Hasbro Q3 2007 Earnings Call Transcript

Hasbro, Inc. (HAS)

Q3 2007 Earnings Call

October 22, 2007 8:30 am ET

Executives

Karen Warren - Senior Vice President, Investor Relations

Alfred J. Verrecchia - President, Chief Executive Officer, Director

David Hargreaves - Chief Financial Officer, Executive Vice President - Finance and Global Operations

Analysts

Shadona Paulit - Lehman Brothers

Margaret B. Whitfield - Sterne, Agee & Leach

Michael L. Savner - Banc of America

Anthony N. Gikas - Piper Jaffray

Sean P. McGowan - Needham & Company

Timothy A. Conder - Wachovia

John Taylor - Arcadia

Gerrick L. Johnson - BMO Capital Markets

Thomas Russo - Gardner, Russo, Gardner

Dean M. Gianoukos - J.P. Morgan

Presentation

Operator

Good morning and welcome to Hasbro's third quarter earnings conference call. (Operator Instructions) With us today from the company is the Senior Vice President of Investor Relations, Karen Warren.

Karen Warren

Thank you, Shirley and good morning, everyone. Joining me today are Al Verrecchia, President and Chief Executive Officer; and David Hargreaves, Executive Vice President and Chief Financial Officer. To better understand our third quarter results, it would be helpful to have the press release and financial tables available that we issued earlier today. The press release includes information regarding non-GAAP financial measures discussed on today’s call and is available on our website at Hasbro.com.

We would also like to point out that on this call, whenever we discuss earnings per share, or EPS, we are referring to earnings per diluted share.

During the call this morning, Al will discuss key factors impacting our results and David 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 plans, anticipated product performance, business opportunities and strategies, financial goals and expectations for achieving our objectives.

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 Al Verrecchia. Al.

Alfred J. Verrecchia

Thank you, Karen. Good morning, everyone and thank you for joining us. Well, all is well here in New England. The Red Sox are in the World Series, the Patriots are 7-0, and Hasbro had another good quarter. But seriously, I hope you’ve all had a chance to read the press release we issued earlier this morning. As you can see, we had another strong quarter, with revenue up 18% from a year ago and operating profit up 27% to 17.1% of revenue.

The strength of our business is broad-based, both in terms of geography and product categories. The North American segment was up 10% and the international segment was up 33%, or 25% excluding the positive impact of foreign exchange. Our boys, girls, preschool and board game categories all performed well in the quarter.

In the boys category, Transformers, Spider-man, and Star Wars continued to do very well and remain the top three boys properties in the industry. Box office for Transformers surpassed the $700 million mark globally, making it one of the top films this year. In addition, Paramount launched the Transformers DVD last week and initial retail sales have been fantastic. The Spider-man 3 DVD will be released on October 30th. We expect both of these DVDs to bring even more kids into these franchises and help drive toy sales as we head into the holiday season.

Let me take a moment to address a question that some have had concerning the performance of the Marvel product line. The Marvel product line has performed very well year-to-date, exceeding the expectations we had when we entered into the agreement. For the full year, Marvel could represent as much as 8% to 10% of our worldwide revenue and it is delivering meaningful profitability.

Given this, I believe most would agree that there is little or not financial risk associated with the Marvel agreement. We are pleased with the year-to-date performance of the Marvel license and we are looking forward to the next four years.

Star Wars continues to be a phenomena in the industry. It is a perennial in the category and continues to deliver significant volume, even in non-movie years, something we expect to continue not only in the fourth quarter but in 2008 as well, given the release of the Star Wars animation.

Our girls category was up 33%, driven by growth in Littlest Pet Shop, My Little Pony, Baby Alive, and Furreal Friends.

The preschool category was up 3%, primarily attributable to the U.K. success of In the Night Garden, which began shipping in late July, and the continued success of our Playskool Busy Basics product line.

The over games and puzzle category was down 2%, due to softness it the plug-and-play trading card games. However, traditional board games were up 14% in the quarter and 8% year-to-date, with a number of new games performing well, including Monopoly Electronic Banking, Are You Smarter Than a Fifth Grader?, and the Game of Life: Twists and Turns.

Before closing, I want to comment on the recent recalls impacting the toy industry. Normally, we wouldn’t comment on product recalls that didn’t involve Hasbro. However, over the last several months, we have received numerous calls from government officials, analyst, investors, customers, and the media concerning the potential impact the recalls could have on our business. So we felt it would be appropriate to answer those questions today.

I am going to borrow David’s popular Q&A format he uses so well at the analyst events. Beginning with the question why hasn’t Hasbro been impacted by the lead paint recalls, given that Hasbro manufacturers products in China?

First of all, there is no issue more important to Hasbro than the safety of our toys and the children who enjoy them and we are proud of our safety record. In many instances, as is the case with lead paint, our standards are significant more stringent than the relevant legal standards. However, setting high standards is not enough. You need to have a very robust testing and inspection process in place to ensure that the standards are adhered to.

In fact, many of the procedures that some companies have recently adopted or described as new are the very same procedures we’ve had in place for many years. We believe our high standards and robust testing inspection procedures have enabled us to avoid these recalls.

