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Hasbro, Inc. (NASDAQ:HAS)

Q4 2007 Earnings Call

February 11, 2008 8:30 am ET

Executives

Karen A. Warren - Investor Relations

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

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

Analysts

Margaret B. Whitfield - Sterne, Agee & Leach

Michael L. Savner - Banc of America Securities

Gerrick Johnson - BMO Capital Markets

Timothy A. Conder - Wachovia

Gregory Badishkanian - Citigroup

Sean P. McGowan - Needham & Co.

Todd Divek - Bank of America

Thomas Russo - Gardner Russo Gardner

David Leibowitz - Burnham Securities

Operator

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

Karen A. 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 fourth quarter and full-year 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 it 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 impact 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 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 disclosure. 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. I hope you’ve all had the opportunity to read this morning’s press release. As you can see, we had a very strong year, representing the third year in a row of record net earnings and earnings per share and the seventh consecutive year of growth in net earnings and earnings per share.

We achieved net earnings of $333 million, an increase of more than $100 million compared to last year’s record net earnings of $230.1 million. We reported earnings per share of $1.97 for 2007.

When the full year results are adjusted to remove both the favorable tax adjustment in 2007 and the mark-to-market expense for the Lucas warrants in both years, net earnings would have been $347.8 million or $2.03 per share in 2007, compared to $261.8 million, or $1.43 in 2006.

We are particularly pleased with the strength of our business in the all-important fourth quarter. Revenues were $1.3 billion, up a strong 16%. For the year, net revenues were $3.8 billion, up 22% compared to $3.2 billion in the prior year. The strength of our business was broad-based, both in terms of geography and product categories.

For the full year, North American segment revenues were up 15% and international segment revenues were up 33%, or 24% excluding the positive impact of foreign exchange. On a global basis, our boys, girls, preschool, and games and puzzle categories all performed well.

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.

I am sure it comes as so surprise to many of you that Transformers, first introduced in 1984, has established itself as a property that can deliver both entertainment and products that resonate with kids and adults alike. Total box office revenues exceeded $700 million and it was the number one DVD in the U.S. in 2007. Transformers was also nominated for three academy awards -- best sound editing, best sound mixing, and best visual effects.

Transformers was not only a theatrical success; it was our leading brand with toys, games, and a very successful licensing program. Together they generated approximately $480 million in Transformer revenues during 2007. That momentum has continued into 2008. We finished the year with very clean inventories and we have a great product lineup for 2008 with many new items, as well as entertainment support from the Transformers animated series that began airing in early January on Cartoon Network.

All in all, we have all the pieces in place to deliver another strong year for Transformers.

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. Given the anticipated release of Star Wars animation later this year, we expect our Star Wars revenues to grow in 2008.

In addition, we had a very good year with the Marvel properties. We are looking forward to another strong year for Spider-man, with television animation expected to begin in March. When you combine this with the scheduled theatrical releases of The Incredible Hulk and Iron Man later this year, our Marvel products are expected to do very well again in 2008.

Given the continued strength of Transformers, the Marvel properties, and Star Wars, as well as the excitement surrounding the upcoming release of Indiana Jones, we expect a strong year in our boys business in 2008.

Our girls category, a very important part of our business which we have grown significant over the past six years, was up 29%, driven by the continued success of Littlest Pet Shop, up 53%; My Little Pony, up 25%; Furreal Friends, up 44%; and a very strong performance in Baby Alive, which was up 85%.

As we said in November, Hasbro has redefined the girls category over the last six years by consistently delivering innovative and exciting new products.

The preschool category was up 7%, benefiting from the Playskool brand being up a solid 10% in part due to the success of In The Night Garden in the U.K. I am pleased with the progress we are making with the Playskool business, although I was disappointed that TJ Bearytales did not carry forward. Absent the impact of TJ, the Playskool brand was up 27%.

In the tween category, Nerf continued to perform well, up 23% for the year. iDog also had another great year, although the success of these two brands was not enough to offset declines in the Now brand ZoomBox and the disappointment of the Power Tour Electric Guitar, which resulted in the category being down 6% for the year.

Traditional board games were up 6% based on the strength of Monopoly Electronic Banking, Operation, Are You Smarter Than a Fifth-Grader?, Sorry!, and The Game of Life Twists and Turns. Offsetting this were declines in trading card and plug-and-play games, which resulted in the games and puzzle category being up 2% for the year.

