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Mattel (NASDAQ:MAT)

Q1 2010 Earnings Call

April 16, 2010 8:30 am ET

Executives

Dianne Douglas - Investor Relations

Robert A. Eckert - Chairman of the Board, Chief Executive Officer

Kevin M. Farr - Chief Financial Officer

Analysts

Tony Gikas - Piper Jaffray

Timothy Conder - Wells Fargo

Sean McGowan - Needham & Company

Drew Crum - Stifel Nicolaus & Co.

John Taylor - Arcadia Investments

Robert Carroll – UBS

Margaret Whitfield - Sterne, Agee & Leach

Felicia Hendrix - Barclays Capital

Greg Badishkanian - Citigroup

Gerrick Johnson - BMO Capital Markets

Linda Bolton-Weiser - Caris & Company

Hayley Wolff – Rochdale Securities

Operator

Welcome to the Mattel first quarter 2010 earnings conference call. (Operator Instructions) I would like to turn the conference over to your host, Ms. Dianne Douglas, Senior Vice President of Investor Relations. Please go ahead.

Dianne Douglas

Thank you. As you know, this morning we reported Mattel's first quarter 2010 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 related to the future 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 2009 annual report on Form 10-K, as well as in other quarterly reports on form 10-Q and 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 headings Financial Information and Earnings Releases.

Now I would like to turn the call over to Bob Eckert.

Robert Eckert

Thank you Diane and good morning everyone. I am pleased with the company’s overall performance for the quarter with worldwide net sales up 12% reflecting good performance in the U.S. as well as international with continued improvement in our gross margins. That said the first quarter is just that; the first 90 days of the year and we still have a lot of work to do to deliver another strong year with our investors.

It is nice to be off to a good start with our core brands as we have successfully transitioned into the New Year with the momentum and energy from the fourth quarter. Our core brands like Barbie, Hot Wheels, Fisher Price and American Girl continue to grow and the newest members of our enriched portfolio are performing quite well. As you know we launched our WWE line of toys on January 1 and it has been very well received by both collectors and kids domestically and internationally. The toys are not only available at retail but are also sold at WWE live events throughout the year.

In anticipation for Toy Story 3 Disney re-launched the Toy Story franchise last fall, building to the release of Toy Story 3 which will hit theaters on June 18th. While the majority of our Toy Story sales in the first quarter were tied to the overall franchise we are very excited about the release of the Toy Story 3 specific products which hit shelves in about two weeks. For those of you who have seen our Toy Story 3 product line you know the toy range covers every way to play off the movie. It includes many categories across several of our divisions; action figures, dolls, plush, vehicles, preschool toys and games.

In the preschool aisle the Thomas and Friends property posted very solid performance particularly with the Track master and the die cast pick and play segments. Not surprisingly, Thomas and Friends is tracking to become the number one brand in the Fisher Price Friends portfolio. From my perspective what is most exciting about our newest license properties is we expect them to perform more akin to evergreen toy brands than one-hit wonders which should auger well for our business not only in 2010 but beyond.

As some of you may know the year 2010 is a personal milestone for me. May 17 marks my 10-year anniversary with Mattel. I joined the company during some tough times and in the midst of change. On my first day I told employees gathered in the company’s cafeteria that we were going to do three things; build brands, cut costs and develop people. We have made good progress on all three fronts.

So after 10 years what I am asked most often whether by investors and analysts or employees in the cafeteria is what is next for Mattel. Let me start with where we have been. In 2000 the senior management team created a vision for the company to be the world’s premier toy brand of today and tomorrow. This vision has served our company well during the past decade and every single word has helped guide us to become a more focused and cohesive company shepherding absolutely stellar brands.

Last week our latest annual report to shareholders was posted on our website for shareholders and other stakeholders. Every year you may have come to expect a theme or word to drive the year. This year’s call to action is “Next.” In the context of what is next we challenged our thinking around the vision itself. This year we are launching a new guiding vision for the company creating the future of play.

At Mattel we are the imaginations behind some of the most recognized and best-loved products around the world but I will let you in on a secret; we don’t just make toys. We create emotional connections that last a lifetime by encouraging children to stretch their imaginations creating joy and allowing children to become lost in play. That is the real value of our toys. That is the value of play.

In keeping with our new vision we have added innovation and new playfulness to our annual report through the launch of an interactive video on our corporate website that takes viewers through a dynamic tour of the company and our products. Creating the future of play is evolution. Our goal is to build on the progress we have made and to push ourselves to achieve more.

That is consistent with our business goals for 2010 which include capitalizing on opportunities to increase revenues by continuing core brand momentum while maximizing the opportunities surrounding our new entertainment properties, maintaining cost and expense controls and delivering another strong year of profits and cash flow.

We believe in the value of play, the possibilities it creates and the joy that it brings. At Mattel we have the unique opportunity to work at the intersection of what is enduring and what is innovative. When we do this there are no limits to what we can invent and the joy we can create.

Thank you. At this time I would like to introduce Mattel’s Chief Financial Officer, Kevin Farr, who will take you through a financial review of the quarter. Kevin?

Kevin Farr

Thank you Bob. Good morning everyone. I will begin my review for the first quarter with a discussion of worldwide gross sales shown on Exhibit 2 of today’s press release.

Total worldwide gross sales for the quarter were up 12% including a 3 percentage point positive impact from changes in exchange rates. U.S. sales were up 12% and international sales were up 12% including a 7 percentage point positive impact from foreign exchange.