As a follow-on to this question, even though you’ve been affected by the recalls, is Hasbro doing anything differently? Yes. We’ve taken additional steps to confirm that our procedures are being adhered to. We’ve increased the frequency of our product testing and we’ve stepped up inspections of all our products, both in our company-owned plans, as well as our vendors in China.

Additionally, we have tested everything in the system and we did not find any problems related to lead paint.

Next question; has any of the additional testing impacted Hasbro's supply chain or resulted in increased costs? The cost of the additional testing has not been material, nor have we experienced any delays in delivering our products to market.

Have the recalls impacted Hasbro's retail sales? That’s something that’s very difficult to quantify, given all the factors that could impact retail sales. However, as best as we can tell, we have not seen any measurable negative impact.

Lastly, do you think this is an industry-wide issue? No. I think the initial reaction of many observers, both in the press and the public at large, was to view the recently reported lead paint safety issues as a China or industry issue. However, I think people are now coming to realize that countries don’t make toys -- companies make toys. It’s the companies that are responsible for testing and conducting inspections to ensure adherence to the applicable safety standards.

Keep in mind the recalled products represent a very small percentage of the 3 billion toys sold in the United States each year. I’m not trying to minimize the importance of the lead paint issue; I just think we need to keep this in perspective. However, I would agree the industry probably needs to do some work on repairing its public image.

Speaking for Hasbro, while it is not possible to say we will never have a recall, we can assure you if there is a problem, we will address it quickly, openly, and decisively, as we have done in the past.

I hope this has been helpful.

In closing, our strategy to grow core brands and our initiatives to improve operating margins are working. You can see it in the success we’ve had with brands like Transformers, Littlest Pet Shop, My Little Pony, and Furreal Friends, along with the substantial improvement in our operating margin. We feel good about the strength of our business and are optimistic about both the holiday season and 2008.

In addition to the brands that have been driving our business throughout the year, we have some great new innovative products and as always, we’ll be very active on the advertising and promotional front.

Thank you for joining us. Now I will turn the call over to David to talk more about our third quarter results. David.

David Hargreaves

Thanks, Al and good morning, everyone. I am very pleased with the results we are reporting today. For the quarter, we delivered worldwide net revenues of $1.223 billion. This compares to $1.039 billion last year, an increase of 18% or $183.9 million.

In constant dollars, revenues were up 16%, or $161.5 million. North American segment revenues were $822.7 million, an increase of $77.2 million, or 10% compared to last year’s $745.5 million.

North American operating profit for the quarter was $134 million, or 16.3% of revenue, compared to $111.6 million, or 15% of revenue last year. The improvement primarily reflects the higher revenue, which was partly offset by higher royalties.

Revenues in the international segment were $374 million, compared to $280.4 million a year ago. The segment was up an impressive 33% in U.S. dollars and 25% in local currencies.

The international segment reported an operating profit of $57.6 million, compared to $43.2 million last year. The improvement is primarily a function of higher revenue, partly offset by higher royalties and higher advertising expense.

Now let’s take a look at earnings. For the quarter, we reported net earnings of $161.6 million, or $0.95 per share. The 2007 results for the quarter include a favorable tax adjustment of $29.6 million, or $0.17 per share. This adjustment related to previously unrecognized tax benefits for which the applicable statutes of limitations expired during the quarter.

Excluding the favorable tax adjustment, earnings were $132 million, or $0.78 per share. This compares to $99.6 million, or $0.58 per share in 2006. Earnings before interest, taxes, depreciation and amortization were $259.3 million compared to $192.6 million a year ago. Gross margin for the quarter was 57.4% compared to 55.6% a year ago. Gross margin benefited from changes in our product mix. As we have stated in the past, entertainment based product lines typically have higher gross margins.

Now let’s take a look at expenses for the quarter. Royalty expense increased by $41.7 million to $93 million, also due to a shift in the mix to more entertainment-based properties.

Research and product development expense declined marginally to $43.5 million from $44.4 million a year ago. You may recall last year we spent additional development monies due to the compressed development times for the Marvel line.

Advertising expense declined to 11.3% of revenue, although it did increase in absolute dollars from $126.8 million to $138.7 million.

SG&A expense at $199.1 million compared to $169.3 million a year ago and was flat as a percent of revenue. The dollar increase is due to a number of factors, including higher shipping and warehousing costs associated with the higher sales volume, higher accruals for incentive compensation and charitable giving, the impact of foreign exchange and general inflationary increases.

Other income for the quarter was $3.5 million compared to an expense of $15.2 million a year ago. The 2006 results include a $19.8 million unfavorable mark-to-market expense related to the Lucas warrants.

Excluding the favorable tax event that occurred in the third quarter, the year-to-date impact of the Lucas warrants and other discrete tax events, our underlying 2007 Transformers was 32.3%, compared to the full year 2006 underlying tax rate of 27.6%. The higher underlying rate for 2007 reflects the tax cost associated with returning a portion of current year international earnings to the U.S.

Now let’s turn to the balance sheet. At quarter end, cash totaled $410.9 million, compared to $309.1 million a year ago, an increase of $101.8 million.