The acquisition of Cranium closed last month. This is a great addition to the Hasbro board game portfolio. As we look ahead, we believe there is an opportunity for growth for the Cranium brand, particularly in the international markets, and we’ll talk more about the Cranium brand at our Toy Fair meeting on Friday.

We will also talk more about our partnership with EA on Friday. Today they announced the first Hasbro titles in development -- Littlest Pet Shop, Nerf, Monopoly, and Yahtzee. This initial slate of Hasbro brands will be developed for game consoles, PCs, and mobile devices. We couldn’t e more pleased with the opportunity this relationship represents for Hasbro.

In closing, 2007 was a very good year for Hasbro. It was the third year in a row of record net earnings and the seventh consecutive year of net earnings growth. We generated significant cash flow and grew the top line 22%, with the strength of our business broad-based, both in terms of geography and product categories. We finished the year strong, with U.S. retail takeaway up double-digits and similar results in most geographies around the world, leading to good inventory positions at retail at year-end.

Going into 2008, we’re excited about the opportunities. We have momentum and we’re looking forward to another good year. We hope you will join us on Friday morning’s webcast from Toy Fair to hear more about our new product plans for this year. With that, thank you for joining us and now I will turn the call over to David to talk more about our results. David.

David Hargreaves

Thanks, Al and good morning, everyone. I am very pleased with the results we reported today. We grew revenues by 22% for the year and we achieved an operating margin of 13.5%, exceeding the near-term target of 12% that we have been articulating. I am especially pleased that when you combine the robust revenue growth we achieved in 2007 with the cost structure improvements and share count reductions we have achieved in recent years, the result is a 53% increase in as-reported earnings per share. In addition, we generated $601.8 million in operating cash flow during 2007.

Before I go into more detail on our performance, I would like to mention a couple of other items that impacted our full-year results. First, as we discussed last quarter, the 2007 full-year results include a favorable tax adjustment of $29.6 million, or $0.17 per share.

Second, as most of you know, in the second quarter of 2007, we exercised our right to purchase the Lucas warrants for $200 million. Prior to this, the warrants impacted our reported results, both in 2006 and the first half of 2007.

For the full year 2007, the Lucas mark-to-market adjustment was a non-operating expense of $44.4 million, or $0.23 per share. This compared to a non-operating expense of $31.8 million, or $0.14 per share in 2006.

If you exclude both of these factors, you get full year earnings per share of $2.03 for 2007 compared to $1.43 in 2006.

Now let’s take a closer look at our results for the full year. Worldwide net revenues were $3.8 billion compared to $3.2 billion last year, an increase of 22% or $686 million. In constant dollars, revenues were up 19%, or $592 million, reflecting the success we have had in growing our core brands, particularly Transformers and Littlest Pet Shop.

North American segment net revenues were $2.5 billion, an increase of $329.7 million, or 15% compared to last year’s $2.1 billion. North American segment operating profit for the year was $318.7 million, or 13% of revenue, compared to $276 million, or 13% of revenue last year. The improvement in dollar terms primarily reflects the higher revenue which was partly offset by higher royalties and advertising expense. In addition, some of the leverage associated with the revenue growth was offset by investment spending in our Wizards of the Coast online initiative and building the Playskool brand.

The international segment net revenues were $1.3 billion compared to $959.3 million a year ago, up an impressive 33% in U.S. dollars and 24% in local currencies. The international segment reported an operating profit of $158.8 million, or 12.4% compared to $90.9 million, or 9.5% last year. The improvement is a function of a higher revenue and higher gross profit, partially offset by higher royalties.

The strength of the international segment revenue and profitability is also driven by our focus on core brand growth, including Littlest Pet Shop, My Little Pony, Transformers, Monopoly, and Playskool. As we have previously stated, our core brands are more profitable and as the grow, we get margin improvement.

Now let’s take a look at earnings. From the year, we reported net earnings of $333 million, or $1.97 per share. Earnings before interest, taxes, depreciation, and amortization were $653.5 million, compared to $515.7 million a year ago. Gross margin for the year was 58.9% compared to 58.6% a year ago. The improvement in gross margin is primarily related to changes in our product mix. As we’ve stated in the past, entertainment-based product lines typically have a higher gross margin.

