partially offset by losses on other investments.

The income tax provision for the year increased from $103.4 million to $108.4 million. The 2007 tax provision included net benefits related to prior years of $42 million relating to tax settlements, reassessment of tax exposures, and tax law changes. For full year 2008, the tax rate was 22.2% and we expect the rate to be around 22% to 23% for 2009 based on current tax laws.

For the fourth quarter, reported net income of $176.4 million or $0.49 per share versus last year's $328.5 million or $0.89 per share. The 2007 fourth quarter earnings included tax benefits of $0.13 per share and recall related costs of $0.09 per share. For the year we reported net income of $379.6 million versus last year's $600 million.

Full year earnings per share for 2008 were $1.05, which included legal settlements and severance related costs of $0.18 per share. Earnings per share for 2007 of $1.54 included tax benefits of $0.11 per share and recall related costs of $0.22 per share.

So to summarize the P&L, the decrease in full year resulted primarily from slightly decreased sales volume, lower gross margin, higher advertising expense, and higher SG&A costs.

Now turning to the cash flow and balance sheet, cash flow from operations for the year was $436 million, driven primarily by net income of $380 million.

Consistent with our capital investment framework, capital expenditures for the full year were $199 million, up from last year's $147 million, and approximately $58 million of cash was deployed to complete several strategic acquisitions.

We also continued to return excess capital to our shareholders in the form of cash dividends and share repurchases. In the fourth quarter we paid an annual cash dividend of $0.75 per share, flat with the prior year. Also during the year we repurchased 4.9 million shares of our stock at a total cost of $91 million. As a result of the repurchase activity, at December 31, 2008 there was $358 million basic shares outstanding.

Year end cash on hand was $617.7 million, down from approximately $901.1 million at the end of 2007, primarily due to lower cash balances at the beginning of the year.

Receivables were $873.5 million or 41 days of sales outstanding, flat with last year. Excluding the year-to-year [changes in factoring], which was down $73 million versus prior year, days of sales outstanding was two days lower.

Inventories at $485.9 million were up $57.2 million or 13% versus 2007 and represented 78 days of supply, which is four days higher than last year. Our data suggests retail inventory levels of our product with our major U.S. customers finished the year modestly above prior year levels, but are in good shape.

Our total balance sheet debt was $900 million, a decrease of $49 million from the prior year. During 2008, the company paid down $349 million of short-term borrowings and $50 million of medium-term notes. These payments were offset by the issuance of $350 million of long-term debt. Our debt to total capital ratio ended the year at 29.8% versus 29.1% last year.

So to summarize, Mattel experienced widespread sales decline in the fourth quarter as retailers became more cautious about inventory risk in light of the challenging global economic environment. That said, we finished the year with a relatively solid balance sheet.

As we move into 2009, we expect our top line to continue to be under pressure due to the continuation of the challenging economic and employment conditions, a light Entertainment pipeline, and the stronger dollar. As you heard from Bob, in 2009 our focus will be on strengthening our balance sheet and managing costs in line with realistic revenues with a goal of improving profitability in our business.

In the middle of 2008, we kicked off a global cost leadership program intended to deliver about $90 to $100 million in net costs savings for 2009 and $180 to $200 million cumulative net savings by the end of 2010. We're well on our way, with about $60 million of annual savings expected to be generated by the work force reduction implemented in the fourth quarter of 2008. The results of this program should be improved profitability and cash flow, which we expect to strengthen our balance sheet and lower debt.

That concludes my review of the financial results. Now we'd like to open the call to questions. Operator?0

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Your first question comes from Timothy Conder - Wells Fargo.

Timothy Conder - Wells Fargo

Could you give us a little bit more color on the channel inventory and how long do you think  will it be the first quarter - until the retailers get the channel where they want in the U.S.? And then, Kevin or Bob, just look to extend that to your major retail customers on an international basis.

Bob Eckert

Our point of sale of the year was up slightly and retail inventories, as best we can calculate them, finished the year up mid to high single digits over a year ago. About half of that increase was due to higher prices.

That said, given the magnitude of the sales decline we experienced and the speed with which the economic crisis hit, I'm pleased with how we managed inventories, both for our retail customers and for us.

I would say in general we don't have data quite as good outside of the U.S. as we do in the U.S., but all of the anecdotes suggest that inventories are pretty clean outside of the U.S. and, if anything, are probably a bit below prior year levels.