In the last 12 months, we have generated over $460 million in operating cash flow and we raised $350 million in cash through our recent debt offering. However, this cash has been largely offset by significant payments, including: exercising our rights to purchase the Lucas warrants for $200 million; paying $70 million to Marvel as part of our five-year agreement; returning $89.7 million to our shareholders in dividends; and lastly, $495 million to repurchase 17.7 million shares of Hasbro stock.

Our receivables at $892.7 million were up $213.3 million compared to $679.4 million last year. The increase is a reflection of significantly higher sales volume, changes in our product mix towards markets with longer payment terms, and the impact of foreign exchange.

The change in mix is the primary driver for the increase in DSOs from 59 days to 66 days. The quality of our receivables remains excellent.

Inventories increased to $395.5 million, compared to $312 million a year ago, reflecting the growth and timing of our business this year, as well as the impact of foreign exchange.

At the end of the quarter, our debt-to-cap ratio was 39%, due to the recent $350 million debt issuance. A portion of this issuance anticipates $135 million of our debt maturing in July of next year. Over the medium to longer term, we would expect our debt-to-cap ratio to be within our stated target of 25% to 30%.

On August 2nd, the Board of Directors authorized the company to repurchase an additional $500 million in common stock. During the quarter, the company repurchased approximately $12.9 million shares at a total cost of $362.1 million.

Since the resumption of our share buy-back program in 2005, we have spent over $1 billion to repurchase more than 41 million shares. When one takes into account the Lucas warrant transaction, we have spent over $1.2 billion to retire approximately 57 million shares and warrants.

In closing, our buy-back program is clearly motivated by our commitment to create value for our shareholders. It reflects both our significant cash generation and our expectations for the business going forward. Clearly we are having a great 2007 and we believe all the pieces are now coming together for a great 2008. We look forward to sharing more about 2008 at our upcoming analyst meeting in November, which will be webcasted.

With that, Al and I will be happy to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Felicia R. Hendrix. You may ask your question and please state your company name.

Shadona Paulit - Lehman Brothers

This is actually [Shadona Paulit] for Felicia Hendrix. Just a couple of quick questions. Congratulations on a good quarter. Was Star Wars up in the quarter?

Alfred J. Verrecchia

Star Wars was down in the quarter compared to a year ago but performed very well during the quarter.

Shadona Paulit - Lehman Brothers

Okay, was it down more than in Q2?

Alfred J. Verrecchia

I don’t have that number handy, to be honest with you.

Shadona Paulit - Lehman Brothers

Okay. In terms of Spider-man and Transformers shipments, do you expect them to be higher in Q3 or Q4?

Alfred J. Verrecchia

Higher than -- do you expect them to be higher in Q4 than Q3? I’m not quite sure of your question.

Shadona Paulit - Lehman Brothers

Do you expect to ship more in the fourth quarter than you did in the third quarter?

Alfred J. Verrecchia

We’re not going to forecast individual product lines from one quarter to another, but clearly Transformers and Marvel continue to do very well and we’d expect them to do well in the fourth quarter.

Shadona Paulit - Lehman Brothers

Okay. In terms of shelf space at retail, do you see any significant differences for the holidays this year than compared to last year?

Alfred J. Verrecchia

Yes, we have more shelf space. Our shelf space has grown over the past season.

Shadona Paulit - Lehman Brothers

Okay. In any specific categories?

Alfred J. Verrecchia

Certainly in the girls categories, which are doing very well, we’ve gained shelf space. The boys category, we’ve gained shelf space. Those are the two principal ones. We haven’t lost any shelf space. We’ve gained some space in the preschool area as well.

Shadona Paulit - Lehman Brothers

Okay, and then just lastly, do you see any potential out of stock issues, given your third quarter performance, for the holidays?

Alfred J. Verrecchia

It’s always possible in the sense of something takes off. Certainly we’re selling Transformers, Marvel, Star Wars will all continue to do well, some of the Furreal line. So there’s some possibilities out there. It just depends what happens with a given promotion.

Shadona Paulit - Lehman Brothers

Okay, great. Thanks a lot.

Operator

Thank you. Our next question comes from Margaret Whitfield. You may ask your question and please state your company name.

Margaret B. Whitfield - Sterne, Agee & Leach

Good morning. Could you comment on the plug-and-play segment, whether that will continue to be a drag in Q4?

Alfred J. Verrecchia

Plug-and-play has not done very well for us this year and I don’t have the numbers that we had last year. I don’t expect it is going to pick up in the fourth quarter. How much of a drag, I’m not sure but it is not going to be -- it will continue to decline in the fourth quarter as well.

Margaret B. Whitfield - Sterne, Agee & Leach

I guess the board games [does seasonally] strong so maybe the overall category might pick up some?

Alfred J. Verrecchia

Hopefully. We’ll see.

Margaret B. Whitfield - Sterne, Agee & Leach

Okay, and preschool has been doing great, a slowdown here -- is it just shipment timing or what’s going on in preschool?