In terms of expenses for the year royalty expense increased significantly to $316.8 million compared to $169.7 million a year ago, due to higher royalties associated with Marvel properties and other entertainment-based product lines.

Research and product development expense declined by $4.2 million to $167.2 million. Spending levels were lower this year compared to 2006, which was exceptionally high due to the compressed timing of the Marvel product line development.

Advertising expense decreased to 11.3% of net revenues from 11.7% last year, although it did increase in absolute dollars from $369 million to $434.7 million. The increase in dollars reflects the impact of foreign exchange translation rates on advertising incurred in our international markets, as well as continued investment in growing awareness of our Playskool and other core brands.

SG&A expenses were $755.1 million, compared to $682.2 million a year ago. However, SG&A declined as a percent of revenue to 19.7% from 21.7% a year ago. The dollar increase is primarily due to increased shipping and warehouse costs, as well as higher incentive compensation, the impact from foreign exchange, and general inflationary increases.

Interest expense increased by $7.1 million to $34.6 million, primarily due to the long-term debt we issued in the third quarter. Other expense net totaled $22.4 million compared to $7.4 million a year ago. The increase is primarily due to the higher expense in 2007 related to the mark-to-market on the Lucas warrants. Excluding the favorable tax event that occurred in the third quarter, the impact of the Lucas warrants, and other discreet tax events, our underlying 2007 tax rate was 30.5%, compared to our 2006 full year underlying tax rate of 27.6%. The higher underlying rate for 2007 reflects the tax costs associated with returning a portion of current year international earnings to the U.S.

Now let’s turn to the balance sheet. At year end, cash totaled $774.5 million, compared to $715.4 million a year ago, an increase of $59.1 million. In 2007, we generated over $600 million in operating cash flow and we raised $346 million in cash through our debt offerings in September.

We have used this cash productively over the course of 2007 in the following ways: exercising our rights to purchase the Lucas warrants for $200 million; paying $70 million to Marvel as part of our five-year agreement; returning $94 million to our shareholders in dividends; and lastly, spending $587 million to repurchase $20.8 million shares of Hasbro stock.

Our receivables at $654.8 million were up $98.5 million compared to $556.3 million last year. The increase is primarily a reflection of our higher sales volume and the impact of foreign exchange. DSOs of 45 days are consistent with last year.

Inventories increased to $259.1 million compared to $203.3 million a year ago, reflecting the growth of our business as well as the impact of foreign exchange. Our debt-to-cap ratio was 38%, an increase from last year due to the $350 million of new long-term debt issued in September. A portion of this offering anticipates $135 million of our debt maturing and being repaid in July of this year.

In light of our strong global cash flow generation and our expectations for the future, the board of directors last week increased our quarterly dividend by $0.04 per share and authorized the company to repurchase an additional $500 million in common stock.

During the fourth quarter, the company had repurchased 4.7 million shares at a total cost of $131.1 million. Since the resumption of our share buy-back program in 2005, we have spent over $1 billion to repurchase more than 45.9 million shares. When one takes into account the Lucas warrant transaction, we have spent over $1.2 billion to retire approximately 62 million shares and warrants.

In closing, our dividend and buy-back programs are clearly motivated by our commitment to create shareholder value. It reflects both our significant cash generation and our expectations for future and earnings growth. Clearly we had a strong 2007 and we believe we are well-positioned for another strong year in 2008. We look forward to sharing more about our products and plans for 2008 at our upcoming analyst meeting on Friday, which will be webcast.

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

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Margaret Whitfield.

Margaret B. Whitfield - Sterne, Agee & Leach

Good morning. In your comments, I think David you were referring a lot to the full year numbers. Could you give me some color on why the operating profit in North America was down 22% but it was up 40% overseas?

David Hargreaves

Yeah, I think in the U.S. in particular, A, we were trying to anniversary a very strong fourth quarter last year. I think what happened last year is that we ended up exceptionally clean in terms of obsolescence, in terms of markdowns and the fourth quarter of last year, we actually reversed some reserves.

That said, this year also included a number of items of investment spending. We are spending against a start-up in Brazil, a start-up of our own company. We have certainly been kept the advertising going later throughout the full quarter in order to make sure we drove a very clean retail position and we’ve also been investment spending in Wizards of the Coast online initiative.

So I think those were factors that meant that operating profit in North America were lower in the fourth quarter.