On a regional basis, sales in Europe were up 9% including a 5 percentage point positive impact from exchange rates. Sales in Latin America were up 10% including a 2 percentage point positive impact from foreign exchange. Sales in Asia Pacific were up 32% including a 16 percentage point positive impact from foreign exchange rates.

I will now review our core businesses and brands for the first quarter. Mattel girl’s and boy’s brands. Worldwide sales for Mattel’s girl’s and boy’s brand segment were up 14% including a 4 percentage point positive impact from foreign exchange rates. On a regional basis, domestic sales were up 18% and international sales were up 11% including a 7 percentage point positive impact from foreign exchange rates

Worldwide Barbie sales were up 5% compared to last year including a 4 percentage point positive impact from foreign exchange. Barbie sales in international markets were flat including a 5 percentage point positive impact from foreign exchange while Barbie sales in the U.S. were up 13%. Worldwide sales of other girl’s brands were up 21% including a 6 percentage point positive impact from foreign exchange rates. Sales of other girl’s brands in the U.S. were up 44% and international sales were up 6% including a 9 percentage point positive impact from foreign exchange.

Good growth in Disney Princess’ was partially offset by declines in High School Musical. Worldwide sales in Wheels increased 3% including a 3 percentage point positive impact from changes in currency exchange rates. The worldwide sales performance reflects good growth in sales of Hot Wheels offset by declines in sales of other Wheels products not continuing into 2010.

Core Hot Wheels increased 9% worldwide including a 4 percentage point positive impact from foreign exchange. Core Hot Wheels sales increased mid single digits in the U.S. and were up low single digits internationally excluding the impact of foreign exchange. Worldwide sales in our entertainment business which includes games and puzzles were up 35% including a 4 percentage point positive impact from changes in foreign exchange. Sales were equally strong in the U.S. and internationally, driven by the addition of new entertainment properties, World Wide Wrestling, Toy Story as well as good growth in our core games business.

Fisher Price brands, worldwide sales for Fisher Price brands were up 11% including a 2 percentage point positive impact from changes in foreign currency rates. On a regional basis, domestic sales in Fisher Price increased 8% and international sales increased 17% including a 6 percentage point positive impact from foreign exchange. Worldwide core Fisher Price was up 5% including a 3 percentage point positive impact from changes in exchange rates. International sales were up 10% including a 7 percentage point positive impact from foreign exchange and U.S. sales of Fisher Price core were up 2%.

Fisher Price Friends worldwide sales increased 44% including a 1 percentage point positive impact from foreign exchange rates. International sales were up 58% including a 3 percentage point positive impact from foreign exchange while sales of Fisher Price brands in the U.S. grew 35%. The growth at Fisher Price Friends was driven really by the addition of products supporting the new Thomas and Friends property as well as good growth in Disney products.

American Girl brands, sales of American Girl Brands were up 6% reflecting growth across all key channels primarily due to strong sales of Laney, the 2010 Girl of the Year as well as a slight benefit from the earlier Easter.

Now let’s review the P&L which is shown on Exhibit 1. Gross margin was 49.1% compared to 44% last year. The improvement was primarily due to lower product costs, savings from the global cost leadership initiatives and price increases. Given the current commodity and labor cost environment relative to year-ago levels we expect input cost pressure on our gross margin beginning in the second half of this year.

Advertising expense was $94.2 million or 10.7% of net sales compared to $84.1 million or 10.7% of net sales in 2009. Selling, general and administrative expenses decreased approximately $24.5 million to $292.5 million. As a percentage of net sales SG&A expenses were 33.2% compared to 40.4% last year. The year-over-year improvement primarily reflects $22 million of lower litigation and legal settlement related costs and savings related to our global cost leadership program.

For the quarter, our global cost leadership program delivered overall gross savings before severance of about $17 million. The gross savings includes about $5 million in SG&A, $11 million in gross margin and $1 million in advertising. For the quarter we recorded a severance charge of $2 million bringing the net savings related to global cost leadership program to about $15 million. We remain on track to deliver cumulative net savings of approximately $180-200 million from this program by the end of 2010.

Operating income during the quarter was $45.2 million compared to a loss of $55.2 million last year. The year-over-year improvement was due primarily to higher sales, gross margin improvement and lower SG&A expenses partially offset by higher advertising expense. Interest expense of $13.6 million was down from $15.9 million last year reflecting lower average borrowings as well as lower average interest rates. Interest income was $2.5 million versus $3.5 million last year. The lower interest income was due to lower average investment rates partially offset by higher average invested cash balances during the quarter.

Other non-operating income expense was an expense of $800,000 versus income of $2.1 million in 2009. The current year expense reflects and relates primarily to foreign currency exchange losses versus foreign currency exchange gains last year.

The income tax provision for the quarter was $8.5 million which translates to an effective rate of 25.4% compared to prior year’s benefit of $14.5 million. For the full-year 2010 we currently expect the tax rate to be about 24-25% based on current tax laws. Overall we reported net income of $24.8 million or $0.07 per share versus last year’s net loss of $51 million or $0.14 per share.

Now turning to cash flow and balance sheet, cash flow used for operations for the quarter was $245 million compared to $215 million in the first quarter of last year driven primarily by the use of cash for seasonal working capital requirements. Our cash on hand at the end of the quarter was $871.9 million, up $467 million from prior year’s first quarter primarily due to higher beginning cash balance of $1.1 billion this year versus $618 million last year.

Receivables were $661.9 million or 68 day says outstanding, three days higher than last year. Factoring decreased from $101 million to zero. Prior to factoring, day sales outstanding decreased eight days. During the first quarter of 2010 we made the decision not to factor receivables due to our current cash position and the availability of lower cost funding alternatives.

