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Hasbro (NASDAQ:HAS)

Q2 2011 Earnings Call

July 18, 2011 8:30 am ET

Executives

Brian Goldner - Chief Executive Officer, President, Director and Member of Executive Committee

Deborah Thomas - Chief Financial Officer, Principal Accounting Officer and Senior Vice President

Debbie Hancock - VP, IR

David Hargreaves - Chief Operating Officer

Analysts

Eric Handler - MKM Partners LLC

Michael Kelter - Goldman Sachs Group Inc.

Gerrick Johnson - BMO Capital Markets U.S.

Felicia Hendrix - Barclays Capital

Andrew Crum - Stifel, Nicolaus & Co., Inc.

Timothy Conder - Wells Fargo Securities, LLC

Robert Carroll - UBS Investment Bank

Gregory Badishkanian - Citigroup Inc

Alex Cook

Sean McGowan - Needham & Company, LLC

Operator

Good morning, and welcome to the Hasbro Second Quarter 2011 Earnings Conference Call. [Operator Instructions] As a reminder, today's conference is being recorded. If you have any objections, you may disconnect at this time. At this time, I would like to turn the call over to Ms. Debbie Hancock, Vice President of Investor Relations. Please go ahead.

Debbie Hancock

Thank you, and good morning, everyone.

Joining me today are Brian Goldner, President and Chief Executive Officer; David Hargreaves, Chief Operating Officer; and Deb Thomas, Chief Financial Officer.

Our second quarter 2011 earnings release was issued earlier this morning and is available on our website. The press release includes information regarding non-GAAP financial measures included in today's call. Additionally, whenever we discuss earnings per share or EPS, we are referring to earnings per diluted share.

This morning, Brian will discuss key factors impacting our results, and Deb will review the financials. We will then open the call to your questions.

Before we begin, let me note that during this call and the question-and-answer session that follows, members of Hasbro management may make forward-looking statements concerning management's expectations, goals, objectives and similar matters. These forward-looking statements may include comments concerning our product and entertainment plans, anticipated product performance, business opportunities and strategies, costs, financial goals and expectations for our future financial performance and achieving our objective.

There are many factors that could cause actual results and experience to differ materially from the anticipated results or other expectations expressed in these forward-looking statements. Some of those factors are set forth in our annual report on Form 10-K, in today's press release and in our other public disclosures. We undertake no obligation to update any forward-looking statements made today to reflect events or circumstances occurring after the date of this call.

Now I would like to introduce Brian Goldner. Brian?

Brian Goldner

Thank you, Debbie. Good morning, everyone, and thank you for joining us today. The Hasbro team executed our global branded-play strategy to deliver not only a strong second quarter, but also continuing to create the framework to deliver meaningful growth for the year and in the coming years.

Today, we are driving growth in our business through immersive brand experiences which are more innovative, more global and increasingly backed by media and entertainment, and in many cases, backed by digital and online gaming.

In addition, we are licensing our brands in a growing number of relevant ways for global customers and consumers. We are executing our full brand blueprint for Hasbro brands, while working with great long-term partners to support their brands, including Marvel, Lucasfilm and Sesame Workshop. To execute this strategy we are leveraging the investments we have made and are continuing to make to expand the reach of our brands for the long-term growth of our business.

Despite being in the early stages of unlocking both the revenue and earnings potential of our strategy, in some areas, we're already seeing positive results from our investments. For example, our International business is growing, posting 43% revenue growth in the second quarter or 30% growth, absent the impact of foreign exchange. This marks our third consecutive quarter of double-digit revenue growth in the segment. The growth this quarter comes not only from the continued strong performance in our emerging markets, where we are establishing Hasbro's presence for the long-term, but from other more mature markets as well.

We are at an inflection point in our business, whereby you can no longer just look at the U.S. business and extrapolate that to represent all of Hasbro. International is as important to us now as the U.S. and will be even more meaningful go forward. In fact, we could see revenue outside the U.S. greater than our U.S. revenue in the coming years. A balanced global business not only provides incremental growth opportunities but has served to help offset some of the continued challenges in the U.S. economy.

In the quarter, the profitability of the international segment nearly tripled as higher revenue more than offset investments in the segment. This profitability growth in the second quarter is very encouraging, given the segment generally contributes more to our profitability in the second half of the year. Specifically, over the last 5 years, the second half of the year has represented, on average, virtually all of the International segment's full year operating profits.

From a brand and entertainment standpoint, the second quarter marked the theatrical release of TRANSFORMERS: Dark of the Moon, as well as the on-shelf date of product to retailers globally. The movie has delivered approximately $700 million at the global box office and has yet to open in China and Japan.

The film has the highest exit poll reviews from audiences of any of the prior TRANSFORMERS movies, and this bodes well for sustained interest until the DVD arrives in the fall, backed by an extensive home-entertainment strategy from Paramount during the fourth quarter.

Importantly, our global retail partners have embraced the TRANSFORMERS: Dark of the Moon merchandise program in toys, apparel, publishing DVD, video game and other licensed goods. These merchandise programs include significant aisle space, feature shops, trend pods, endcaps, pallets and more. Promotional programs at retail ramped in mid-June, as promotion for the movie began in earnest at that time. We have a great licensing program, with over 325 licensing partners. Product is available through our global retail partners, and we have everything from apparel to skateboards and bikes to publishing.

Another top performer in the quarter, BEYBLADE, continues to be in high demand globally. From a capacity standpoint, we increased our tooling this year and expect to be caught up with demand in the coming weeks. Our new BEYBLADE XTS EXTREME TOP SYSTEM, will be on shelf in August and bring strong innovation to BEYBLADE globally. In the next season of programming, BEYBLADE: METAL MASTERS will be on Cartoon Network in the U.S. this fall and various broadcasters worldwide.

Other Boys brands contributing to growth in the quarter were Super Soaker, TONKA and Marvel, including Captain America: The First Avenger, which is selling well, leading into the movie release this Friday, as well as our initial shipments of KRE-O.

Beyond strength in what is shaping up to be a very strong year for Hasbro's Boys brands, our Girls brands MY LITTLE PONY, FURREAL FRIENDS and BABY ALIVE were up in the quarter. In Games and Puzzles MAGIC: THE GATHERING, SCRABBLE, SIMON, CUPONK and our line of Cars 2 games grew revenues in the second quarter. Within Preschool, we began shipping Sesame Street product during the quarter.