All that said, clearly in the current economic environment, retailers are looking to reduce inventories. And, as you know, it's not just a function of our inventories; it's whatever else they have across their business. So I suspect they'll continue to be very focused on inventories. I don't have a time for you when a given retailer will feel like they're in pretty good shape. But again, across the board I'm pretty comfortable with our inventories right now.

Timothy Conder - Wells Fargo

And then just a clarification point. Kevin, did you say that the legal and severance costs for the year were about $0.18 a share?

Bob Eckert

I think you said they were probably an incremental $52 million. I can't do the arithmetic off the top of my head.

Timothy Conder - Wells Fargo

And then how much were they in the fourth quarter?

Kevin Farr

Well, legal expenses were down in the fourth quarter overall, but we did incur legal settlements in the fourth quarter, which was about $13 million related to the settlement agreement with the state AGs and with California.

Timothy Conder - Wells Fargo

Could you comment on the D&A for '08 and your expectations for D&A and CapEx for '09?

Bob Eckert

Well, I think, Tim, this is the first year in many - that is, 2008 - where we actually spent CapEx in line with our guidance of $180 million to $200 million. I think it was $198 million, Kevin?

Kevin Farr

It was $199 million, Bob, and it was $147 in 2007. The increase in capital expenditures in 2008 were related to investments regarding moving American Girl Place Chicago to a new location on Michigan Avenue at Water Tower Place. We were building the House of Barbie Shanghai. We renovated our design center in El Segundo. We implemented low level automation in our manufacturing facilities in Asia, and we incurred higher costs of steel to build tools for our product.

And that being said, in 2009 we'll be tightly managing CapEx. We expect to reduce CapEx in 2009 to levels that we were at a couple of years ago, below $150 million.

Timothy Conder - Wells Fargo

And D&A, Kevin, for '09 expectations?

Kevin Farr

D&A was about $172 million, flat.

Timothy Conder - Wells Fargo

And then for '09, expect that up just a little bit?

Kevin Farr

Up just a little bit, but not significantly.

Operator

Your next question comes from Felicia Hendrix - Barclays Capital.

Felicia Hendrix - Barclays Capital

So just, Kevin, at the end of the call you outlined cost savings for '09 and what you'd get to by the end of 2010. I'm wondering if you could just break that out for us, SG&A versus cost of goods sold type savings?

Kevin Farr

It's going to be mainly SG&A savings. As we said, our focus will be on strengthening our balance sheet and managing costs in line with realistic revenues with a goal of improving profitability of our business in 2009.

And there are three drive lines to this global cost leadership program, which should result in significant savings. The first relates to the reduction in force of 1,000 headcount that was implemented in November of 2008. We have another driver line related to the coordinated overhead efficiency strategic plan that includes structural changes to lower cost and improve effectiveness, things like offshoring and outsourcing IT, clustering international regions, which is being implemented, and additional direct procurement focused to leverage Mattel's global scale. We're on track to deliver the $90 to $100 million in net saving for 2009 and about $180 to $200 million in cumulative savings for 2010.

And when you look at the timing of the 2009 savings, we expect approximately $60 million of the savings related to last year's reduction of force to be spread evenly throughout the year and the remaining savings weighted towards the second half of '09.

Bob Eckert

Another thing we're going to do, Felicia, is realign our ad budgets with today's environment. The fact is the fourth quarter sales came in below our expectations, but the advertising was already committed. So as we go into 2009, we're going to make sure that the ad budgets line up with realistic revenue assumptions.

Felicia Hendrix - Barclays Capital

Bob, ever since you joined Mattel you've been talking about SG&A reductions. It's been a major focus for you over the years and particularly in focusing on overhead efficiencies. Kevin, you just laid out some of the achievements that you've already made, but can you give us confidence that all of these goals will be achieved, because you have been talking about this sort of thing for years.

Bob Eckert

Well, we've already taken action for 2009 across a number of fronts. We've reduced the infrastructure of the company just by the headcount reduction. We're going to continue to work on efficiencies, as Kevin suggested. Legal costs have certainly been high given a couple of significant issues we've been facing.

But we're going to do things even like, Felicia, look at our SKU count. You know, like most businesses, a relatively small portion of our SKUs generate the most sales and profits, and it takes a fair amount of work to make all these underperforming SKUs and we're going to go after it. So we're going to have few SKUs in 2009 than we had in 2008 across some really key businesses, like our girls product line, and I think it's going to show up 2009. We'll see.