Inventories at $429.6 million were down $58.3 million or 12% versus 2009. Our total balance sheet debt was $750 million, a decrease of $150 million from the prior year, reflecting the pay down of maturing long-term notes. Our debt to total capital ratio ended the quarter at 22.4% versus 30.5% for last year’s first quarter. Capital expenditures were $24.2 million, up slightly from last year’s $20.1 million.

To summarize, as Bob mentioned we are pleased with this quarter’s results but there is a lot of work to be done between now and the end of the year to deliver on our priorities of continued core brand momentum, maximize the opportunities surrounding our new entertainment properties, maintaining costs and expense controls and deliver another strong year of profits and cash flow.

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

Question and Answer Session

Operator

(Operator Instructions) The first question comes from the line of Tony Gikas - Piper Jaffray.

Tony Gikas - Piper Jaffray

Looking at the cost of sales for 2009 I think input costs were a relative push but as we move into the back half you do expect some cost pressure there. Is that the biggest risk to the back half of the year? Any way to quantify what you are seeing so far with some of your manufacturing partners?

Kevin Farr

With respect to the challenges in 2010 I do think that the rising input costs will be a challenge to the second half of the year. I think we have made good progress in rebuilding our gross margins in 2009 and full-year gross margins of 50% and our goal to sustain gross margins consistent with our long-term goal. When we look at gross margin for the second half of the year there is many factors that impact those margins besides input costs like freight and distribution costs, minimum wage growth, royalties, foreign exchange mix and tooling to name a few. So predicting our gross margin is very difficult due to the complexity of all of the moving pieces and lack of transparency and predictability but we know looking forward we have higher royalty costs in 2010 due to our new entertainment partnerships and while it is impossible to predict what will happen with commodity and labor costs we are already seeing year-over-year cost increases which will increase our gross margin for the second half of 2010.

For example, there has been a steady recovery in crude oil prices. The current level is $85 per barrel compared with about $40 per barrel this time a year ago. We are also seeing minimum wage and foreign exchange pressures in China. That said we are going to continue to execute our global cost leadership programs and other cost and manufacturing efficiency programs in 2010 and we priced our products consistent with making progress against our long-term annual goal of 15-20% of operating margins.

Tony Gikas - Piper Jaffray

Could you also just comment on point of sale during Q1 and maybe the first part of the second quarter here? Then sales in Europe seemed to pick up nicely. What were your thoughts there? What might be the better performing international markets later this year?

Robert Eckert

Point of sale has held up pretty nicely with the change of Easter it makes it a little bit more difficult to look at the quarter end point of sale but if you try and normalize that as best as one can by looking kind of point of sale through the most recent weeks I would say our point of sale is up sort of low to mid single digits across the company. I think there is no question an important factor in the first quarter’s results is the absence of the prior year’s inventory depletions. In essence, retailers bought what they sold this year. Last year they really could support their business without having to buy much from us.

So I wouldn’t say they are rebuilding inventories. In fact we are still seeing inventories a bit below the prior year and I have seen some studies that suggest broadly, and that is not just toys and not just in the U.S., retailers are continuing to focus on reducing inventories and from everything I am reading here they see this as a sustainable strategy for the foreseeable future.

As it relates to international, POS is tracking ahead of our shipments in international. Retailers are continuing to very tightly manage inventories particularly in markets where economies are struggling more so. We see pretty good growth in the first quarter around the globe. We had good performance in Latin America. We had good performance in virtually all of the markets of Asia Pacific although that is off a very small base and we had pretty solid performance in some of the more mature markets of Western Europe.

This is one of those quarters where we love all our children whether it is brands or markets and fortunately they have all seemed to have done pretty well.

Operator

The next question comes from the line of Timothy Conder - Wells Fargo.

Timothy Conder - Wells Fargo

A follow-on on the input costs. Kevin you went through several items there. One thing you did not talk about and you have outlined before even back when you rolled out the GCI back in November of [2011] are SKU reductions. I think you have mentioned also Bob and Kevin that SKU reductions really did not benefit gross margins in 2009 and that is going to be more of a 2010 item. Can you kind of add that into the whole mix as far as your strategy and maintaining gross margins?

Kevin Farr

I think the global cost leadership program is an important aspect of improving and maintaining our gross margins as well as we continue to work on manufacturing, productivity and efficiency programs. I think we said the size of the prize with regard to the SKU reductions is 30% of our SKUs generate about 1-2% of our revenues and managing the number of SKUs and improving our SKU productivity is strategic way to cut non-value added work from the organization.

SKU rationalization cuts across the entire value chain. It touches all functions like [D&D], sales, marketing, engineering, manufacturing, testing and other supply chain areas. That rationalization should result in less headcount, lower tooling spend, less testing, less inventory and lower mark downs. It is a sustainable advantage to us by managing SKUs because it aligns us well with SKU efficiency focus of our major retailers. We have made progress in 2009 with respect to reduction of SKUs and in 2010 we continue to work on SKU reduction in 2011.

I think you are going to see more of the benefits from SKU rationalization really in 2011 as we get momentum on this strategic initiative.

Timothy Conder - Wells Fargo

I think in prior calls or at the Toy Fair you mentioned a 27% tax rate at that time was sort of more reasonable. Now you have updated that for 24-25%. Can you walk us through on what maybe has changed here on the tax rate outlook for the year?

Kevin Farr

I think as I said on the call today we expect the 2010 tax rate to be 24-25%. The calculation of our worldwide expected tax rate is a very complex calculation. We basically, the computation of the tax rate is dependent on where income is earned geographically and how that income is taxed in those geographic locations. Based upon our most recent calculation our current estimate is for the 2010 worldwide effective tax rate to be between 24-25% for 2010 and likely beyond.