Of these brands posting growth, MY LITTLE PONY is an interesting proof point to discuss, as it relates to television. As you know, the MY LITTLE PONY brand has been reinvented based on Hasbro Studios' animated series MY LITTLE PONY Friendship is Magic. The program is airing on The Hub in the U.S. and Treehouse in Canada. On both networks, it is a top-rated program. In Canada, the program began airing in January on Treehouse, and point-of-sale trends at our top 4 accounts are up over 30% year-to-date through July 2.

In the U.S., The Hub recently began its summer schedule, which has the program airing 7 days a week. While still early, U.S. POS at our top 4 accounts was up 9% in June versus May. Additionally, MY LITTLE PONY recently began airing on Cartoon Network's U.K. Boomerang channel. It is in the top 5 shows airing on the network, and compared to the channel's previous 4 weeks average for that same time slot, the show boasted the channel rating by 53%.

By this fall, we expect entertainment to be airing in markets, which represent 90% of MY LITTLE PONY business. We're also receiving tremendous feedback from key licensees and retailers around the world based on the strength of the entertainment and broad consumer interest. MY LITTLE PONY has all the right ingredients to fill a gap in the marketplace that currently exists for a strong, young girls' multi-category property. MY LITTLE PONY is an important brand for Hasbro, and we are delighted to see it posting growth again based on engaging entertainment, innovative product and strong retail support.

Our overall television initiatives, which speak to both The Hub in the U.S. and our international distributional programming remain on track for the long term. The Hub recently implemented a new summer schedule, which reflects a higher percentage of programming from Hasbro Studios. This new summer schedule on The Hub has delivered widespread gains over the pre-summer schedule, outpaced the percentage growth among kids 2 to 11 of the new summer schedules against a few competitive networks and produced the highest ratings of the calendar year for The Hub.

Internationally, we continue to sign new deals and currently have placed Hasbro Studios programs in all major European markets, including the U.K., France, Spain, Italy, Germany and the Middle East, as well as important emerging European markets like Russia, Turkey and Poland. In Asia, we have deals in place for Australia, New Zealand, Singapore, Hong Kong and Korea. Finally in Latin America our programming will be seen in Mexico, Brazil, Chile, Argentina and Peru.

I'd like to take a minute and speak with you about our Games business. Following a softer-than-expected 2010 holiday season, our Games and Puzzles category has been working off excess inventory this year. While POS trends in the U.S. have improved in recent weeks, and despite growth in the category internationally in the quarter, the Games and Puzzle category, overall, declined in Q2.

I know from speaking with many of you that you are worried about the future of the Games business and what it means for Hasbro. I want to tell you, I am not worried. Given the expected growth of our business in other categories this year, 2011 is a perfect time for us to take strategic steps to accelerate the innovation and evolution of our gaming business.

In this vein, we took an important step when we announced the Center of Excellence for Hasbro Games in Rhode Island. This center will bring the top games talent in the industry together with the broader Hasbro brand teams to drive integrated, innovative gaming experiences for not only traditional face-to-face gaming, both on and off the board but in video, digital and online gaming as well. It is an investment we are making to fully leverage the long-term potential of this business.

To lead this coordinated effort, we have named Eric Nyman, a proven global brand leader at Hasbro to head the combined team. Eric has led the reinvention and reignition of several key Hasbro brands, including NERF and FURREAL FRIENDS, and we are confident that he and his team's innovative thinking will bring a fresh perspective to our gaming initiatives.

Where we are driving innovation in brands like MAGIC: THE GATHERING and SCRABBLE, we are seeing growth. We know that a number of gamers in the market is growing. Research tells us that parents and kids alike want to spend time together. And by keeping our gaming experiences fresh and relevant, while leveraging the industry's best portfolio of brands, we believe the gaming business will continue to be a strong contributor to Hasbro over the long term.

It is important to point out that from a profitability standpoint, we have dramatically grown Hasbro's operating profit in recent years by building bigger, more global brands in all categories, not just in Games. Our strategy has enabled brands across the business to rival the profitability of our traditionally higher-margin games brands.

As we begin Q3, a number of our initiatives for fall will begin hitting retail shelves around the world. KRE-O, our new construction brand, built on TRANSFORMERS is on shelves now and is launching globally in Q3. Already a few of you have told us that you are playing with and enjoying the sets, and we are seeing strong point-of-sales trends with this new initiative.

Sesame Street product, including Let's Rock Elmo is hitting shelves for the fall and holidays, and we are very excited about beginning this long-term relationship with Sesame Workshop in our Preschool space.

LITTLEST PET SHOP brings walkable pets to the market for the first time; MY LITTLE PONY continues to build on its entertainment platform globally; and FURREAL FRIENDS has another great pet, COOKIE, coming this holiday season.

Finally, last quarter, we have shared with you that we expected Hasbro Studios to launch programming on more than 20 markets globally by year end. Today, I'm pleased to say that due to the hard work of our teams and the strong appeal of our shows, we currently expect Hasbro Studios programming in over 30 markets globally by year end.

As I stated earlier in the year, we began to build momentum in the business during the second quarter. During the quarter, retailers were focused on key entertainment properties, including TRANSFORMERS, and we are seeing strong representation around the world. As we head into the remainder of the year, we'll begin to see the innovation and additional categories on shelf and we'll also begin to recognize licensing revenue from TRANSFORMERS: Dark of the Moon.

As we shared with you at the beginning of the year, 2011 is the first year in which we are fully activating our brand blueprint across all its elements. Our evolution to a branded-play company necessitates a higher level of investment spending in several areas, including television, entertainment, licensing and online. Additionally, we have been investing in Hasbro's owned and operated offices around the world, as we establish Hasbro as a global leader.

As we have shared with you in the past, many of these investments are ahead of the associated revenue they will create, while in the quarter have limited our margin expansion. As we go forward to the full year 2011 and beyond, we believe these investments will pay dividends in revenue and profitability improvements.

In sum, our outlook for 2011 is similar to yours and that we expect to deliver meaningful revenue and EPS growth for the full year.

Now I'd like to turn the call over to Deb. Deb?

Deborah Thomas

Thank you, Brian, and good morning. Hasbro is in a strong position, entering the important second half of the year. Our cash position is healthy, investments overseas are driving growth, and we have exciting innovation across our businesses for the holidays.