Felicia Hendrix - Barclays Capital

And then with the cost pressures that you're seeing, gross margins will be a challenge. Should we think about kind of continuing the rate that we've seen towards the end of '08 going forward?

Bob Eckert

Well, we're working on two important things in gross margins. Number one, we have taken a modest price increase in our spring line, recognizing the realities of today's cost. But secondly, we're going to be working with our vendors and our own procurement group in our manufacturing plans to take advantage of what hopefully will be lower commodity costs this year.

Felicia Hendrix - Barclays Capital

And then just finally, getting to Thomas, do you have the rights to the wooden trains and do you have full global distribution?

Bob Eckert

No, we do not have the rights to the wooden trains; that remains with RC2. And I believe we have global distribution. Kevin?

Kevin Farr

Correct.

Felicia Hendrix - Barclays Capital

For the die cast?

Kevin Farr

Correct, die cast and plastic.

Felicia Hendrix - Barclays Capital

And that's how the relationship is going to stay? There's no plan to eventually get the wooden part?

Bob Eckert

Well, I don't think I get to decide that. But clearly, we aim to do a really good job for [inaudible] Entertainment with Thomas. It's a wonderful property  one of the best preschool properties around the world - and I think it's going to be an important opportunity for us.

Operator

Your next question comes from Robert Carroll - UBS.

Robert Carroll - UBS

I know you just touched on it briefly, but would you be able to just go into the commodity cost outlook and what you saw exiting the quarter and even at current run rates what it may imply for 2009?

Kevin Farr

Obviously, we saw record high commodity costs last year. And, as you know, there's been a lot of volatility in input costs over the last couple of years, particularly during our peak production season in 2008.

We're seeing some declines in our oil-based input costs from the record high levels that we experienced last year; however, while costs may not be as high as they were a few months ago, overall our basket of input costs are still well above year ago levels.

So we've implemented, as Bob said, a modest price increase for the spring of 2009 line. And as you probably know, due to our manufacturing cycle there's typically a lag of several months before input cost changes are reflected in our cost of goods sold. Generally, our cost of goods sold in the current quarter is heavily weighted to inventory that was made in the prior quarter.

In addition, we purchased about half of our product from third-party vendors, who generally quote prices to us about nine months in advance of our selling season. However, due to the rapid rise in input costs over the last couple of years, in some cases we allowed them to increase their prices after the original quote, so now, as Bob said, we're renegotiating prices with vendors to recapture savings as some of the input costs begin to decline from record-high levels.

For products manufactured in our own plants, the impact of changes in input costs reflect in cost of goods sold sooner, and it's our goal to improve gross margins over time and if costs continue to moderate, we'll expect to see improvements sooner.

Robert Carroll - UBS

Then just looking at one of the other expenses, as the MGA legal expenses taper off given kind of where things stand, how is that expected to play out over 2009?

Bob Eckert

Well, Robert, of the approximate $52 million of incremental legal and settlement related costs, the majority of legal costs do relate to MGA. As many of you know, what MGA says and what it does aren't always consistent. And in this case, despite its public pronouncements regarding its supposed desire to settle our dispute, we've seen no indication of a genuine interest in settlement throughout the case.

So we're preparing to go to the second phase of the case, which alleges, among other things, MGA's systematic theft of Mattel's trade secrets. I believe the evidence in Phase 2 is just as compelling as the evidence was in Phase 1, which you'll recall resulted in a unanimous jury verdict against MGA and its CEO. So we'll continue make these types of investments until the legal issues are resolved.

Robert Carroll - UBS

On promotion expense, would you guys be able to just touch on that during the quarter because obviously retailers probably tried to push back on shared promotional costs around the holidays? And then if there'd just be any hangover from that as they continue to discount to move inventory during Q1?

Bob Eckert

That shows up generally in the difference between our gross sales and net sales line, which I think, Kevin, is about 8% of sales?

Kevin Farr

Yes.

Bob Eckert

It hasn't really changed much. And all the expense from 2008 was accrued in 2008. I don't see anything special coming in that line.

Robert Carroll - UBS

So the retailers weren't pushing particularly hard to try and share some of the discounting that they had to do during the quarter?