Timothy Conder - Wells Fargo

But I guess, what in the overall calculation are you expecting higher revenues and income from areas that would reduce that rate? Has that changed in the last 2-3 months?

Kevin Farr

I think we just refined that calculation and it does relate back to the geographical mix.

Timothy Conder - Wells Fargo

You have already commented about in response to the prior question the inventories in the channel. Do you think there could be as we move closer to the Christmas and holiday season some potential modest increase in inventory versus last year? What I heard you say earlier that may not be the case as you see things right now. If you could maybe clarify that.

Robert Eckert

My perspective on inventories is that we are unlikely to see sort of the rebuilding of inventories. I think retailers are very sharp with what they are buying. They are buying what they think is going to sell. They finished the year with very clean inventories. Their inventories today continue to be very clean. We are just not anticipating they are going to want to kind of slide backwards on inventory reductions. Who knows. We won’t know until the season comes along and I think certainly retailers are more bullish about this holiday season than they were last holiday season but I don’t know if that is going to translate into inventory build.

Operator

The next question comes from the line of Sean McGowan - Needham & Company.

Sean McGowan - Needham & Company

Can you give us what the depreciation and amortization was in the quarter?

Kevin Farr

I can. Just give me a second on that.

Sean McGowan - Needham & Company

Related to the previous question, on the gross margin improvement as you have done in the past could you sort of give us an idea what of the factors that drove us higher which was more important? So if you are looking at price, cost cuts and input costs how do they rank out in terms of what influence they had?

Kevin Farr

I will answer the first quarter. It is about $41 million for the quarter versus about $44 million last year. Looking at the first quarter gross margin the first quarter gross margin improved by 510 basis points to 49.1% compared to last year’s first quarter gross margin of 44%. Gross margin benefited primarily from favorable product costs, savings from the global cost leadership program, price increases and favorable mix.

This quarter we continue to benefit from lower commodity cost markets that occurred last year when we were buying input costs and manufacturing for our 2010 product line. Our 2010 gross margins also improved due to continuous improvement programs related to the global cost leadership program and other manufacturing efficiency programs across the supply chain. We have made good progress in rebuilding gross margins and our goal is to sustain gross margins consistent with our long-term goal.

Sean McGowan - Needham & Company

In the past I think you have said things along the lines of 1/3 of the increase or decrease in certain quarters has come from X and 1/3 came from Y. Are they kind of equally contributing to the increase in the first quarter?

Kevin Farr

No. I think the biggest impact was the favorable product costs followed by savings from the global cost leadership program which was about $11 million in the quarter related to gross margins. Then price increases and then favorable mix. So that would be the order of magnitude.

Sean McGowan - Needham & Company

If you can give us a little color on within the Barbie line what seemed to be driving that. You are up against a pretty tough number in the first quarter in the U.S. Anything particular that stood out as working well within Barbie and do you think it is sustainable?

Robert Eckert

There is. We continue to experience good momentum on Barbie. POS is increasing even when we compare it to last year’s 50th birthday celebration of Barbie. The I Can Be segment is performing particularly well. You will recall we launched Barbie’s 125th and 126th careers during the quarter. The Spring Entertainment which is Barbie in a mermaid tail is doing well. Fashionistas are doing well. Barbie basics are doing well. That is the little black dress line right now. I think there is no question that Barbie is gaining share and continues to have good momentum. Beyond Barbie Disney Princess’ is doing very well both in the U.S. and abroad.

We have had good success with the Princess and the Frog line. The DVD was released just a couple of weeks ago and I think Disney Princess is going to do well all year particularly as we approach the fall movie Tangled, which is the Rapunzel story. Probably the offset there to some degree is High School Musical but the momentum we have on Disney princesses looks pretty solid.

Operator

The next question comes from the line of Drew Crum - Stifel Nicolaus & Co.

Drew Crum - Stifel Nicolaus & Co.

I want to go back to the cost of goods solid. I think you mentioned Chinese currency being an item. I know it has been in the news quite a bit recently and I think we have talked about the impact. Can you talk about strategies you have in place in the event the Chinese government lets the Yuan float? Are you doing anything in anticipation of that?

Robert Eckert

As you know, the vast majority of the world’s toys are produced in China. The majority of our toys are produced in China. But we are one of the few folks that actually also manufactures our own toys and manufactures toys in markets other than China including Malaysia, Thailand, Indonesia and Mexico. We are relatively less dependent on China than the rest of the toy world but it is still very important to us.

Kevin Farr

I would like to add that it is just another cost pressure. The same as our look at input costs and labor costs so it is just another cost pressure we have got to when we consider pricing our products that we price to the new reality of the costs.

Drew Crum - Stifel Nicolaus & Co.

Could you comment on what you saw in terms of performance for the new entertainment properties domestic versus international? Specifically, WWE.

Robert Eckert

We are off to a really solid start on all of the new properties. Toy Story. The Fisher Price segment the Thomas property is off to a really nice start as is WWE. WWE has done well globally. It is not a big factor in every market around the world but clearly I think we are going to build an international presence for WWE. Anything we have been struggling in the past several months to keep up with demand for WWE so it is off to a pretty nice start. Broadly speaking I would say all of the new properties are performing well globally with pretty good performance everywhere in the world where those properties have been supported.

Drew Crum - Stifel Nicolaus & Co.