The second quarter was driven by a number of strong brand performances, as worldwide net revenues increased 23% to $908.5 million versus $737.8 million last year. Foreign exchange had a positive $35.8 million impact on net revenues for the quarter. Excluding the impact of foreign exchange, net revenues grew 18%.

As Brian mentioned, during the quarter, we announced the creation of our Center of Excellence for Hasbro Games in Rhode Island. As a result, we are relocating 59 employees to Rhode Island, and we had a reduction in force of 96 people.

In the second quarter, we recorded $13.1 million of pretax expense or $0.06 per share for severance, relocation and related costs. These costs were approximately evenly split between product development and SD&A. We anticipate an additional $7 million in cost over the next 3 to 4 quarters.

These remaining costs are primarily associated with the recruiting of additional talent and office space to support the expansion of our business and teams in Rhode Island. Excluding these costs, operating profit grew 17% for the quarter to $93.5 million or 10.3% of revenues versus $79.7 million or 10.8% in 2010.

Looking at our segment results for the second quarter 2011. The U.S. and Canada segment net revenues were $505 million, up 14% versus $444.5 million last year. As expected, the Boys category posted strong growth in the quarter, which was partially offset by declines in the Games and Puzzles, Girls and Preschool categories.

The U.S. and Canada segment reported an operating profit of $57.7 million or 11.4% of revenues. This compares to $58.7 million or 13.2% of revenues in 2010. The decline in operating profit margin reflects a higher volume of sales related to close out inventory, as we work down our carryover from last year. Although we wrote this inventory down last year, the subsequent sale has minimal to no profit. This more than offsets the favorable impact on profits from higher revenues of TRANSFORMERS and BEYBLADE.

Net revenues in the International segment increased 43% to $374.5 million versus $261.4 million in 2010. Absent a positive foreign exchange impact of $34.1 million, net revenues in the International segment grew 30%. The results in this segment reflect growth in all major geographic regions, including the emerging markets, as well as growth in the Boys and Games and Puzzles product categories, partially offset by declines in the Girls and Preschool product categories.

Operating profit in the International segment nearly tripled in the quarter, increasing 191% to $33.8 million, compared to an operating profit of $11.6 million in 2010. Operating profit improved on higher volume in the quarter, which leveraged our spending and more than offset our continued investment in emerging markets and international expansion. Historically, a greater portion of full year operating profit is derived in the latter half of the year, and we're encouraged by the second quarter levels.

The Entertainment and Licensing segment net revenues decreased 11% to $27.2 million compared to $30.5 million in 2010. Revenue in the Entertainment and Licensing segment declined primarily due to lower movie-related revenue versus the second quarter 2010, which included a payment related to the BATTLESHIP film scheduled for release in 2012. This was partially offset by revenue associated with selling our television programming to The Hub and some international networks.

As Brian mentioned, we have a strong licensing program for TRANSFORMERS: Dark of the Moon, and licensing revenue associated with the film will begin to be recorded in the third quarter of 2011. As you know, our licensing revenue in entertainment brands lags traditional toy and game revenue by quarter due to when our licensing partners report their revenue to us.

For the second quarter, the Entertainment and Licensing segment reported an operating profit of $600,000 compared to $13 million in 2010. These results reflect the lower movie-related revenue, year-over-year increases in online investments and our incremental investments in building out the global talent of our licensing teams. Program amortization was largely offset by television programming revenue in the quarter.

Now let's look at earnings. For the second quarter 2011, we reported net earnings of $58.1 million or $0.42 per diluted share compared to $43.6 million or $0.29 per diluted share a year ago. This includes a favorable tax adjustment of $20.5 million or $0.15 per diluted share, which relates to previously unrecognized tax benefits and other adjustments resulting from the completion of a tax audit.

Additionally, in the quarter, we recorded pretax expense of $13.1 million or $0.06 per diluted share from severance, relocation and related costs associated with establishing our Center of Excellence for Hasbro Games in Rhode Island. Excluding both these items, net earnings were $46 million or $0.33 per share.

For the quarter, average diluted shares were $139.2 million compared to $148.5 million last year. Cost of sales in the quarter was $378 million or 41.6% of revenues versus $300.3 million or 40.7% of revenues in 2010. Despite a positive impact from higher-priced, royalty-bearing products, cost of sales as a percentage of revenues was higher due to the level of sales of close-out inventory from last year at low to no margin, as well as the impact of unfavorable manufacturing variances from a slowing of games production.

Operating profit margin in the quarter was 8.9%, including $13.1 million of severance relocation and related costs. As I mentioned previously, these were approximately evenly split between product development and SD&A. Excluding these costs, operating profit was 10.3% versus 10.8% last year.

Overall, our year-over-year run rate of expenses is at a higher level than in 2010, as we have funded important growth initiatives in the past year, including driving future product innovation through investments in product development, developing and expanding our emerging markets business through talent and marketing investments, building out our global licensing team, as well as supporting our television initiatives globally.

We have already begun to see leverage from these investments in the International segment. And we expect in the second half of the year, we will gain some additional leverage from these investments, as well as anniversary to increasing cost in certain areas. Specifically, costs for lifestyle licensing, digital gaming, movies, television and online, all within the Entertainment and Licensing segment, have a current quarterly fixed expense run rate of approximately $15 million to $16 million. We grew our investment in the quarter in licensing, TV and online, and much of these expenses have been added ahead of the incremental revenue we anticipate generating in future periods.

Advertising, at 9% of revenue, declined as a percentage of revenue. This is consistent with previous years that had significant entertainment initiatives. Advertising as a percentage of revenues is expected to be at the lower end of our typical annual range of 10% to 11% of revenues.

In contrast and as expected, royalties grew in the quarter, reflecting increased entertainment-based offerings. For the second quarter, royalties were 9% of revenue versus 6.8% in 2010. This is primarily the result of royalties related to TRANSFORMERS movie products and BEYBLADE.

Within SD&A, emerging market and international expansion were key drivers of higher spending levels. We also had increased spending associated with our Licensing business and our non-cash SAP depreciation, which began in the first quarter. Foreign exchange also was a factor in our SD&A increase in the quarter.

Additionally, $6.7 million of the costs associated with the games action was in SG&A. For the full year, we continue to expect SG&A to be below 20% of revenues including the cost associated with our Games group.