Alfred J. Verrecchia

I hate to get into if you exclude X than there’s a balance that’s good, but I think what’s happening in the Playskool category is last year during the third and in particular the fourth quarter, we shipped a lot of T.J. Bearytales, which quite frankly hasn’t worked for us, and that’s been pulling the preschool category down. I think without the decline of T.J. Bearytales, we’d be even stronger in the preschool category.

Margaret B. Whitfield - Sterne, Agee & Leach

Given the recalls and all the publicity, could you comment on what overall toy sales at retail have been like thus far this fall?

Alfred J. Verrecchia

Are you talking for Hasbro or the industry?

Margaret B. Whitfield - Sterne, Agee & Leach

Either or, or both.

Alfred J. Verrecchia

Our sales, our retail sales have been strong all year. They’ve been up double digits. They continue to be up double digits, although it has been a soft retail environment during the last month or two. So I think from an overall retail perspective, it’s been a bit soft. I know apparel is certainly down but our business has been strong and we are very optimistic about the fourth quarter.

Margaret B. Whitfield - Sterne, Agee & Leach

When you say soft retail, are you talking about toys or in general? Or could you be specific?

Alfred J. Verrecchia

I think in general and I think toys has felt some of that overall weakness as well. If I look at it from an industry perspective -- again, our business has been strong and it continues to be strong. Would it have been stronger with a stronger retail environment? I suppose so but again, we’ve been up double digits and continue to be double digits, so it is hard to say.

Margaret B. Whitfield - Sterne, Agee & Leach

And a competitor has commented that they might have to spend more for “demand creation”. Do you expect to do the same here in the holiday period?

Alfred J. Verrecchia

Well, we are certainly going to be very active during the holiday period. I mean, that’s the key selling season at retail for toy and game companies, so we have a lot of activities planned both from an advertising and in-store promotional activity, so we are going to be very active.

Margaret B. Whitfield - Sterne, Agee & Leach

Any pick-up in your plan, given the recalls? Have you increased it?

Alfred J. Verrecchia

I don’t think we’ve increased our promotional activity as a result of the recalls. We’ve got a pretty active program planned and we haven’t seen any fall-off in our business, any measurable fall-off, anyway, as a result of the recall, so again, that’s kind of hard to measure.

Margaret B. Whitfield - Sterne, Agee & Leach

Just finally, you’re in -- a partnership with Electronic Arts was announced after the Q2 call. Could you comment as to what this may mean for Hasbro in ’08?

Alfred J. Verrecchia

Well, ’08 is going to be the first year where we are actually seeing product delivered by Electronic Arts and we’re going to talk a bit more about that at the upcoming analyst event in November, but we’ve seen some of the initial products that they are working on and we are very excited about what we see coming down the road in 2008, and that’s going to come in ’08, although ’08 will still be a ramp-up year, so I think as you see ’08, it’s ’09 and ’10, they’ll get even stronger as more and more product comes into the marketplace.

Margaret B. Whitfield - Sterne, Agee & Leach

Okay. Thanks again, Al.

Operator

Thank you. Our next question comes from Michael Savner. You may ask your question and please state your company name.

Michael L. Savner - Banc of America

Thanks. Good morning. Sorry to make you answer that same question, guys. I want to make sure I understood it correctly. So in terms of Margaret’s question about marketing spending in the fourth quarter, you don’t anticipate spending more than you typically would in a seasonally high period, because you are not seeing much push-back. Did I interpret that correctly?

Alfred J. Verrecchia

We are going to be very, very active in the quarter. When you say are we spending more because of recalls, I don’t think so. Are we spending more than last year? Yes, so we will be more active this year than last year but we had planned that all year long. We are not doing anything substantially different as a result of product recall, so --

Michael L. Savner - Banc of America

That helps, thanks. And then, just to again keep on topic of revisiting things you’ve already talked about, we’re hearing and some of your competitors are talking about some hesitation, some anxiety on the part of retailers, given the recalls. It doesn’t sound like you are getting the feeling from any of your retail partners that they are going to slow down and take a wait-and-see attitude, or do you think that is part of what’s been driving as you’ve just said, a slightly softer retail environment in the last month or two? Are those two issues related, in your mind?

Alfred J. Verrecchia

I think -- you know, I’ve been in this industry a long time and every year at this time, retailers and manufacturers get anxious about the holiday season. Certainly I think some of the larger economic factors out there are likely to have a more significant impact on retail sales and recalls, unless something where to happen over the next couple of weeks. So I would be more concerned about the price of oil and things of that nature than I would about the recalls impacting sales.

As we talk to retailers, yes, they are anxious about the holiday season. Am I anxious about it? You know, you pick up the paper and people are forecasting it to be the worst holiday season in five years, yeah, you worry about that. On the other hand, when I pick up our reports and I look at the way our product is selling, our product continues to do very well.

So there is always anxiousness going on. We are always looking to make sure we are -- that we’ll be active and aggressive during the holiday season and I think probably over the next several weeks, when some of these retailers will be dropping catalogs, we’ll get a good feel as to how the consumer really is going to be in the holiday season.