Bob Eckert

Well, they always do that. And obviously, it was a tough year at retail and a very tough holiday season across the board. But we partnered well with retailers to move the inventory out. Again, fortunately we were able to turn off the spigot of the supply chain reasonably well given the timing and the magnitude of the economic crisis. So the inventory levels in general at both Mattel and our customers are in reasonable shape, and we clearly worked with them to move that inventory in the fourth quarter.

Operator

Your next question comes from Sean McGowan - Needham & Company.

Sean McGowan - Needham & Company

Just a follow up on that last point. So would you say then that the level of markdown money compared to the overall business was not especially high in the fourth quarter or was it?

Bob Eckert

No, I'd say it was at a fairly normal level, Sean.

Sean McGowan - Needham & Company

Shifting to another area, then, can you give us some kind of an updated status report on the various aspects of the recall related litigation. Where are we in that process?

Bob Eckert

We settled issues with the state attorneys general. I believe it was a group of about 41 states. And then there was a separate agreement with the State of California related to Proposition 65. The remaining litigation in product recalls relates to the individual class actions and I don't have an update for you on that, Sean.

Sean McGowan - Needham & Company

Would you expect the spending related to that ongoing piece of business to be comparable to what the overall spending was last year or should we see a reduction in legal spending related to the recall related issues in 2009?

Bob Eckert

Well, it's really hard to tell. You know, some of this agenda we don't control, so it's a function of how much preparation needs to be done for a trial, if there ever is a trial in the product recall case. And in the case of MGA, it's a function of how long MGA wants to keep going at this. The facts are friendly to us. We're winning and we anticipate prevailing, so we'll just go as long as MGA wants to go.

Sean McGowan - Needham & Company

On the MGA, there was another part. They had a suit that they were going to launch against Mattel. Has that evaporated because of the outcomes that have been decided in '08?

Bob Eckert

No, but our defenses in that particular portion of this second phase are very strong.

Sean McGowan - Needham & Company

And then the last part, for Kevin, would you mind getting into a little bit more detail on the breakdown of the decline in gross margin? How much of that was cost component versus mix?

Kevin Farr

Yes, I think, Sean, as I said, the gross margin for the full year declined to 45.4% compared to last year's recall impacted margin of 46.5%.

The biggest component was the continued pressure from commodities, then Chinese labor rates, the appreciating Chinese currency, incremental product testing and logistics, which were partially offset by the benefit of price increases, lower recall related costs and favorable forex. And then gross margin was also negatively impacted by mix as a result of higher closeout sales, but that wasn't as pronounced as really the cost increases that we incurred for the year.

Operator

Your next question comes from Tony Gikas - Piper Jaffray.

Tony Gikas - Piper Jaffray

You talked a little bit about your manufacturing partners. Is there any risk looking to '09 with any of your manufacturing partners, question number one. Question number two, do you see fewer toy manufacturers out there in the coming year? Does that present any opportunity for you? And then the third question, you said that you took a little bit of share, I think you said, for the year. Could you comment on your share change in the December quarter specifically?

Bob Eckert

I was commenting specifically on the share change - what we have for the holiday season. Remember, we do not yet have the December NPD data and that's obviously important, so we won't get it for several weeks. But in the season to date - that is, September through November  we did clearly gain share in the U.S. And Kevin, my recollection is it was more share gain than we've seen in previous years.

Kevin Farr

Correct, Bob.

Bob Eckert

Tony, as it relates to your question on vendors, we were impacted in 2008. About 40 vendors or thereabouts make up probably 80% of our vendor capacity. We did have issues with, I'm going to say, five to 10 vendors that were somehow impacted by the global crisis. They tend not to be our significant big vendors, but some of the smaller vendors. That was an issue for the industry in 2008. It was an issue for us in 2008. We're working closely with our vendors in our manufacturing plans for 2009.

So this is one of the areas that we are focused on, both our vendors and our retail customers. We have some anxiety on both sides of our supply chain, so we're working very closely with our partners on both sides of the supply chain.

As it relates to fewer toy companies out there, I don't know how that will play out. I can tell you that, as Kevin, I think, outlined on the call, from our own priority for capital deployment, in these tough times we want to strengthen the balance sheet, that is, reduce debt and increase our cash balances. From a shareholder perspective, our priority is to protect the dividend, so you won't see a lot of activity likely out of us in areas like either share repurchases or M&A. I think this is a year to really hunker down and run the cash machine for cash.