Moving below operating profit. Other expense, net, totaled $4.6 million compared to other income, net, of $3.2 million a year ago. The year-over-year change was primarily the result of higher foreign currency losses in 2011 compared to 2010 on non-hedged transactions due to a weaker U.S. dollar.

Additionally, our 50% share of The Hub is included in the slide on the P&L. For the second quarter, our share of the earnings in The Hub was income of $197,000 compared to a loss of $76,000 in the second quarter 2010. For the second quarter 2011, our underlying tax rate was 27.7% compared to an underlying tax rate of 28.5% in 2010.

Now let's turn to the balance sheet. At quarter end, cash totaled to $584.8 million compared to $872.3 million a year ago. Operating cash flow for the past 12 months was $324 million and includes $73 million in television programming costs for the period.

In December of 2010, we entered into a new $500 million credit facility, which extends through December 2014. And in January of this year, we established a commercial paper program to allow us to issue commercial paper as a source of short-term liquidity as needed.

During the second quarter 2011, we repurchased a total of 2.4 million shares of common stock at a total cost of $112 million and at an average price of $45.80 per share. In the first 2 quarters of 2011, we repurchased 3.8 million shares at a total cost of $175.7 million at an average price of $45.69 per share. At quarter end, $474.5 million remained available under our current share repurchase authorization.

The quality of our receivables portfolio remains good and receivables at quarter end were $838 million, up 26% compared to $663.5 million last year. This reflects a 23% growth in revenues and an impact from foreign exchange.

DSOs were 83 days, up 2 days versus last year. The increase is primarily due to lower Licensing revenue, which have shorter payment terms, combined with the increased revenue in international emerging markets, which have longer payment terms.

Inventories at $426.9 million compared to $342.1 million a year ago and $401.3 million at the end of Q1. While inventories increased year-over-year, $23.5 million was a result of foreign exchange differences, and the overall growth was not as big as it's been in the past several quarters.

During the quarter, we took steps to move some slower moving carryover inventory, which negatively impacted our cost of sales but helped to improve the quality of our inventory portfolio. Overall, our inventory quality is good, and we believe sufficient to support our continued, expected international growth and the exciting new initiatives we have coming, which Brian spoke of earlier.

Depreciation and capital expenditures in the quarter were $28.3 million and $28.7 million respectively.

Overall, we believe we are on plan to deliver a strong 2011. The second quarter showed healthy revenue growth. And with the innovation we have coming to retailers globally this fall, we believe we will deliver meaningful revenue and earnings per share growth for the full year versus the $4 billion in revenue and $2.74 in earnings per share we reported in 2010.

Brian, David and I are now happy to take your questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question is from the line of Drew Crum of Stifel, Nicolaus.

Andrew Crum - Stifel, Nicolaus & Co., Inc.

I want to start with the Games and Puzzles business, guys. Any savings from the reorganization you're expecting in 2011? And could you comment on the inventory levels in for that business, both domestically and internationally, heading into the second half?

Brian Goldner

All right. Dave, you want to talk about inventory, and I'll...

David Hargreaves

Certainly, at the retail level, we said both on our end-of-year call and on our first quarter call that inventories were high. Right now, on the Games, inventories at retail are down versus a year ago.

Brian Goldner

And Drew, what we're really doing here -- and we took the opportunity this year to sort of do 5 things in the Games business. The first was to really accelerate the pace of the reinvention of that business, given where several of our other categories we're going. It was a perfect time to go do that. We had in our mind's eye to create a Center of Excellence around gaming, where we're able to marry the analog and the digital across a number of different formats, engaging more of the brand teams in that integrated and innovative manner. We have new leadership in the team, really proven global brand leaders who have reinvented and reimagined other brands for us globally. We have a whole new marketing approach for this fall, as well as a lot of new initiatives for the fall, but particularly, new marketing approach. We talked a lot about what we have done in marketing, particularly, in the U.S., with too many initiatives being supported and not a focus on kids marketing. And we're doing all of that. And then, longer term, in 2012, you will see more impactful and many more new initiatives and innovations. So really, it's a holistic approach to the business that we feel very good about, as we look towards 2012 and beyond.

Andrew Crum - Stifel, Nicolaus & Co., Inc.

And Brian, if I could shift gears to TRANSFORMERS, could you comment on the sell-in, sell-through performance, relative to your expectations, relative to TRANSFORMERS II? And then the follow-up to that is just going forward, what are the plans as far as media support for this franchise? And then I guess, I'm speaking specifically to another theatrical release.

Brian Goldner

We're very expect excited about TRANSFORMERS. And what's so great about it, in particular, if you focus first on the global box office is the fact, the global box office is very compelling and growing in several of those emerging territories so Russia, Brazil, emerging markets, China. That's a lot of the growth you're seeing in the global box office, and certainly, 3D is also contributing to that. Our business looks very similar to 2009 in some ways, and then different in other ways, and that we have more international retailer support than we've ever had. We have more licensees, and we have several new categories of product, including 2 more significant new introductions: one is TRANSFORMERS RESCUE BOTS, and the second is the introduction of KRE-O. So we're into a lot of new play patterns and new categories, more international support. But yet, overall, I'd say, it's a similar result to -- and certainly thus far to 2009 versus 2007 movies. As we look at the future, certainly, with the kinds of results we're seeing, our great partners at Paramount, as well as Hasbro, are very excited about what's possible. We have a lot of great promotional partners who are equally interested over the weekend, watching TV and seeing all the Burger King promotions, and our Activision games business coming online. People would certainly be excited about reinventing and reimagining TRANSFORMERS for the future. And certainly, movies play a role as does TRANSFORMERS: Prime. As the animated TV series will go around the world that we announced this morning, that we're now going to be in over 30 countries by year end versus the 20 we had guided toward earlier in the year.

Andrew Crum - Stifel, Nicolaus & Co., Inc.

And my last question, just a follow-up on that Brian. Is the guidance for the television initiative for the company still neutral to modestly accretive in 2011?

Brian Goldner

Well, what we're seeing thus far is tremendous progress in our overall television strategy. We are very encouraged by what we're seeing in The Hub. June was our highest ratings month we had seen since last December. Lots of momentum around the new summer schedule and greater proportion of Hasbro brands and Hasbro-branded content are 7 of the top 10 shows.