Michael L. Savner - Banc of America

Great, and then just one last specific one on the Transformers; not unexpectedly, it’s done very well this year. To what extent do you think maybe some of the success have been front-end loaded in 2Q and 3Q, and how do you feel about what the inventory that’s out there in the channel, or do you feel that that’s not a fair assessment that the demand has been relatively linear and you are comfortable that it is going to continue into the fourth quarter?

Alfred J. Verrecchia

Well, certainly when the movie came out or right after the movie, you get a spike in sales but the demand for Transformers continues to be very, very high and continues to grow. Keep in mind we just, or Paramount just launched a DVD, and like I said a few moments ago, the initial sales have been fantastic, so we’re seeing a pick-up there as well. So I think Transformers is going to be strong throughout the holiday season and I expect it to be pretty strong in 2008, because we have a lot of new product coming and there are a lot of kids that have come back into the franchise.

We’ve got animated TV going on with Transformers that I believe breaks in the first quarter, so we are excited about the brand and we have not seen any fall-off, other than that peak they get right at the movie and then it levels off at a pretty high level. And from that level, it’s been growing right along.

Michael L. Savner - Banc of America

Terrific. Thanks, Al.

Operator

Thank you. Our next question comes from Tony Gikas. You may ask your question and please state your company name.

Anthony N. Gikas - Piper Jaffray

Good morning, guys. Nice quarter. A couple of questions; I just want to go back to the retail environment and the shelf space question. Just for the industry wide, are you seeing from Wal-Mart and Target any expansion in shelf space for the category this year, or perhaps less?

Second question, I have been getting some questions from some investors regarding the video game segment and do you expect the strong growth that that category is experiencing this year at much higher price points could have some impact to traditional toy sales?

And then, third question, could you just give us a little bit more color on the tax benefit, what that was in the quarter? Is there more of that to come and what should we be using for tax rates going forward?

And the last one’s a housekeeping, just the share count at the end of the quarter.

Alfred J. Verrecchia

I’m going to let David take the last two in a moment. In terms of shelf space overall, I don’t believe that the major retailers are allocating significantly more or less shelf space to toys in their stores. I know we’re getting more space but I don’t know that Wal-Mart or Target have actually changed the amount of shelf space from ’06 to ’07.

In terms of the video game business and its impact on toy sales, you know, we get this every so many years. It depends upon obviously the success of specific video games out there. We’ve been competing with them for many years now and I think it always has some impact, just like a hot toy product can have impact in a given year.

I don’t see the success in the video game business having any meaningful negative impact on our business either in the boys business or in the games business. We see softness in the plug-and-play category in our business but I don’t think that has anything to do with the videogame business.

And then David, do you want to talk about the tax benefit?

David Hargreaves

The tax benefit is clearly in earlier years, we had made some provisions for potential taxes which didn’t arise, so therefore we are reversing those provisions and it was $30 million. And no, we are not expecting any further impact related to that.

Also during the quarter, we made a decision that we would repatriate about $90 million of earnings from overseas, and these earnings had been made in countries with lower tax rates, and therefore, we had to take an additional tax charge, recognizing that we would repatriate, bringing it up to the U.S. federal rate. That took our underlying rate up from -- we’ve been planning at about 28% this year. It’s taken up to sort of 32.3, and as we adjusted our rate, we had to adjust it for the three quarters year-to-date so far because we do it on an accrual basis. So that was probably in about $14 million to $15 million, but it is not a discrete, one-time event. It is part of our ongoing business.

Going forward, we will -- each year we will sit down and look at our requirements at the beginning of the year to work out if we need to repatriate current year earnings from overseas or not. We certainly have no plans to repatriate prior year earnings at this time, at this point in time.

And finally, regarding the share count, at the end of the quarter our shares outstanding were $149.6 million.

Anthony N. Gikas - Piper Jaffray

Okay. Great job. Thanks, guys.

Operator

Thank you. Our next question is from Sean McGowan. You may ask your question and please state your company name.

Sean P. McGowan - Needham & Company

A couple of questions; one, David, on royalty rates, were they -- on any of these license properties, was the rate applied to the revenue in the quarter consistently with what it had been before, or was there any change?

David Hargreaves

No, we’re applying royalty rates consistent with the contractual terms.

Sean P. McGowan - Needham & Company

Looking at -- I appreciate the comments regarding Spider-man, Al, or just Marvel in general, being maybe in excess of your expectations. It would seem certainly relative to Transformers but even in absolute terms, that maybe Spider-man didn’t meet retailers’ expectations, just based on the amount of shelf space and the amount of products still out there.

Can you tell us if you expect this to have any impact on their appetite for Iron Man and Hulk in 2008? And what are generally your expectations for those properties, relative to the ones you’ve seen so far from Marvel?

Alfred J. Verrecchia

You know, it’s interesting; there were a lot of people when we entered into the Marvel agreement that just sort of said, okay, it’s Spider-man and maybe there’s Hulk and there’s some other movies, but didn’t really ascribe much value to some of the other properties.

That’s changed dramatically as we’ve now been able to see some snippets and footage from both Iron Man and Hulk, and as we begin to show that to our retailers, we’re really excited about Iron Man and Hulk in 2008. We think they are going to be meaningful properties.