It doesn’t look like you did any share repurchase during the quarter. Can you just update us on your thoughts on use of cash? You are sitting on close to $900 million of cash on the balance sheet. We expect you to generate some cash flow during the year. What are your updated thoughts on uses of cash?

Robert Eckert

I would start by reminding everyone that last year given the macro environment we were really in hunker down mode around here. We said a year ago that our priorities for 2009 were to strengthen the balance sheet. We wanted to increase cash, reduce debt and protect the dividend. We were successful in achieving our goals last year. So as we look at 2010 we are transitioning back to our capital investment framework which we developed in 2002 or 2003 and have been using ever since.

In the end, capital deployment is a board level decision but I can tell you that we have recently reaffirmed the key tenets of our framework with the board and there aren’t really going to be any changes in the near future.

Operator

The next question comes from the line of John Taylor - Arcadia Investments.

John Taylor - Arcadia Investments

Thailand seems to be in the news again here and I wonder if you might talk about that a little bit from a supply security side of things. The other thing would be container capacity out there, things stacking up in remote places and what not. That would be the first operational question. Then Bob I wonder if you could expand a bit on your opening comments about sort of the new Mattel and the new decade we are looking at. What are we seeing executed this year and if there is anything you can sort of foreshadow for us next year what are the implications of the out-of-the-box thinking might be for play?

Robert Eckert

A couple of things. First as it relates to Thailand we have a good presence in Thailand. Our operations and supply chain really haven’t been materially affected by what is going on over there. In history, or at least in the 10 years since I have been here, there is usually 1-2 places that are of concern from a supply chain standpoint and we are not solely dependent on one area of the world. Even if we run into hiccups we generally have an ability to overcome those and I would say the situation in Thailand is consistent with that right now.

As you think about the company going forward I really think over the last decade we have been very focused and very disciplined and it has served us well. We have built shareholder value. We look at the benchmarks and what has happened over the past 10 years. I am generally pleased with the progress we have made. As we think about the company going forward one of the points I wanted to make in the opening comments is it is evolution, not revolution. We think there is a lot of potential and value in thinking more about play. Toys are certainly an important component of play. I think 10 years from now if all goes well we are going to continue being the leading toy company in the world.

But we see avenues for growth in the years ahead beyond just traditional toy play. As an example, we are doing a lot of work right now in the digital space. We know kids are playing digitally and they are playing with our brands digitally and they are staying in the marketplace longer than they used to. I remember in 2000 talking about kids getting older younger and a lot of us seemed focused on that phenomenon. In fact today kids seem to be playing with our brands in the ages that are inconsistent with kids getting older younger. They are just playing in a different way.

We have to figure all of that out. We have to figure out how to generate revenues out of that and how to make money in that. I think that is one example of a new avenue of growth for the company and hopefully profitable growth when we think of the years to come.

John Taylor - Arcadia Investments

I wonder if you could call out anything that is going on in China as it relates to the retail store? The footprint you are trying to build there and consumer reaction?

Robert Eckert

The store is okay. It is not great. If you look at that store as how many toys it sells relative to all the toys sold by all the retailers in Shanghai or even in China it is actually performing quite well. You still have to think about the future potential of China and the future potential of Barbie in China and as much as anything else that store is designed to kind of introduce China to Barbie. Generally speaking whether you are talking about Barbie or talking about all of our brands in China we are seeing good growth.

We didn’t grow last year in China as kind of the global economy didn’t do as well as it had previously. But we kind of picked up again this year in virtually all of the emerging economies like China and India. That being said while the growth rates look pretty good and it is really impressive when you put the percentage signs next to them it is off of a very small base. We are making progress but it is really a long-term strategy and is still not material for the company.

Kevin Farr

With respect to your question on containers, every year we have challenges in our supply chain and we manage through those. We haven’t heard anything yet about having container capacity issues here for the fall.

Operator

The next question comes from the line of Robert Carroll – UBS.

Robert Carroll – UBS

Are you able to give the percentage of COGS that are denominated in R&D just to bring that full circle?

Kevin Farr

I am sorry, I didn’t catch the question. Percentage of cost of goods sold in RMB?

Robert Carroll – UBS

Yes.

Kevin Farr

I think with regard to if you look at RMB it is a small percentage because most of it relates to labor and local value add. If you look at a 1% movement in the RMB it has about a $5 million impact positive or negative based upon that.

Robert Carroll – UBS

Going into some of the entertainment properties it seemed like Toy Story kind of got off the ground earlier than we were expecting with some pretty strong retail support. Big picture do you see that as being incremental so it adds to the pile for 2010 or slightly pulling things forward from some earlier quarters versus later quarters?

Robert Eckert

I would say generally speaking Toy Story is consistent with our expectations right now. We had good success with Toy Story last year and as I have been out in retail stores so far this year we see continued good performance of the core franchise Toy Story products. As I mentioned, over the next couple of weeks here we ought to start seeing support for Toy Story 3. So my view of Toy Story is it is an evergreen property like Car which is now in its fifth year for us and has been an evergreen property and like we think WWE and Thomas will be.

So that is one of the things that is most exciting for me right now is we have our hands on brands, and they are really brands not just movie properties.

Robert Carroll – UBS

Is the full Thomas line out at the market yet? I guess back at Toy Fair it hadn’t fully been launched yet.

Robert Eckert

I don’t really think it is. I was in stores last weekend and I still see some of the segments in which we are now selling products represented by older products. I think there is still going to be some transition to Thomas. That being said Thomas again is consistent with our expectations and doing very well. My observation for what it is worth is that we are still not fully through the pipeline and seeing our products on shelves every day.