As we go forward, we are certainly seeing the halo effect of having our shows on The Hub and on international markets like MY LITTLE PONY. We don't yet have all of the product out there for the shows that are on the air. Most of that happens late this year. And it starts to become more clouded about which of these brands are growing as a result of the motion picture versus the TV. But what we do know is that overall, the TV strategy is certainly contributing to the business, both domestically and internationally. We don't really want to continue to talk about specific accretion, but suffice it -- and the reason for that, obviously, is because it's hard to delineate the specific cost and the specific results -- positive results, that we're seeing from TV-related -- to TV versus other marketing initiatives. But overall, we feel very good about the overall TV strategy in particularly about The Hub.

Operator

Our next question is from the line of Eric Handler of MKM Partners.

Eric Handler - MKM Partners LLC

First, when I look at your gross margin, you now put together 5 consecutive quarters of lower year-over-year margin. At what point do you think that we see an inflection point and start seeing that rise again? And then secondly, with The Hub, maybe you can give a little color on the advertising traction you're seeing there. And also the cable network upfront is pretty much wrapping up right now, and how you're seeing that did on a year-over-year basis.

Brian Goldner

Yes, overall, Eric, we're going to still see our gross margins in that 58-point-something range for the full year. That's really where we've seen our business going. Deb talked about getting the leverage from the revenues growth you're seeing in second quarter. And we believe that fact to be the case. Good signs of that, unless you want to comment further.

Deborah Thomas

The one thing that you're seeing impacting in the second quarter that normally it wouldn't have as much of an impact is the level of closeout inventory sales that we had particularly in the United States in the quarter. Because while we took all of the charges associated with writing that inventory down last year to the level we would sell it at, we had a higher level of revenue at little to no margin. Now typically, we always have closeout sales, but they come closer to the holiday period when revenues are higher, so you don't see that impact. So I do think you're seeing some of that in the quarter as well. But on a full year, as Brian said, we still expect our gross margins to be in that 58-point-something-percent range.

Brian Goldner

Right. And on The Hub, what we're seeing is growth in advertising revenue, very consistent with our long-term plan and up several fold versus a year ago. Lots of advertisers that have come on board that had not advertised prior on Discovery Kids. And again, we are on track for our long-term plan on The Hub, as well as the International business, which is actually ahead of our expectations. And having our programming on the air in 30 markets -- 30-plus markets this fall is certainly as good as one could've expected and certainly better than our overall plan.

Operator

Our next question is from the line of Michael Kelter with Goldman Sachs.

Michael Kelter - Goldman Sachs Group Inc.

I just wanted to first off follow-up on the gross margin question. I guess, if -- because your margins were down 100 basis points, you mentioned that games production was slow, and you had to close out. Could you maybe tell us would gross margins have been flat, if not, for those 2 things? I guess, just give us some sort of a magnitude of how they impacted your P&L.

Deborah Thomas

I think, gross margins would have been up absent those 2 things, Michael. Given the mix of our products in the sales we talked about the strength of TRANSFORMERS and BEYBLADE. And when we do have these entertainment-driven properties, we tend to have a higher gross margins to offset the higher royalty costs. So we will get those things together. And I think, if we had looked at those 2 things together, absent the closeout and the impact of the manufacturing slowdown on the game side, you would have -- we would've seen this be up.

Michael Kelter - Goldman Sachs Group Inc.

And then on board games, I heard, David, you mentioned that retailer inventories are now down versus a year ago. Can you talk about your own inventory levels, and if they're also in line, and inventory, really, at this point is clean going forward?

David Hargreaves

We've got no problem with our inventory levels. If you look at our inventory, right now, it's $426 million. That's up 24% versus a year ago. Take out foreign exchange impact of that, and it's up 17.8%. That's fully consistent with the growth that we're having in our business. As we said, a lot of those inventories in new markets that we didn't used to be in. So we've opened up business in Columbia. We've opened businesses in Korea over the last few years. They need inventory. So we are unlike the end of the first quarter and the end of last year, where we weren't fully comfortable in our inventory levels, we are now very comfortable with our inventory levels.

Brian Goldner

Michael, the inventory levels are really following the sales. So now our inventory is very split between domestic and international inventories. So it's not a -- not inventory in a place where we don't have sale.

Michael Kelter - Goldman Sachs Group Inc.

So now that you're inventories are clean, and you can kind of just look forward, what are -- and you mentioned the longer term confidence in the business, what about the back half of this year? I mean, you talked about getting back some support and displays at major retailers in the past. And do you think there's a reasonable chance that business could be up, or is it still just going to be one of those kind of transition years for board games?

Brian Goldner

I don't want to guide within specific categories, within the year. And certainly, our view toward our business is certainly in the medium- and long-term versus just for the year. Having said that, we feel very good about our overall ability to achieve meaningful revenue and EPS growth this year. And that's inclusive of our re-imagination and reinvention in the Games business. And as we go forward, the number of new initiatives this team is bringing forward and a new approach of the Games business is very heartening for us and is very consistent with the kinds of re-imagination you've seen from us in other brands that have then gone on to have global success.

Michael Kelter - Goldman Sachs Group Inc.

And then one last one on -- you had mentioned TRANSFORMERS is tracking kind of towards '09, at least at this point, how about BEYBLADE? Is that still tracking directionally towards '03, or maybe not as great as that year?

Brian Goldner

BEYBLADE is performing exceptionally well. And it's performing well all around the world in every country that it's in. We're in more countries around the world than we've been in before, with greater impact. You're seeing that uptake with kids. The show is on the air around the world. I'm not going to guide again toward a specific number, but TRANSFORMERS and BEYBLADE are certainly major contributors in the Boys arena.

Operator

Our next question is from the line of Felicia Hendrix, Barclays Capital.

Felicia Hendrix - Barclays Capital

Brian, touching upon something that you just talked about before, when you were giving us your overview for your business. You're rather optimistic, but if we look at the first half of the year, there were significant down -- declines in each of the segments other than Boys. You just talked about the Games. But I'm just wondering how you view the growth prospects for the non-Boy business for the second half of the year. Should we expect to see year-over-year growth?