Margaret B. Whitfield - Sterne, Agee & Leach

I also wondered if you could give us the increase in the boys segment. I think you gave every other segment on the prepared remarks.

David Hargreaves

I think it was 78% for the full year.

Margaret B. Whitfield - Sterne, Agee & Leach

And the first half of last year was so strong -- any deliveries other than the movie-related lines that would support your business in Q1 and 2 in terms of new products or existing products, such as Transformers continuing?

David Hargreaves

As we go into ’08, I think clearly we have very strong momentum across a lot of our product line. I think retailer inventories are in pretty good shape and we are looking forward to a good first quarter.

Alfred J. Verrecchia

I think, not to refute what David said, but Transformers continues to be very strong at retail. Star Wars continues to do well -- Littlest Pet Shop, My Little Pony, so the brands that carried us through 2007, many of the continue to do very well in the early part of 2008.

David Hargreaves

And of course, Littlest Pet Shop VIPs, which were test-marketed at the end of last year, will be rolling out both nationally and starting to roll out internationally during the first quarter.

Margaret B. Whitfield - Sterne, Agee & Leach

Okay, final question -- with the expected end of the writers’ strike, could you tell us what the status is of the ’09 movies -- the G.I. Joe, Transformers 2? Or what your expectations are if the strike is, as it appears, is currently expected to settle very soon?

Alfred J. Verrecchia

G.I. Joe starts shooting this week -- I think today, as a matter of fact. And it is scheduled for release in 2009, as is Transformers 2.

Margaret B. Whitfield - Sterne, Agee & Leach

So no delays?

Alfred J. Verrecchia

Currently, no delays.

Margaret B. Whitfield - Sterne, Agee & Leach

Great. Okay, thanks.

Operator

Our next question comes from Michael Savner.

Michael L. Savner - Banc of America Securities

Two questions -- first, David, can you help us think about royalty expense next year, just directionally? Because I know you’re not giving any specific guidance but if we just look at the Marvel properties and the assumed royalty rate for those, is it fair to say that all other things being equal, you should see an aggregate decline in royalty expense next year, or is that logic not necessarily correct?

David Hargreaves

I think you will see a decrease in royalty expense next year from this year. It’s very high level but that said, I wouldn’t assume that that’s going to be so significant that it takes you back to 2006 levels because clearly we are expecting entertainment driven brands, whether it’s Transformers, Star Wars, or the Marvel properties, including Iron Man and Hulk, or whether it’s Lucas’ Indiana Jones, we are still expecting a lot of volume through entertainment driven properties which tend to have higher royalty rates.

Michael L. Savner - Banc of America Securities

That’s helpful, thanks. And will you be shipping any Iron Man and Hulk product in the first quarter or will most of that go outright at the beginning of the second quarter?

David Hargreaves

I don’t think we’ve got material amounts that we’ll ship during the first quarter.

Michael L. Savner - Banc of America Securities

Okay, and last question -- you had mentioned on the last conference call an expected surge in toy sales around the DVD releases of some of these key properties, like Spider-man and Transformers. Can you give us now some backward looking commentary about how significant that is, how important the DVD is to driving toy sales? Or is it more just a general seasonal benefit that you get?

Because I guess at the root of my question is if we are starting to see some type of maturation of DVD product, albeit Transformers did fantastic, if that business is maturing somewhat, how important is that to getting that second lift of toy sales later in the year after a move comes out?

Alfred J. Verrecchia

I think in general having that DVD and providing that second life is very important to the brand. It’s very difficult to differentiate how much of the volume in the fourth quarter is due to seasonality versus the DVD release, but I think over the years and in particularly I think ’07 continued to demonstrate that the DVD release of a popular movie will drive additional volume and it’s another marketing event that we can drive business around.

So we think it’s important and we look forward to the DVD releases when they come.

Michael L. Savner - Banc of America Securities

Terrific. Thank you very much.

Operator

Thank you. Our next question comes from Gerrick Johnson.

Gerrick Johnson - BMO Capital Markets

Good morning. I had a question on third-party manufacturing. As you get your quotes back from the third party manufacturers, what kind of price increases are they looking for for existing and then new lines? And what kind of cost increases do you think you’ll be able to pass on to retailers this year?

Alfred J. Verrecchia

David.