Tony Gikas - Piper Jaffray

For calendar '09 you cited that it's going to be a year of reducing costs, maintaining your balance sheet. There was little mention of new products, so maybe - I don't know if you want to talk about any product catalysts; I know you're going to do more of this in a couple of weeks at Toy Fair, but anything you could share there today. And then international sales being down significant more than the domestic market where international's been a bright spot in recent years, do you think that’s an incremental concern?

Bob Eckert

Yes, our international results are disappointing in '08. I think it's the first year of a sales decline outside of the U.S. since I've been with the company. All of the decline occurred in the fourth quarter and our focus was on finishing the year with clean retail inventories and to collect the cash and we were successful on both of those fronts.

That said, we underperformed in the more mature markets, especially places like Western Europe. That was partially offset by growth in the developing markets, but our business in the mature European markets was not nearly as strong as we wanted so, as we go into 2009, we're going to have to match our spending and investment plans with realistic revenue targets, particularly in Europe.

So it is an area of concern for me. Again, international has led our growth. I continue to think international is a bright spot for the company, but we've clearly got to do a better job in Europe.

Tony Gikas - Piper Jaffray

And then any mention of product that you can talk about for calendar '09?

Bob Eckert

Well, we will get to it in '09, but I think in general you're going to see us focus on the core.

We have some exciting plans for Barbie in her 50th. And although it wasn't a great year for the doll category in general - I think the doll business was impacted to some degree by maybe the Wii system or Webkinz - the fact is we have some relatively good news on Barbie. Barbie's share was up in the September through November period, whether you look at it against dolls or even against the total toy business. We ended the year very clean on retail inventories in Barbie. And, if you look more broadly across our entire portfolio of girls businesses, our business was pretty flat for the year. So I'm optimistic about our girls business. We've got some great properties and partnerships with Disney and others, and I think Barbie's 50th will help.

Hot Wheels has done a very nice job over the past year or two. That brands in stronger shape than it's been since I've been here. We're going to do some television work with Cartoon Network on Hot Wheels that'll start in the fall with a product line that goes with the new Hot Wheels television show.

The Fisher-Price core continues to do well, the infant and preschool business. So I think more than anything else you'll us in this kind of environment focus on our core brands.

Operator

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

Linda Weiser - Caris & Company

Can you just explain once again, Kevin, that $19 million other income line? Was that all an FX gain or can you explain what that was?

Kevin Farr

Yes, that's right, Linda. Generally, it was the FX gain with respect to our Venezuela subsidiary. As I said, for the year, other non-operating income was $3.1 million compared to $11 million last year. The lower income from the prior year is primarily due to lower foreign currency gains. It relates to a reevaluation of U.S. dollar cash balances held by our Venezuelan subsidiary. And we also this year incurred an investment impairment charge of $4 million.

And if you look going forward, the U.S. dollar cash balances held by our subsidiary may create paper gains or losses that will be reported in other non-operating income or expense as they are retranslated into bolivars using the parallel exchange rate at the end of each quarter.

So we've seen a lot of volatility each quarter this year with regard to this particular U.S. cash balances held by this subsidiary, but overall for the year it was income of $3.1 million.

Linda Weiser - Caris & Company

And Bob, maybe you could just talk about your thinking on - I mean, granted, it's very bad economic times and I haven't done all the numbers, but it looks like your cash flow wasn't clearing your dividend by too much in '08 - if things get really worse, really bad, and your cash flow remains a little bit under pressure in '09, what are your thoughts about cutting the dividend, reducing it? Would it be if you would be actually borrowing to pay it? What is your philosophy on that?

Bob Eckert

Well, Linda, that, as you know, is ultimately a Board decision that takes place quite a bit later in the year. But clearly in this kind of environment our top priority is to strengthen the balance sheet - more cash and less debt. And I think when you look at the year end cash, Kevin, there was something like $81 million that is not in the cash line that's in a current asset line from a money market fund that we'd begun to receive the proceeds of. But in general that's going to be our priority.

We're also going to reduce CapEx, as I mentioned. 2008 was a high mark in CapEx, probably since I've been in the company, and we're going to revert back to lower levels, without question, in 2009. In returning funds to shareholders, our priority is to protect the dividend. We'll have to see how the year goes and ultimately that's a Board decision later in the year when we have a better look at the full year. But clearly, we want to protect the dividend.