Brian Goldner

Well, we have -- within the Girls business, for example, we have significant year-over-year growth in several brands: MY LITTLE PONY, and FURREAL Friends, BABY ALIVE. But you have some offsetting things that are going on. For example, in Easy-Bake, because of the whole light-bulb situation, that's a brand that's off significantly. And while it's not a significant contributor to global growth, given the issues in electrical products and the fact that you can't take that product all around the world, it has an impact on the segment in the quarter. And so if you look at the major global brands that we have -- we talked about the one brand that needed a major reinvention was LITTLEST PET SHOP, and that is on track. The new initiatives start launching very shortly now for the fall, including the walkable pets that I've talked about. So once you get beyond some of these secular shifts in products like Easy-Bake, you really start to see the major global brands come to the floor, and that's why, in Girls, I feel very comfortable.

But in Preschool, again, some positive signs there as well. Our Sesame Street launches, and brands like PLAY-DOH and TONKA contributing. And PLAYSKOOL, again, getting into the leads a bit. That was a case in the early part of this year, where we had a few perennial products that were not as profitable for us or the retailer that had great innovation, but given costs that had escalated over time needed to be reinvented like the STEP START WALK 'N RIDE. And the BALL POPPER needed to be reinvented. And so those products' volumes came out of the early parts of the year. It has an impact on our business, but we're reinventing those products and those lines. And they will be out in the second half of the year for us, and then going into '12. So again, overall, there's nothing in the structural elements within those segments that concern us.

Felicia Hendrix - Barclays Capital

Okay. And then -- and I'm just curious, because your competitor, on Friday, said several times on their earnings call that they're gaining share. I know the industry's pretty fragmented, but there are 2 big players. And I'm just wondering if you can address that, and if there's any areas that you might be just being affected competitively.

Brian Goldner

Actually, if you look at shares around the world, our shares throughout Europe are growing in every country. The U.S., especially, early this year, had stepped back within terms of share. More recently we're seeing better results out of the U.S. But if you go all around the world -- in major regions around the world, our shares are growing. We did have to work through issues in our U.S. business, which we've talked about. And go forward, we feel that we will gain market share in the U.S. as well. But in every territory, in every country around the world, we are growing market share and doing so fairly significantly. And so again, as a global company now, we look at our global market shares and feel that we are on track.

Felicia Hendrix - Barclays Capital

And then my next question has been asked, but I'll touch on it a different way. I mean, obviously, you look at everything globally. A lot of folks have been kind of doing their own channel checks. There's just been talk about sell-through of TRANSFORMERS. Just wondering, what do you think the end consumer takeaway is, and are you comfortable with the sell-through?

Brian Goldner

I think, for a lot of reasons, again, the overall size and scope of the brand that we've talked about is being more comparable to 2009 than 2007. But there are some market differences, and they're positive ones. We have more new innovation and new categories: Brands like KRE-O launching in our top 8 markets and then will be global next year; RESCUE BOTS; other categories of product like TRANSFORMERS: Universe, the smaller scale products are launching and performing quite well. So again, I think that the template for this brand continues to expand and evolve. That's part of the idea of having an evergreen brand. The number of licensees that we have and promotional partners we have continues to evolve. So overall, the audiences gave it a 90% positive rating on exit polls, which is better than any of the prior movies. So with the playability, we think, it's quite good. It even performed well this past last weekend in the face of strong competition from Harry Potter. And around the world, it's performed exceedingly well with over $700 million. And so we'll play well through the DVD period. And then Paramount has a tremendous plan in home-entertainment DVD for the fourth quarter. And that will be where even more kids will come and get to see the movie. Because, of course, it's a PG-13 movie, we recognize that sometimes littler kids don't go out to the theaters in the first couple of weeks. And again, there's nothing about the TRANSFORMERS business that worries us. In fact, we've very excited about owning and operating a brand of this strength, and the opportunity to continue to reinvent it over the next several decades.

Felicia Hendrix - Barclays Capital

Great. Final question, just curious on the -- on your Entertainment and Licensing, the profitability just seem to be a lot lower year-over-year. Deb touched upon the BATTLESHIP payment. Was that, primarily all of it, x the BATTLESHIP payment? Should we be -- should we have expected to see a more normalized margin there?

Brian Goldner

Yes. If you look overall for the year, Felicia, you'll -- it's partly what you're seeing in terms of revenues, obviously, that could cover the cost. I mean, just timing around when you get payments on royalties for licensed properties. They happen in arrears, and we'll follow in the third and fourth quarter. You have program amortization in that, in the cost there that's different than the year ago. That accounts for some of the profitability, the investment in licensing personnel, accounts for some of the profitability. But overall, again, by year end, you see a segment that again returns the kinds of profitability we've seen historically.

Operator

Our next question is from the line of Sean McGowan of Needham & Company.

Sean McGowan - Needham & Company, LLC

Deb, where do you expect the full year tax rate to be?

Deborah Thomas

We think the full year tax rate, we still expect it to be in the 28% range.

Sean McGowan - Needham & Company, LLC

That's normalized. So that will be excluding the adjustment?

Deborah Thomas

That's correct.

Sean McGowan - Needham & Company, LLC

Okay. Second, Brian, you mentioned a couple of things that was strong and just wanted to drilled down on a couple of other product categories. How is NERF performing?

Brian Goldner

Yes. Overall, that -- what we're seeing in the U.S. has been the restaging of the business in early in the year, probably a little bit too much inventory. Internationally, significant growth overall. For the quarter, it was relatively flat, because you've got strong International growth up against the U.S. staging and preparing for VORTEX. The second half of the year we have a major launch from VORTEX, the VORTEX line coming in the market, as well as new initiatives within the dart side of the business. So that's where we are thus far, and we feel very good about that business. The other part of that business now is Super Soaker, which has performed very, very well, up significantly versus year ago in second quarter. And that's true particularly in the U.S., That's the brand that's done very well in the second quarter. And so for the full year, again, NERF looks very strong.

Sean McGowan - Needham & Company, LLC

Okay. Now regarding the impact of closeouts on margins, do you think that, that's now been normalized, or should we expect that to continue in the second half? The impact from gross margin, that is.

Deborah Thomas

No. I mean, we do expect to have more closeout sales in the second half of the year, but as we get closer to the holiday season, it really gets leveraged against the revenue growth -- the additional revenue growth of some other parts of the business. So we don't expect -- well, we have more, we don't expect that we'll see an impact similar to what we saw this quarter.

Sean McGowan - Needham & Company, LLC

So in other words, you always have some, right? I think, it's now...

Deborah Thomas

Right. Yes, we always have some.