David Hargreaves

I think so much of our product is new every year and obviously as we cost that, we build in the latest costs, whether it’s labor, commodities, or whatever, and we price that into the line when we announce the line, so it’s not like we have one item that cost $4.99 last year and it’s gone to $4.99 this year.

However, if you look at the cost increases, clearly they are significant. I would say if you average out labor, commodities, the impact of the Chinese currency revaluing, the cost of additional testing and quality work that has to be done nowadays, I think if you average all of that out, coming out of China you are probably looking at something like a 14% to 15% increase in costs. That doesn’t mean that we have to pass all of that in in terms of pricing, because certainly we are taking actions to try and offset some of these cost increases.

Some of our vendors are moving further into China in order to obviate the higher labor costs. We are certainly looking at cost engineering our products to China to offset some of the increases. And certainly not all of our product comes out of China. Our entire games business comes out of factories in East Long Meadow, Massachusetts and Waterford, Ireland. And certainly the kind of cost increases, particularly labor and overhead, are not nearly as significant.

Alfred J. Verrecchia

The other thing, David, as we’ve discussed, cost represents generally speaking in the range of 40% of selling price, so if you’re talking about -- even if you use 15%, 40% of that would be about 6%. You’d need a 6% price increase to offset a 15% cost increase. And that assumes no improvement in operating efficiency.

So clearly there will be some price increases this year. We’ll continue to look to improve efficiencies in the supply chain and as David said, not all the product that we sell is coming out of China, especially with the board game business.

I think the bottom line is we would expect to hold our margins in 2008 with 2007.

Gerrick Johnson - BMO Capital Markets

Okay, great. Very detailed. I appreciate that. I have one more question on inventory; what would it have been excluding the currency effect you talked about? And also the inventory level at the channel, you said they were in good shape. I was wondering if you could put some numbers behind that. How did you end the quarter there? And also related to that, what kind of point of sale data can you provide to us? How did that trend through the quarter?

Alfred J. Verrecchia

Let me talk about POS, and we have to keep in mind that the amount of information that we have with regard to POS is certainly much better in the U.S. with our key account than it is in other parts of the world but in general, our POS in the U.S. was up double digits during the holiday season. And if we go around the world in most geographies, we found similar results. We picked up market share in virtually every geography around the world and our retail inventories are in good shape.

I think in general our retail inventories are probably down from a year ago, although again that’s anecdotal evidence in some geographies and we get better information in the U.S. but we are very comfortable with where we are at retail and in our own inventories as well.

David, do you want to add anything to that?

David Hargreaves

Approximately half our inventories at year-end were overseas and versus a year ago, but it was probably a 10% to 12% increase on that, so probably about $15 million of the increase was due to foreign exchange. And the balance really is just that we’ve been operating our business at a much higher level. Our business operated throughout last year at about 22% higher than prior year.

Gerrick Johnson - BMO Capital Markets

Okay. Great. Thank you very much.

Operator

Thank you. Our next question comes from Tim Conder.

Timothy A. Conder - Wachovia

Thank you. First of all, congratulations on another great year and good execution. A couple of things here, just continuing on in the inventory and sell-through side -- can you give any specific color related to Spider-man, how those channel inventories are in the sell-through? And just to clarify I think your response to the last question -- you’re saying that collectively, domestically and internationally, your global channel inventories are down on a year-over-year basis?

Alfred J. Verrecchia

Let me get to the last point -- I can’t give you good number internationally in the sense that we get very good information here in the U.S., but when you start to get into some of the countries in Latin and South America, Asia-Pacific, the data is not as good. But anecdotally, in talking to our sales organization our inventories at retail generally speaking around the world are in very good shape and in many cases lower than a year ago. They are certainly in very good shape here in the U.S. with our major customers.

In terms of the Marvel properties and Spider-man, our product did well. You have to keep in mind there’s a lot of Spider-man product out there that is not ours, but we are in good shape inventory wise and we are off to a -- you know, we get a lot of momentum, we’re off to a pretty decent start in ’08.

David Hargreaves

I think on Spider-man in particular, there had been fairly significant retailer inventories throughout a lot of the year but to Michael’s comment about the DVD, we did see a significant jump in Spider-man 3 after the release of the DVD and I think after that, our inventories got back into pretty good shape on Spider-man.