Operator

Your next question comes from Greg Badishkanian - Citigroup.

Greg Badishkanian - Citigroup

As you look at your major retail customers this holiday season, were there any trends that emerged in terms of their purchasing decisions besides generally, I'm assuming, being more conservative? Did they focus on innovation or toys with the best brands? Is there anything that you kind of saw from then?

Bob Eckert

Well, it's hard to tell because we don't have all the data yet in from places like NPD. I think my recollection is that at least through the September through November period, we had something like five of the top seven brands of toys at retail, so I think consumers in this kind of environment are focusing on core products and brands with which they're familiar.

Obviously, innovation is very important in this business. Elmo Live did well, as an example of a very innovative toy. So I think the formula for success in this business hasn't changed and likely won't change, but in a tough environment it's important to have good strong brands and it's obviously important to have new ideas for consumers.

Greg Badishkanian - Citigroup

And over the next quarter or two, I know it's a smaller selling season, but are you getting a sense that they're going to be even more conservative in terms of inventory and buying?

Bob Eckert

Yes, I think they will be. I was in a department store over the weekend. It's not a store that carries any toys, but I was amazed how this store had redone all of its fixtures and my bet is it took half the inventory out of the store.

And if you're a retailer, you're going to focus on inventory. We're focusing on inventory on our end of the supply chain and we're going to encourage our vendors to focus on their inventory. So as I've said all along, inventory is cash in the form of a depreciating asset, so we all need to make sure we run it as tightly as we can. And I'm confident retailers are going to see it that same way, not only in the first part of the year, but as they manage their entire year and think about the next holiday season. They're going to be tight.

Greg Badishkanian - Citigroup

And just housekeeping, bad debt expense fourth quarter, I don't know if you mentioned that. What was that?

Kevin Farr

For the full year it was about $13 million. For the fourth quarter it was about $1 million.

Operator

Your next question comes from Margaret Whitfield - Sterne, Agee & Leach.

Margaret Whitfield - Sterne, Agee & Leach

Yes, you mentioned, Bob, that Barbie's share was up in the September to November period. I've seen new 50th birthday product on shelves and the new spring line, Thumbelina. I wondered if you could comment what the early read is on those two areas.

Bob Eckert

Well, I don't have a lot yet; it is very early. But I can tell you that not only did we pick up a little share in the fourth quarter, our POS was positive here in the U.S. on Barbie for the first time in a bit. And also the NPD measured sales - that is, retail sales - again, we don't have December but from September through November we're up a bit in Barbie, not just in sale but in sell through.

So we do have a strong lineup. You've seen it in stores. You hate to get out in front of Barbie, but I think we'll be in better shape this year on Barbie than we've been in awhile.

Margaret Whitfield - Sterne, Agee & Leach

And you mentioned price increases on the spring line. Can you quantify the percentage and when it took effect?

Bob Eckert

It took effect January 1. I'd call it mid single digits. Our pricing wasn't as high as it was a year ago when we raised prices, but it's above the levels we were taking two or three years ago. So I think it's a reasonable level of pricing given the current cost environment.

Margaret Whitfield - Sterne, Agee & Leach

And at the outset you mentioned toy sellers filing Chapter 11 in U.S., U.K., Mexico collectively. What kind of volume is that going to be for '09 in terms of loss?

Bob Eckert

Well, at the end of the day we will clearly lose sales, particularly related to retail inventories. And you know folks like KB here in the states or Woolworth in the U.K. are significant sellers of toys. Ultimately, I think the consumer is going to continue to buy toys and just shop at other stores. So the real hit is only on what inventory they hold in the system, and I don't think that's a sizeable number. Kevin, do you?

Kevin Farr

No, I don't think it's a big number, Bob.

Margaret Whitfield - Sterne, Agee & Leach

And of course we don't have the Entertainment properties that we had last year, the three properties. Collectively, what did those lines benefit '08?

Bob Eckert

Well, they were significant. Batman was clearly a very good property. Fortunately, Batman goes on TV. It started in the fall with Batman: The Brave and The Bold television show, and so we're going to be producing toys in the spring for that. Cars continues to be a good property. It's not as big as it was, but it's now three years since the movie and it's clearly an evergreen property like Toy Story's an evergreen property. Kung Fu and Speed Racer were not big toy properties.