Sean McGowan - Needham & Company, LLC

But it won't be something that you need to call out? That's your expectation, that it's not going to have...

Deborah Thomas

Yes, that's our expectation.

Sean McGowan - Needham & Company, LLC

And just to -- I hate to come back to this horse and take another whack at it, it seems to be dead. But I just want to be clear, sell-through on TRANSFORMERS, is that up or not up versus 2009?

Brian Goldner

Sell-through on TRANSFORMERS in the U.S. is probably down a bit versus '09, but internationally is up. So particularly up significantly in the emerging market businesses.

Sean McGowan - Needham & Company, LLC

Okay. And you've mentioned all those other additional revenues sources that you might not have had last time around.

Brian Goldner

Right. Probably that what you have there, Sean, and it's a good point is we've purposely created a more diffused product line. So KRE-O is new business, and you wouldn't have those POS comparisons. So you're taking a category that we plan differently in the Boys action arena, this time than last time and again in the U.S. in particular, where POS is down a bit in the U.S. It's up significantly in several markets around the world. We really much -- take much more of a global view to this, the number of licensed products, categories that are performing well is there as well. So it's hard to make an apples-to-apples comparison, but broadly speaking, that's what we think we're seeing.

Sean McGowan - Needham & Company, LLC

Okay. Great. And then my last question is we've asked about earlier about the impact of The Hub. I think Drew asked them. You said, you didn't want to get into what the exact impact was. But you had said, I think, earlier this year that you to continue to believe that it would be neutral. Are you not commenting, because that's not true or you're not commenting, because you just don't want to comment?

Brian Goldner

No, no. So if you took -- but thank you for asking. If you took last year's dilution of about $0.30, we're not going to see that kind of dilution this year. I think that's what you guys want to know. So what the relative thoughts is, if it costs us a few million dollars or if it's flat or its slightly accretive, the point is the contribution that it makes now becomes melded into the rest of the marketing initiatives of the product lines. And so the reason I try not then try to tease it back out is because it's really hard to tell exactly all the contributors to something and why it's selling. But having said that, we're not going to see that kind of dilution you saw a year ago.

Sean McGowan - Needham & Company, LLC

Okay. But is your outlook essentially the same as it was at the beginning of the year?

Brian Goldner

Yes. It's essentially what it was the beginning of the year. We don't have any reason to believe differently. In fact, some of the more recent ratings are very positive.

Operator

Our next question is from the line of Greg Badishkanian of Citigroup.

Gregory Badishkanian - Citigroup Inc

Just two questions. First, you mentioned the Games inventory is lower versus last year. Are there any other categories or any other brands where maybe inventory is higher, if you kind of exclude the movie-related toys?

David Hargreaves

Greg, the answer is no. I think I talked about -- already about our inventory. Our inventory absent FX is only 17.3% about a year ago compared to the first quarter, when we were looking at like 77% above so. I think between strong production then in our Games business, which is of course a little bit of the under-absorption of margin immersion, I think moving anything which was slow-moving, which has caused a bit of margin -- not profit, but margin dilution. We've done everything we needed to do to get our inventory back in shape which is what we told you we're going to be in February. I think the retailer inventories, we're comfortable with the level of inventory in our retailers. We're down single digits, we're down double digits in terms of Games inventory at our 4 major retailers in the U.S., where we get good data. So inventory had been an issue at the end of year. It had been an issue at the end of the first quarter. We don't regard it as an issue now, either our inventory or our retailers.

Gregory Badishkanian - Citigroup Inc

All right. Good. And as you talk to major customers, is there any difference between now versus last year this time, as you -- as they start to plan for holiday, in terms of how much they plan to stock up in terms of inventory? Are they being more conservative? Are they buying later? Any change -- any differences?

David Hargreaves

I think, again, they came into the year, hoping to grow their business. They see this is a strong entertainment and product year. I think, at the end of the day though, they have to be a little bit cautious about what's happening with the U.S. economy. Now that's very different with the international markets, where a lot of the economies, Brazil, Russia, China are sort of surging ahead. But I think in the U.S., we're 2 years after out of recession, unemployment is increasing, underemployment is increasing, house prices are still going down. I think retailers will be appropriately cautious as they go into the end of the year. And certainly, we are appropriately cautious, but it doesn't change our guidance that we've have given you.

Operator

Our next question is coming from the line of Tim Conder with Wells Fargo Securities.

Timothy Conder - Wells Fargo Securities, LLC

Just a couple of clarifications. Besides the negative hit that you took on gross margins due to selling product at virtually no related margin, I just want to clarify, were there any incremental inventory charges that you took during the quarter? And if so, how much were those?

Brian Goldner

There weren't any, Tim.

Timothy Conder - Wells Fargo Securities, LLC

Okay. And then, also to clarify, you said that you expect SD&A as a percentage of revenues to be under 20%, including the charges related to the Games division?

Deborah Thomas

That's correct.

Timothy Conder - Wells Fargo Securities, LLC

Okay. Great. And then on TRANSFORMERS, so far, year-to-date, how are retail sales trending year-over-year of TRANSFORMERS product? I know the question was asked related to '09, but just any color on a year-over-year basis at the end of the second quarter, or however you want to answer the question there.

Brian Goldner

Great. If you look at our POS on TRANSFORMERS, in our overall business for the second quarter, TRANSFORMERS' POS year-on-year is up significantly. Significant double digits, which you would expect. Our overall POS, as a company, was up in the second quarter, driven by our Toy business, with improving trends in our Games business. So that's, particularly, in the U.S. In International markets, TRANSFORMERS' POS was up significantly where we have data and where we have more proprietary sell-through information, similarly in emerging markets where you don't have as much published data, but we have our own results.

The overall -- obviously, the TRANSFORMERS movie is -- has contributed significantly. The product lines are selling very well, although with different strategy than we employed in 2009 purposely.

Timothy Conder - Wells Fargo Securities, LLC

Okay. And then Brian or whoever wants to answer this, related to The Hub and the change in the agreement as far as how The Hub compensates Hasbro Studios for content. Can you give us a little bit more detail there, and what triggered that? And then also, a filing by Discovery indicated that there would be a reevaluation of the carrying value of The Hub. Just little more color around both of those issues.