I certainly don’t think they are necessarily going to be at the level of a Transformers or a Spider-man, but we are very excited and our retailers are looking at Iron Man and Hulk entirely differently than they might have been a year ago.

In addition to that, we’ve got the Indiana Jones movie from Lucas coming, so from that perspective, we are pretty excited about ’08 and some of the newness we have and I think that Spider-man and Transformers and Star Wars will still be strong. They may be down, obviously, from a movie year but they will still be very strong in ’08.

Sean P. McGowan - Needham & Company

And last question, probably for David, what was the timing of the actual payment to Lucas during the quarter? I presume that this is the last we’ll have to make an adjustment for that?

David Hargreaves

The actual payment on the warrants was actually in the second quarter.

Sean P. McGowan - Needham & Company

So why was the expense then taken in the third?

David Hargreaves

It wasn’t. The only reference to a Lucas mark-to-market was referencing the third quarter of ’06.

Sean P. McGowan - Needham & Company

Oh, I’m sorry. I misread the press release. Okay, thanks.

Operator

Thank you. Our next question comes from Tim Conder. You may ask your question and please state your company name.

Timothy A. Conder - Wachovia

Thank you. First of all, congrats again on a great quarter. A couple of items; give us maybe a little bit more color, gentlemen -- a couple of your competitors out there, both public and not, have had problems in the girl category. Just a little bit more color on your successes there.

And then, input costs -- not too -- you didn’t make too many comments regarding that. Just give us an update on that. How do you look at being locked in as far as shipping? How far out you’re shipping contractual agreements?

And then I have two more after that.

Alfred J. Verrecchia

David will take you through the input costs. I’ll talk a little bit about the girl category. Our business has been very strong. When we talk about girls, we’re talking about My Little Pony, Littlest Pet Shop, Baby Alive, Furreal Friends. Certainly the small dolls category, which is the My Little Pony Pet Shop has been very strong for us. As I said, our business overall in the girls category is up 33%. Baby Alive continues to do very well, as does Furreal Friends.

I think some of the softness in the girl category, you know, as opposed to a specific brand, has probably been more in the larger -- the large doll, fashion doll category as opposed to the small doll category. But again, you’ll have to talk to competitors as to what they mean by that.

We have not seen any softness certainly in the girls products that we’ll involved with.

David, the input costs?

David Hargreaves

In terms of input costs, certainly they are trending up. A couple of things, which I pointed out before, that resin costs don’t move in a high correlation with the price of oil. It depends on a lot of other factors, including the amount of capacity in the industry at the time, so the price of oil has certainly been trending up in recent months. Resin hasn’t been trending up nearly as significantly.

In addition, I think we have to remember that of every 100 units of revenue we get, our cost of goods sold is only about 42% of that and the cost of resins is only about 4.5 percentage points of that, so we have to put it in perspective because there’s a lot of other components and a lot of other costs that we have, other than just resins.

In terms of how far do we look in, we basically once we cost and fit a new product into our line, our suppliers, our vendors give us their price, which is good for the practical life of that product. Now certainly, we turn over a lot of products every year, so each year when they give us new quotes for the new line for the coming year, they factor in the latest commodity, exchange rates, and labor costs. So we are kind of updating and factoring those cost assumptions in on an ongoing basis.

Timothy A. Conder - Wachovia

Okay, and again, David, your commentary on percentages were related to resins. How does that look again -- and I guess you are talking about the shipping factored all into that when your contracts will cost collectively, your latter comment -- is that correct?

David Hargreaves

Yes, what I’m saying is we look at our costs for the practical life of a product, so for carryover products, we’re not expecting any cost increases and for new products, we don’t specifically have to take price increases as such, because the new products are costed using the most recent commodity, labor, shipping, cost factors and exchange rate cost factors, so certainly as we price our new line, we are looking to maintain our margins.

So year over year, will a like-to-like item be priced a bit higher to reflect commodity costs? Yes, it will.

Timothy A. Conder - Wachovia

And at the Dallas show, were there some -- did you address those looking into the ’08 period, or will those be addressed as we look more into the first quarter for Christmas holiday ’08?

Alfred J. Verrecchia

We don’t participate in the Dallas show. We have our own private showing here in Rhode Island. In fact, we are in the midst of that right now and we’ve been doing that for about the last 20 years. Certainly this is the time of year, not necessarily at this show, when everyone is talking about pricing and things of that nature.

Timothy A. Conder - Wachovia

Okay, and I guess the last question I had to follow-up on a previous one, can you give us any dollar amounts, as you’ve done in the past, related to Star Wars in the quarter or year-to-date? And the same thing for Spider-man and Transformers?

Alfred J. Verrecchia

Well, we are not going to give individual lines in the quarter. Whatever we do have to do will come out when we issue the 10-Q. There is no question that Transformers had significant volume in the quarter versus a year ago, as did Marvel. Star Wars, while it was down in the quarter, it wasn’t down by a lot compared to the third quarter of last year, and that’s sort of where it is right now. We are not going to give individual numbers, other than what we would put into the 10-Q.