It is going to be an Entertainment-light year for us in '09. '10 will be bigger, obviously, with the WWE and with Thomas and some other properties we're working on, but, you know, we'll still have some Entertainment business in '09.

Margaret Whitfield - Sterne, Agee & Leach

Glad to see American Girl grew again. Is there any Entertainment properties, any new boutiques, and what contribution did the new stores do for you in the fourth quarter in Minneapolis?

Bob Eckert

The stores did well, Margaret. Both Minneapolis and Boston, in fact, all of the retail business was up for the quarter and the year, as was the catalog and Internet business. So American Girl did well across its portfolio.

As it relates to new stores, I think we're going to let the economy and clearly the retail sector shake out before we make more long-term commitments. I think there's certainly promise in more boutiques - the boutiques have done well - but I don't think this is the environment in which to make long-term commitments right now, so we're going to let things shake out.

Margaret Whitfield - Sterne, Agee & Leach

There would be no movies?

Bob Eckert

We don't have a movie property in '09. Clearly, the '08 Kit movie was successful, so we do have some discussions right now with some studios on prospects for additional movies.

Operator

Your next question comes from Drew Crum - Stifel Nicolaus & Company, Inc.

Drew Crum - Stifel Nicolaus & Company, Inc.

I wonder if I could ask a question on product testing, what the incremental costs were in 2008. And I know there's been some volatility changes in terms of the timing on the new legislation perhaps being delayed by a year. How would that impact your business in 2009 as far as product testing costs are concerned?

Bob Eckert

Drew, there won't be an impact on the announcement that I read over the weekend about the CPSC clarifying the timing of their testing requirements. Product integrity and safety is really important to us. We've dialed up our testing levels significantly and we're going to continue to test at the levels we're testing whether or not regulators require it.

Kevin Farr

And if you look at testing costs, in addition to incremental testing costs for lead, which we previously announced would be approximately 1% of cost of goods sold, we've also enhanced our testing and quality control and procedures for a variety of heavy elements and other chemicals. So if you look at 2008 in combination with lead costs, total incremental testing and other quality control costs were approximately 1.5% of cost of goods sold.

Looking forward to 2009 and beyond, due to increased regulatory requirements, we expect testing costs to rise in the near term, but longer term we'd expect them to decline as we get more efficient with our testing process in our plants and third-party vendors.

Drew Crum - Stifel Nicolaus & Company, Inc.

And then I wonder if I could ask a question on the pension accounting. Can you give us a sense as to where the underfunded status for the defined benefit plan was a year end and just expected contributions to the fund in 2009?

Kevin Farr

Yes, Mattel has defined benefit plans in various countries, including the U.S., the U.K., and Germany, which are subject to minimum funding requirements under the pension regulations of those countries. Significant declines in worldwide investment markets during 2008 had the effect of lowering the value of investments held by these plans and thereby lowering their funding status. Additionally, the funding status of the plans were further lowered as a result of the value of pension liabilities were driven up by the end of the year as a result of lower interest rates towards the end of 2008.

Mattel expects to have higher cash contributions and incur higher pension expense in 2009 versus 2008; however, such incremental amounts are not significant in relation to Mattel's cash flows and operating results.

Drew Crum - Stifel Nicolaus & Company, Inc.

Can you quantify the impact foreign currency had on profits in the fourth quarter?

Kevin Farr

Yes, I can do that. On the fourth quarter, with regard to sales, it had a negative 5% impact, as I've indicated. Full year, it was flat.

With regard to EPS for the full year, it was a positive $0.02 in the fourth quarter and a positive $0.06 for the year.

And just to kind of give you a sense of what forex would look like in the future, whether that's going to be a positive or a negative, hard to speculate; likely, a headwind in 2009. All else being equal, every 1% movement in the U.S. dollar index should impact EPS by about $0.01 to $0.02 and impact revenues by a half a percentage point.

Operator

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

Gerrick Johnson - BMO Capital Markets

I was hoping you could give us a retail POS number for the fourth quarter. I think you gave us the entire year, but how was the fourth quarter and how did that progress through the fourth quarter?

Bob Eckert

Gerrick, I'm sorry, I didn't hear the beginning of your question.

Gerrick Johnson - BMO Capital Markets

Retail POS, takeaway at retail, how'd that perform in the fourth quarter?