Robert Carroll – UBS

On Monsters, any sort of update on that or playing into your expanding the play area comments and broader thoughts on [reaching] entertainment properties?

Robert Eckert

No. That is an interesting part of the story going forward. I think we are going to do an analyst day here coming up in the spring and Anne promises me that sooner or later we are going to have to talk more specifically about Monsters and I have told her I think it might be a good idea to do that then.

Operator

The next question comes from the line of Margaret Whitfield - Sterne, Agee & Leach.

Margaret Whitfield - Sterne, Agee & Leach

You mentioned the Easter shift as it related to American Girl. If you could give us some commentary as to how the earlier Easter benefited your top line in Q1 and what might occur as a result in Q2?

Robert Eckert

I think it had some effect. It is hard to tell but I think from my vantage point the easiest way to think about it is in the first quarter of 2009 my recollection is American Girl was down 4% in sales and in the first quarter of 2010 it was up 6% of sales. Easter is one relatively small component of that. There are a lot of other things going on in American Girl like the stores doing well, like as Kevin mentioned Laney doing particularly well compared to the prior year’s girl of the year. But generally speaking I think clearly the earlier Easter had some impact. I think personally it is a fairly minor impact but a positive impact this quarter at the expense of next quarter.

Margaret Whitfield - Sterne, Agee & Leach

I was referring to the entire company. So you think it is a minor impact in Q1?

Robert Eckert

I do. We don’t know what the second quarter is going to look like yet but we will see. In my experience doing this for awhile now it tends to be a little bit of a shift from the first quarter to the second quarter or vice versa but not a big deal.

Margaret Whitfield - Sterne, Agee & Leach

On Barbie the U.S. did extremely well against tough numbers. International was flat with currency positive. Could you comment on why international lagged a little bit as comparisons, as I recall, are easier?

Robert Eckert

I think as we rationalize the line particularly internationally we focus more on fashions and this year in the career aspiration segments so we have seen declines on My Scene which is a relatively larger line outside of the U.S. than in the U.S. where it has been discontinued. Especially in the younger princess segment overseas. So as we transition to Disney Princess in Europe, for example, we are clearly looking to build that business.

Margaret Whitfield - Sterne, Agee & Leach

Could you give us an update on the MGA situation? Phase two and the appellate court?

Robert Eckert

There really isn’t much. In December the 9th Circuit heard MGA’s arguments for its appeal of the trial court’s orders that granted an injunction against MGA and the other equitable release to Mattel. The orders were originally issued by the trial court after the 2008 unanimous jury verdict against MGA and Mr. Larian. The court hasn’t yet issued any opinion addressing the merits of the case but in December it ordered a stay on the equitable relief including the transfer of Bratz and registration and trademarks and those things to Mattel. We are still awaiting the 9th Circuit’s opinion. At the same time we are very busy preparing for the next phase of the case which focuses on trade secrets among other things.

Margaret Whitfield - Sterne, Agee & Leach

Is that in Q2, the beginning of phase two?

Robert Eckert

Well we really don’t know. I think it will happen fairly quickly after the 9th Circuit opines on the first phase of the case. We are certainly gearing up for that. So we are ready to go whenever the time comes. I have no clue of whether that will be second quarter, third quarter, fourth quarter or whenever.

Margaret Whitfield - Sterne, Agee & Leach

Finally you mentioned Tangled as probably a strong property in the second half. I know Toy Story and WWE and Thomas will likely be. Anything else to call out post Toys there in terms of where the retailers are placing their bets in terms of your new line?

Robert Eckert

No, I think we have it covered. I think when we get to the Monsters property that is going to start. Exactly how that plays out is yet to be seen. I don’t think it is going to be a big deal for this year’s numbers. I think we have all of the drivers already in place for this year.

Operator

The next question comes from the line of Felicia Hendrix - Barclays Capital.

Felicia Hendrix - Barclays Capital

Circling back to the gross margins one of the items, although it was the least important, was the favorable mix. I am trying to understand that. Other than Barbie increasing which is obviously more profitable, what else in your line contributed to the favorable mix?

Kevin Farr

It was really all of the performance of the core brands where we don’t pay royalties. So we saw good growth in core brands.

Felicia Hendrix - Barclays Capital

On the strength of Disney Princess’ the Princess and the Frog was there anything else or was it just that?

Robert Eckert

I wouldn’t say it is just that. I think the line broadly speaking is doing well. If you look at the product line and look at just physically the products we are introducing in Europe as we speak and it has been a pretty slow transition in Europe because there is a fair amount of old products still in the marketplace, but if you look at the Princess doll we have created and compare those to the princess dolls that have been in the marketplace in Europe in my judgment it is night and day better. I think we have some great products. We have had very strong retail support and so I think the franchise is doing particularly well, not just one individual item.

That having been said, we have had very good success with Princess and the Frog and it has clearly been one of the key drivers and I think it is going to continue to do well.

Felicia Hendrix - Barclays Capital

In terms of the shipments for Thomas and WWE going forward, adjusting for seasonality should the shipments basically be even throughout the year or do we see more in the first half or is it like everything else that is core and evergreen is just kind of comes throughout the year and obviously adjusting for seasonality?

Robert Eckert

I think it is like everything else. I don’t think those are unique. Certainly Toy Story will be a little different because of the entertainment coming up in June of this year. But if I think about something like Thomas I don’t think there is an unusual seasonality to Thomas.

Kevin Farr

No. I think in general 30% of our sales are done in the first half of the year and 70% is done in the back half. I don’t see any difference in Thomas and WWE from that.