Timothy A. Conder - Wachovia

Okay. Thank you, gentlemen.

Operator

Thank you. Our next question comes from John Taylor. You may ask your question and please state your company name.

John Taylor - Arcadia

Congratulations. So I want to follow up on the line of question about cost as well. The authorities in China have tightened up dramatically the export license requirements and I’m wondering whether you guys are anticipating any sort of industry-wide reduction in capacity in China that might have an unusual impact on cost negotiations this year. Let me approach it from that side.

Alfred J. Verrecchia

No, we have not had any indication that there is going to be a reduction in the capacity because individual vendors are not able to get export licenses. Now, I suspect that could happen with C-level vendors, but certainly the people that we have been using have not indicated any difficulty, nor have we experienced any difficulty thus far I getting our product to market, so we are not looking at any capacity issues as it relates to the import licensing and factors not being able to operate.

John Taylor - Arcadia

And consequently no unusual pressure on costs, such that factories might be able to catch up on some repressed inflation from previous years, anything like that?

Alfred J. Verrecchia

No, I think as David said, the costing will be based upon current commodity costs, current labor costs, and certainly there are pressures there that we have every year and have been growing and as David said, we incorporate that into our pricing.

John Taylor - Arcadia

Okay, great and then last question, on electronics; with the EA agreement, does this change the priority of your trying to develop the kids electronics business? In other words, do they take over a greater burden of that? I wonder if you could talk about how that affects your approach to the electronics category.

Alfred J. Verrecchia

No, you mean products like -- that we did before, such as an iDog and VideoNow and some of the other electronics products we’ll continue to do. In fact, I think there is a strong possibility that the relationship with EA would really enhance our ability to do some of those products as we would be partnering with them on some of those things, and we have a few things that we are working on now with them where we’ll partner with them on electronic toys, so I don’t see us moving away from that because of the EA agreement -- not at all.

John Taylor - Arcadia

Great. Thank you.

Operator

Thank you. Our next question comes from Gerrick Johnson. You may ask your question and please state your company name.

Gerrick L. Johnson - BMO Capital Markets

Following up on one of Tim’s questions, without breaking out sales in each particular category, per se, or each particular line per se, can you give us an idea of what sales growth would have been like in the quarter excluding the movie properties, Transformers and the Marvel movies?

Alfred J. Verrecchia

No, we wouldn’t go into that level of detail. I can tell you certainly that as I said earlier in the conference call, we’ve seen growth in the girls category of about 33%. We had growth in the category on the overall preschool business of about 3%. Our board game business was up 14%. The total games business was down 2% and that’s because of the decline in both the interactive and some of the trading card game businesses.

Now obviously within those categories you have individual products that go up and down, but that’s -- we’ve had growth across a number of categories, although I’m not going to give you individual dollar amounts.

Gerrick L. Johnson - BMO Capital Markets

Outside of those specific categories that you mentioned have done well, what was probably the biggest surprise for you on the upside, outside of Transformers, Spider-man, those things?

Alfred J. Verrecchia

The biggest surprise on the upside, I think probably, in all honesty, it’s the broad-based growth we’ve had. We certainly expected Littlest Pet Shop to be strong. It did stronger than I think we thought it was going to be, but you are always sort of forecasting how good can something be, and you can be pleasantly surprised there. But outside of the boys category, I think the overall strength in the girls category, while we knew we had it, I don’t think we would have forecasted 33% for the quarter.

I think the fact that our board game business is up 14% is a pleasant surprise for us and the strength of the electronic version of Monopoly, as well as the Are You Smarter Than a Fifth Grader, are certainly pleasant surprises for us.

David Hargreaves

I think also we were pleasantly surprised by the strength of our international business, up 33% overall. And we if look at outside of Europe, if we look at our emerging markets, we are probably up 40% year-on-year, so I think we are very, very pleased with how well international, particularly the emerging markets, are doing.

Gerrick L. Johnson - BMO Capital Markets

Great, and last question, you did mention you are beginning to show 2008 lines to buyers. I was just wondering how you think they are approaching 2008, given the relative softness we’re seeing just in general in the current toy market. Any changes to their outlook for next year or anything that you’ve noticed there?

Alfred J. Verrecchia

No, and I think it would be early in the sense that they need to get through this holiday season to see what kind of a season they have. They have the jitters at this time of year, like they do every year. Looking at our line, they are very excited about what they see in our line and they’ve been very positive in that regard, but I think as an overall comment, I think it’s a bit early in terms of their expectations for ’08, because we are just entering the holiday season.

David Hargreaves

I think going into the year with toy buyers and the toy people that run the toy departments, we’ll be looking to anniversary the strength that we had this year from the movie related properties, and I think we’re looking forward to trying to do that.

Gerrick L. Johnson - BMO Capital Markets

Thanks a lot.

Operator

Thank you. Our next question comes from Thomas Russo. You may ask your question and please state your company name.