Brian Goldner

I'll deal with the payments, and Deb can talk about the value. On the payment side, what we -- we started and we made an agreement prior to producing any programmings. And so as we produce the programming and put it on the air, it was quickly realized that Hasbro shows were 7 of the top 10 shows -- were really driving ratings for the channel and were the most successful shows for the channel. So we, with our partners, agreed to make a change to the licensing fees that we are being paid, particularly, for animated programming. And that license fee was raised to Hasbro -- to Hasbro Studios, that was more commensurate with the market rate for animation. So we got increased monies for our production of shows domestically from The Hub and was consistent with what people pay for animated programming. So that, of course, changed the economics for Hasbro Studios and for Hasbro, but of course, caused this change in the agreement.

Deborah Thomas

And because of that change in the agreement, it just triggered The Hub management to do a review of -- for impairment of their goodwill. And they have completed that review of goodwill impairment, and we don't expect any write-downs to be reported by The Hub in connection with that. They just have to have their auditors need to finish auditing the procedures, and that's nearly complete.

Operator

Our next question is from Robert Carroll with UBS.

Robert Carroll - UBS Investment Bank

Just a quick one on international. I mean, just given the strength in consumers in particular, just the divisional, overall. I mean, how do we think about the profitability progression over time? I mean, how much of the delta between North America and International profitability is just structural, and how much can be -- I guess, how much of that spread can be closed as some of brands really build up scale internationally?

David Hargreaves

So I think, firstly, in the short-term as Brian mentioned in the script, historically, much more of our profit internationally comes in the second half of the year. So if you look at the relative calendarization of profitability between the U.S. and Europe, it comes later in Europe. So I think the fact that it's less profitable during the first half of the year, even when we had a lot of growth of sales, is not a representative of the annual.

Brian Goldner

But if you look over the last 5 years -- go ahead.

David Hargreaves

So for the full year, we expect that the kind of overall operating return that we get internationally will be very similar to the U.S., if not be better. Within International, we clearly, have some new markets, Brazil, China, which are major growth markets for us over time, and we are investment-spending. We're investment-spending, putting paper on the ground, putting offices there, advertising our brands. So those markets today don't achieve a breakeven. And I think, we said repeatedly that some of those are on track to deliver profitability in 2013. And obviously, as we go beyond, that will improve. And then similarly, we've just opened an office in Korea this year. We'll open Colombia this year. So as we open these new markets, they're contributing to growth. But those new markets, we have to appreciate will be a little bit of drag on our margins in the short-term.

Brian Goldner

If you look over -- I was saying, and if you look over the last 5 years, 98% -- on average, 98% of the International segment's profitability came in the second half of the year. So the fact that it's already showing some good profitability and growth in profitability bodes very well for the full year.

Robert Carroll - UBS Investment Bank

Okay. I guess, just as a quick follow-up, so I mean, if we were look at a more developed international market, say Europe, and compare it against North America and operating margins, I mean, are they adjusting for FX? I mean, are they on par?

David Hargreaves

Yes. So in fact, some of our highest-margin markets in Europe. And if you go back and look at the full year, the last year, very close between International and U.S. and within that, as we said, we've got some emerging markets, which are drag, but we also got some margin markets, mature markets, like France, for example, where margins clearly exceed the U.S. and then Australia had good margin markets as well.

Operator

Our next question is from the line of Gerrick Johnson with BMO Capital Markets.

Gerrick Johnson - BMO Capital Markets U.S.

I had a question on digital games, 2-part question. First, if you could go over the economics of say a board game sale to Toys"R"Us versus a digital sale to say iTunes? And then secondly, on the digital sale, do you think it's a substitute for a board game? Is it a complement? Is it somewhere in between?

Brian Goldner

Sure. We'll start with the economics first. If you sell a board game, you have an operating profit margin into that board game. And as we know, a lot of board games tend to be very profitable. So call it a high-teens operating profit margin on a board game. On average, if you sell a digital game, the operating profit percentages are different by category: as to mobile game, higher operating profit margins; an online game versus a console game, which have more traditional levels of operating profit margin, given the cost of R&D and development and marketing.

What we are seeing is a significant growth in the number of digital items that we are selling year on year, in fact, EA has come out and published that they now believe there's 1 billion players globally, up from 200 million just a few years ago. So just like their business, our business is trending toward that significant inflection point, where you are not only collecting analog dollars but lots of digital dimes. And we don't see them as substitutional to a very different experience. When you play a MONOPOLY game on your smartphone or you play SCRABBLE on your iPad, that's a very different game than playing face-to-face.

And one of the key consumer insights that we are seeing as we do quantitative research is that face-to-face gaming are still something people really want and they seek out. And our Games business can absolutely grow. In fact, in the second quarter, our International games business grew. We've been working through the issues in our U.S. business, but overall, you will see more marriages of digital and analog. You'll see more new reinventions of our analog business and off-the-board games that will come into the future. So we think you can grow both.

Gerrick Johnson - BMO Capital Markets U.S.

Okay. And on the economics again, just to be clear. Digital operating margins, I know, they're different between category, but compared to a board game...

Brian Goldner

They're higher.

Gerrick Johnson - BMO Capital Markets U.S.

Higher, okay. And on your inventory, the closeout activity in the second quarter, can you give us an impact that had on the top line, as well as gross margins?

David Hargreaves

We probably -- we did move a lot of the slow-moving inventory, so we were probably in the region of $40 million to $50 million, as product that was sold at below full cost, or regional price, not certainly below cost.

Gerrick Johnson - BMO Capital Markets U.S.

Right, so just you might not necessarily hit your gross profit dollars, just your margin?

David Hargreaves

It doesn't hit profitability, but it does hit margin, yes.

Operator

Our final question is coming from the line of Alex Cook of Voyant Advisors.

Alex Cook

I was wondering if you guys could talk about the program production costs, specifically what the balance was as of Q2, and how much was capitalized during the quarter?

Deborah Thomas

Certainly, about -- at the end of the quarter, we had about $60 million on our balance sheet. And during the quarter, we spent about $22 million.

Alex Cook

But when you say spent, is that what was capitalized?

Deborah Thomas

Yes, that's our cash expenditure.

Operator

There are no further questions at this time. I would like to turn the floor back to management for closing comments.

Debbie Hancock

We'd like to thank everyone for joining the call today. The replay will be available on our website at approximately 2 hours. Additionally, management's prepared remarks will be posted on our website following this call. Thank you.

Operator

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.

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