Bob Eckert

It was pretty consistent. My recollection is it wasn't a great holiday season in general, but I didn't see any huge trends. Clearly, the Thanksgiving week was pretty strong. All of retail got weak until the very end as we've all trained consumers to shop later, and the inventories were there at retail to facilitate that. So I think the pattern continues to be more pronounced over time, that is, good retail business around Thanksgiving and good retail business right before Christmas, and tough sledding in between.

Gerrick Johnson - BMO Capital Markets

Well, what was the total final number for the fourth quarter on retail takeaway?

Bob Eckert

Our retail takeaway was flattish in the fourth quarter. I think it was up slightly for the full year in retail takeaway and here in the U.S. maybe down very slightly in the fourth quarter. But order of magnitude, it's all fractional so I think of it as kind of flattish for the year and for the quarter.

Gerrick Johnson - BMO Capital Markets

On legal expense, can you just give us the absolute number for legal expense for 2008 and for fourth quarter '08 and what you're expecting for '09, because I think before you were adding in severance and other things. But just legal expense, what was that in 2008?

Bob Eckert

We don't disclose that level of line item. We do talk about the incremental expense. And it wasn't severance in there; it was a settlement that we made with the attorneys general.

Kevin Farr

So incremental legal fees for the full year were about $37 million and then the legal settlements were about $15 to $16 million overall.

Gerrick Johnson - BMO Capital Markets

And finally, your inventory at the end of the year was up 13%. It was only up 3% after the third quarter. How'd you go from a decent inventory position to one that seems a little bit heavy that quickly?

Kevin Farr

An 11% sales decline is the biggest reason.

Bob Eckert

Yes, I think the increase in inventories are reasonable given the magnitude of the fourth quarter sales decline. You know, inventories are up due to higher input costs in '08 and earlier production that meets supply chain requirements, including longer lead times for certain growing international markets. So overall, I think about half of that increase relates to cost increases inherent in making that inventory, and the balance relates to both the decline in the fourth quarter, more than expected, and also longer lead times for growing international markets.

At this time we're not really concerned about obsolesce expense. We think they're clearly valued.

Gerrick Johnson - BMO Capital Markets

Okay, so nothing to read into that on perhaps first quarter programs or promotions being canceled or pulled in or anything like that?

Bob Eckert

No, I don't think so.

Operator

Your last question comes from Dara Mohsenian - J.P. Morgan.

Dara Mohsenian - J.P. Morgan

Bob, I was a little bit confused as to why you're comfortable with inventory levels at retail. We're hearing in many consumer categories retailers are actually cutting inventory well below historical levels and yet I think you guys are a little bit higher than a year ago, so can you just flesh out a little more detail there on what's driving your comfort?

Bob Eckert

Yes. I don't know that I'd use the world comfort. What I was pleased about is that it could have been much worse given the magnitude of the sales decline, that is, our inventories and inventories in general at retail.

The retail inventories as we can best measure it on our goods, we're kind of up mid to high single digits and about half of that is due to pricing. Obviously, retailers want to take inventories down just as we're going to want to take inventories down, so it is going to be an area of focus for us. But if you look at the magnitude of the sales decline that we experienced in the fourth quarter, it was sizeable and it was quick. And the fact is, given the lead time in the toy business, either retailers or Mattel could have been hung with significant inventories; neither of us were.

Dara Mohsenian - J.P. Morgan

And then I'm just wondering on the mid single-digit spring price increase, given retailer pushback, I guess, with both the weak retail sales environment as well as lower commodity costs out there, are you comfortable that you'll be able to fully realize that without increasing promotional spending or that it won't impact your shelf space going forward?

Bob Eckert

Well, commodity costs may not be as high as they were a few months ago, but they're clearly higher than they were a year ago. S we're continuing to see cost increases and it's not just commodities; it's the whole basket of things that go into product costs.

So the reality is that the costs are higher, our margins have declined because we haven't fully captured the higher costs and we're committed to improving that. So the fact is we've taken a price increase on our spring line - it's in effect today - and we're going to continue to price the business for the reality of current costs.

Operator

And we have no further questions in the queue at this time.

Dianne Douglas

All right. Thank you, Operator. There will be a replay of this call available beginning at 11:30 a.m. Eastern Time today. The number for the replay is 719-457-0820 and the passcode is 3790024.

Thank you for participating.

Operator

And that does conclude today's conference, ladies and gentlemen. We appreciate your participation today. You may disconnect at any time.

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