Thomas Russo - Gardner, Russo, Gardner

First, congratulations. Let’s see, continuing John Taylor’s question about the involvement with Electronic Arts and your own activities in electronic toys, to what extent do you think Electronic Arts will help you with your developing a platform for social networking, much like we read about Barbiesgirls.com and other social network sites? Will the products that go through EA have that capacity to generate multiple layers of revenues? And if so, will you participate in those?

Alfred J. Verrecchia

I’ll let David talk about the financial side of it but in terms of where they can help us, I mean, clearly they know that space and so anything that we do in that area with our brands we’ll do with them. I think that their knowledge of the space, coupled with our knowledge of kids, is going to be very beneficial to us and clearly there are things that we’re doing before that we used to do individually that we will now do with them.

Some of those things will actually impact the economics of the deal but a lot of it will just be being able to understand the marketplace better by talking with them, just as they will understand the kids market and some of the opportunities that we would have with their brands that they’ll get from us.

But they won’t necessarily all be reflected in economics. David, do you want to --

David Hargreaves

I think there’s a huge opportunity. Clearly the growth in the digital gaming business isn’t coming so much with the hardcore, 14 to [34-year] old gamer. There’s a lot of growth in the -- an increasing rate of growth in the casual gamer, families and children. And with our brands and EA's capabilities and their commitment to growing in this area, we think we can do well across all platforms -- and by all platforms, certainly [inaudible], that division, we will be doing a lot in the cell phone gaming. Certainly [by their] Pogo subscription-based site, we’ll be doing a lot in terms of Internet gaming.

We’ll certainly be doing console-based games, particularly for -- as they become more family-oriented, like the Nintendo Wii has opened that up to a much bigger demographic, a lot more families and kids playing.

I think the [Dream Screen] and the handheld devices, we’re looking for a lot of product in those areas. And finally, when you talk about social networking, you are talking about things like light persistent state worlds, like Webkins, like Club Penguin, like Second Life, and we will be developing over time entries into that area.

And in terms of the revenues, yes, we would be looking for revenues from microtransactions, from subscriptions, as well as normal royalties on the basis of sales. So we are looking over multiple platforms and multiple revenue formats in this rapidly growing area over the next few years.

Thomas Russo - Gardner, Russo, Gardner

Thank you so much. And then, David, on the share repurchase, can you just bring us up to date as to how much you’ve retired, but average price, over the past say couple of years, two or three years? And then talk about the future plans for share repurchase and what that might have on sharper reduction in shares outstanding now that there’s no more overhang, Lucas and other dilutions?

David Hargreaves

I think, as we said, we’ve not spent over $1 billion to retire 41 million shares, and if you add in the Lucas payment and the warrants, then it’s $1.2 billion and we’ve retired 57 million shares and warrants.

Clearly, although we have great cash flow generation, about $450 million in the last 12 months, we can’t continue the level of share repurchase that we are doing over recent, over the last couple of years.

We had more cash on our balance sheet than we needed a while ago and I think we’ve been purchasing aggressively, so will we be as aggressive go forward? Probably not. I’m not sure we generate enough cash to keep that up. But we certainly have $240 million left on our current authorization and we certainly expect to generate a lot of cash over the next two to three years and we will be in the market, as you can imagine, and continue to buy stock back.

Thomas Russo - Gardner, Russo, Gardner

Thank you.

Operator

Thank you. And our final question comes from Dean Gianoukos. You may ask your question and please state your company name.

Dean M. Gianoukos - J.P. Morgan

Hi, this is actually Gopal in for Dean at J.P. Morgan. A couple of quick questions, I’m not sure if you addressed them already, but Transformers, was it up sequentially for the quarter?

Alfred J. Verrecchia

Hold on a second.

Dean M. Gianoukos - J.P. Morgan

And the same question for Spider-man 2, actually.

Alfred J. Verrecchia

Spider-man 2 I don’t believe is up sequentially for the quarter. Transformers --

David Hargreaves

I don’t think Transformers is either. Remember, during the second quarter we shipped in --

Alfred J. Verrecchia

We shipped a lot for the movie.

David Hargreaves

A lot of Transformers in for the launch of the movie.

Dean M. Gianoukos - J.P. Morgan

I didn’t mean Spider-man 2, I meant Spider-man --

David Hargreaves

Three.

Dean M. Gianoukos - J.P. Morgan

Yeah, right.

David Hargreaves

No, sequentially quarter to quarter, our shipments of Marvel products, including Spider-man, would have been probably marginally down.

Alfred J. Verrecchia

Yes, but just marginally. I would almost say that they are probably flat, but -- flat to marginally down.

Dean M. Gianoukos - J.P. Morgan

Okay, and Transformers was marginally down, too?

Alfred J. Verrecchia

Transformers was probably flat with the second quarter, maybe up a tad. But flat -- for all intents and purposes, flat.

Dean M. Gianoukos - J.P. Morgan

Okay. Thanks a lot.

Operator

Thank you. At this time, I’ll the call back over to Karen Warren for closing remarks.

Karen Warren

Thank you, Shirley. I would like to thank everyone for joining us on the call today. The replay will be available on our website after 2:00 p.m. Thank you and have a good day.

Operator

This does conclude today’s conference. We thank you for your participation. At this time, you may disconnect your lines.

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