Felicia Hendrix - Barclays Capital

In prior quarters you would break out the components of the cost initiative program savings. You said it was $11 million in the quarter. How is that split among SG&A, advertising and cost of goods sold?

Kevin Farr

I think with respect to the global cost leadership program in the first quarter we delivered gross savings before severance of approximately $17 million as I said in addition to the $5 million of gross savings reflected in SG&A. As I said there is roughly $11 million of savings in gross margin and $1 million in advertising expense. With $17 million gross savings and $2 million in severance charges we achieved net savings of $15 million from our global cost leadership program. We remain on track to deliver cumulative net savings of approximately $180-200 million from the program by the end of 2010.

Operator

The next question comes from the line of Greg Badishkanian – Citigroup.

Greg Badishkanian - Citigroup

On the cost cutting program, the $180-200 million target you said you are on track. If sales continue and momentum continues to be strong like it was this quarter do you think it is still achievable or do some of those costs rise making it not as achievable?

Kevin Farr

No I think as I said we are on track to deliver the $180-200 million and I don’t see our volume changing. I think we are really reflected or focused in on specific programs to cut costs in things like SKU rationalization, clustering of our European operations, we are working on consolidating our Southern California distribution centers, we are working on outsourcing our IT infrastructure. Programs that are independent of our top line revenue growth.

Greg Badishkanian - Citigroup

Obviously nice performance in Barbie. Any color on the competitive environment there that maybe helped you and in terms of MGA and in terms of what shelf space they have been getting and what they are expecting to get in the fall ahead of Christmas?

Robert Eckert

I am always fascinated to hear about how they comment on their business. I don’t think I’d do that.

Greg Badishkanian - Citigroup

Any other sort of color in terms of what you have been seeing over the last few months or any changes in the competitive environment?

Robert Eckert

I think Barbie has good momentum as I mentioned. Disney Princess’ has good momentum. Other brands come and go but we have been at this for a long time and things seem to be going pretty well.

Greg Badishkanian - Citigroup

On the third quarter call you talked about Toy Story being over $100 million business during the movie year. As you kind of look out how well do you think that could be relative to that year? Obviously stronger but how much stronger do you think?

Robert Eckert

I don’t know if I said that. If Kevin said that I will strangle him. I may have said something from which you can infer, a good movie property is $100 million or more and there is every reason to believe Toy Story is going to be a good movie property. So if I have gone beyond that I apologize and I will reprimand myself and we won’t do it again. Obviously Toy Story should be a really important property. It has been a great property for the last 10 years without entertainment support and everything I have heard about the movie is it is going to be a terrific movie. So it is obviously going to be bigger than a bread basket.

Operator

The next question comes from the line of Gerrick Johnson - BMO Capital Markets.

Gerrick Johnson - BMO Capital Markets

I was wondering if you could talk about Fisher Price and provide some sort of organic growth number for Fisher Price exclusive of the Thomas shipments?

Robert Eckert

I think Fisher Price is one of the areas that is a really good example of retailers this year needing to buy what they sold as compared to last year. Last year in the first quarter retailers didn’t need to buy that much from us in order to support the POS they had. This year they had to do that. I think Fisher Price is probably the most shining example of that. There is certainly some areas in core toys that are doing well but the momentum on Fisher Price is right now more consistent with the fourth quarter or the holiday season in the POS end of Fisher Price than we expect it to be later this year.

We have made some changes to the key drivers of the line in terms of the innovations we have and the price points we will be offering. I think right now the Fisher Price success in the first quarter is really more related to what retailers needed to do than the POS trends.

Kevin Farr

We don’t break out with respect to each of the businesses excluding the entertainment but if you look at Fisher Price core globally it was up 5% which would exclude Thomas as well as if you look at it domestically it was up 2% and international core was up 10%.

Gerrick Johnson - BMO Capital Markets

Core hasn’t been the problem. It has been Friends. I am wondering how that number looks exclusive of Thomas.

Robert Eckert

I wouldn’t say that just Friends has been an issue. I think we have had some issues on core as well but within Friends Dora did very nicely this quarter. We have seen some increases in Dora. We have seen increases in Disney in the Fisher Price line and the Friends line and we have seen some decreases in Sesame Street which is consistent with the trend. Some of the things like Dora that have been a drag on our sales potential certainly from a point of sales standpoint actually we have seen better success on Dora of late than we have in some time.

Gerrick Johnson - BMO Capital Markets

It sounds like you have been in the stores a lot lately. I was wondering if you could perhaps comment on any sort of industry trends you are seeing and category trends in the fashion business where are kids gravitating these days? Particularly interested in the Girl’s segment. Fashion dolls, [mini] dolls, etc.

Robert Eckert

I think toys in general have held up pretty well in the holiday season last year just as they did for the past 5-6 recessions. I think they have pretty good momentum relative to other categories in the toy business right now. I don’t know that is going to change. We are certainly seeing good momentum in our girl’s business. We tend to be the leaders in things girls so I think that bodes well for what is happening in the marketplace.

Gerrick Johnson - BMO Capital Markets

Discount retailers, are there any changes in the way they do business that may be benefiting the industry and Mattel? We often talked about what they are doing that is detrimental to the industry but what might they be doing this year that might benefit you guys?

Robert Eckert

I don’t know there is any significant change in the retail landscape that I have seen.

Operator

The next question comes from the line of Linda Bolton-Weiser - Caris & Company.

Linda Bolton-Weiser - Caris & Company

Can you talk a little bit more about the retail inventory situation? I am trying to gauge how many more quarters you could actually have shipments exceed the POS growth. Was it second quarter or more like third quarter where the retailers started to behave a little more normally on the inventory front.

Robert Eckert

My recollection from last year was that inventories as we calculate them, that is retail inventories based on what we ship in and what POS has sold declined every quarter last year compared to the prior year. This year in the first quarter we are seeing retail inventories down versus the prior year. I don’t think there has been a change in trends. Again, as I tried to mention earlier I am not really betting on a big change in trend. I think retailers are going to continue to focus on inventory management.

Linda Bolton-Weiser - Caris & Company

But certainly your shipments can’t exceed POS for many more quarters. So is it one more quarters or two more quarters before the math works out that the retail inventories year-over-year are more normalized? Do you understand what I am asking?

Robert Eckert

I guess I understand what you are asking. I am not sure that I can answer the question. The changes on a percentage basis are consistent with having different bases. What we really saw in the first quarter that I tried to communicate is retailers bought what they sold. So the percentage change on shipments is a function of what they bought last year but today they are currently buying what they are selling.

Linda Bolton-Weiser - Caris & Company

On the pricing can you remind us is the pricing you mentioned that favorably contributed to gross margin is that a carryover from actions taken in 2009 or was that like new pricing initiatives in early 2010?

Robert Eckert

It is primarily a carryover.

Linda Bolton-Weiser - Caris & Company

Can you remind us again was there two rounds of pricing in 2009? What is the thought in 2010?

Robert Eckert

There was one round of pricing generally speaking in 2009. There will be one round of pricing in 2010. We did not price significantly in 2010 but we did price and it is consistent with what we had planned on input costs being at the time.

Linda Bolton-Weiser - Caris & Company

On your global cost of leadership you have been very successful with that so far and you will be realizing the final savings this year. Are you thinking about initiating a new program or focusing in other areas or continuing it? Might we hear more about details on that at the analyst meeting?

Kevin Farr

I think from the perspective of the global cost leadership program I think we are executing. I think we are on track to deliver the $180-200 million. I think as part of this program we are really trying to infuse our culture with a continuous improvement philosophy and I think like we have in the past we will continue to look for opportunities to be more efficient and effective and drive cost savings programs. Whether that will be a formal program or informal program we will continue to look at what makes sense.

Operator

The next question comes from the line of Hayley Wolff – Rochdale Securities.

Hayley Wolff – Rochdale Securities

The cost savings schedule in 2011, Kevin earlier talked about SKU reduction starting to benefit you in 2011 and now that you are running your business a lot smarter and a lot more efficiently we should be able to expect some cost savings?

Kevin Farr

Yes we should expect cost savings from SKU rationalization. We did see some of that in 2009. We expect to see more of it in 2010 and we expect to deliver even more in 2011.

Hayley Wolff – Rochdale Securities

Order of magnitude relative to GCO, can you comment on that?

Kevin Farr

I am not going to get into specific details but the 2010 savings are in the $180-200 million goal we have for 2010.

Hayley Wolff – Rochdale Securities

You won’t give us a sense relative to what 2011 could have relative to 2010 from the initiatives in place now?

Kevin Farr

I am not trying to be difficult but it is a pretty difficult thing to estimate because it touches the entire value chain.

Hayley Wolff – Rochdale Securities

American Girl, the Denver Store, did that benefit you in the first quarter or is that a second quarter?

Robert Eckert

More second quarter. It did open in the first quarter and we are continuing to look at expansion opportunities for American Girl. It is our smallest store. It is under 10,000 square feet. It is kind of a test of the new, smaller store that doesn’t have any food service involved. It did not have a big impact on the first quarter. Remember what we sell at retail is what gets counted in numbers at American Girl and it has really only been open a couple of weeks.

Hayley Wolff – Rochdale Securities

There has been some talk about a re-release of Avatar in September I think or some time during the fall?

Robert Eckert

Avatar is a focused product line. It was a terrific movie. The DVD comes out in a couple of weeks here or maybe even next week. It is not a big driver of our performance. It is not a big toy property. That is what we thought when we went into the development of the line and that is exactly how it has played out. Avatar is not going to be a big contributor this year. Again, when I visit stores there is plenty of Avatar products out there. It is good product and it tells the story well but it is just not going to be a big entertainment property for the toy business.

Hayley Wolff – Rochdale Securities

Can you comment on any legal expenses for the Bratz litigation and how we should think about them throughout the course of this year?

Kevin Farr

As you know we have incurred significant legal costs over the last couple of years related to MGA and recall related litigation. For full-year 2008 we incurred incremental legal costs of about $37 million related primarily to phase one of the MGA trial which occurred in May through July of 2008. For 2009 litigation related legal costs decreased by $33 million. Additionally in the first quarter of 2009 we recorded $21 million in charges related to the legal settlement for product liability related litigation. The good news is going forward we expect legal fees related to recall related litigation to be relatively minor given the recent legal settlement for product liability related litigation.

As Bob said and as you know we are still in litigation with MGA and current legal costs associated with the case being reviewed by the Court of Appeals. In addition we are also incurring legal fees as we prepare for the next MGA trial which could occur in 2010. While we reduced expenses in 2009 we will continue to make the appropriate level of investments in legal fees until legal matters are resolved. Q1 legal costs are up $6 million in Q1 versus the prior year.

Dianne Douglas

I would like to thank everyone for participating in the call today. There will be a replay of the call available beginning at 11:30 a.m. ET today. The number for the replay is 706-645-9291 and the pass code is 61632801. Thank you.

Operator

Ladies and gentlemen this does conclude today’s conference. You may now disconnect and have a wonderful day.

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Source: Mattel Q1 2010 Earnings Call Transcript
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