Timothy A. Conder - Wachovia

Okay. And looking at the first quarter, gentlemen, I know generally you don’t give guidance here but given the very hard comparison of the first quarter and it sounds like you obviously ended the year on a very good momentum. Can you give us any color? I mean, are retailers going to have to come back and then given our inventories are down year over year, it sounds like, restock pretty aggressively ahead of the launch of the Spider-man I guess in particular animation and then the animation that’s already out there on Transformers?

Alfred J. Verrecchia

Well, if we answered all those questions, I think we’d be giving a lot of guidance. Let me just say that we have good momentum. The brands that did well for us in ’07 continued to have momentum and they are doing well in ’08 and as both Dave and I said, we are looking forward to a good year in ’08.

Timothy A. Conder - Wachovia

Okay, and then David, relating to the increased share authorization on the repo side, could part of that be used to offset the 2.75 convert that you have out there, given how it is relative to the dividend yield on the stock?

David Hargreaves

Yes, I mean, certainly as we increase our dividend, it becomes more compelling for the convertible bond holders to convert and obviously they will be getting more yield on the dividend than they are from the coupon on the debt. I don’t think that’s too material for our diluted earnings per share because we already include the converts in the calculation of diluted earnings per share most times. But certainly our buy-back program will offset those converts as they convert, yes.

Timothy A. Conder - Wachovia

Okay. Thank you, gentlemen.

Operator

Thank you. Our next question comes from Gregory Badishkanian.

Gregory Badishkanian - Citigroup

Thanks. I just have two questions; first one, I believe you mentioned the Transformers animation came out in January and since you do have some additional ones that haven’t been out yet, your other properties, did it give you the lift in sales that you were expecting?

Alfred J. Verrecchia

Are you talking about the Transformers animation?

Gregory Badishkanian - Citigroup

Yeah, exactly.

Alfred J. Verrecchia

Yeah, Transformers animation is doing very well. The ratings are outstanding and in the line, the Transformers brand continues to do well at retail.

Gregory Badishkanian - Citigroup

Good. And you did notice once that came out that you saw sales get a nice lift from that?

Alfred J. Verrecchia

Yeah, generally, but I mean -- it’s kind of hard to say that it’s due to any one factor because Transformers has been a very strong brand right along. We didn’t see it weaken at all right after -- even after the holiday season but I suspect that the animation certainly helped.

David Hargreaves

And it certainly was that -- certainly some Transformers items which were in short supply towards the end of the last year and as we got back into supply, [inaudible] again.

Gregory Badishkanian - Citigroup

Great. That’s helpful. Also, just with the EA partnership, the press release that came out, just wondering -- I guess the first launch is going to be in the spring, it mentioned, and just if you were to look out ’08, ’09, are you going to see primarily the benefit coming in 2009 still?

David Hargreaves

Yes, I think most of the titles, or probably the ones that will do higher revenue, consoler and handheld, tend to be very late in the year ’08 and I think revenues this year, in the context of Hasbro Inc. are probably not that material. As we go into ’09 and beyond, we think they start to become material and will grow fairly rapidly.

Gregory Badishkanian - Citigroup

Great. Thank you.

Operator

Thank you. Our next question comes from Sean McGowan.

Sean P. McGowan - Needham & Co.

A couple of questions -- tax rate, David, is there anything other than kind of getting the full year to look the way it is supposed to, is there anything unusual going on in the fourth quarter?

David Hargreaves

I think we had to tune up our underlying rate a little bit, which brought the underlying rate for the year down compared to what we thought it was going to be in the third quarter. But absent that, there really wasn’t any discrete items. The $29.7 million was in the third quarter and the additional costs that we had associated we repatriate in some of the current year overseas earnings was impacted off of the last two quarters.

Sean P. McGowan - Needham & Co.

Okay, and what would you say would be a good rate to use for a full year ’08?

David Hargreaves

Really it depends on how much -- as we look at our cash requirements, how much of overseas earnings that we determined to repatriate, because there’s a tax cost associated with that. But I think the days of when we used to be 26% to 27% as an underlying rate are probably gone and I think probably being 30% to 31% as an underlying rate may be more appropriate go forward.

Sean P. McGowan - Needham & Co.

Okay. Of the cash on hand at the end of the year, how much of that is in the U.S.?

David Hargreaves

Most of it is overseas.

Sean P. McGowan - Needham & Co.

Still? Okay, so even after repatriating last year, so you used that for the buy-back last year?

David Hargreaves

Yeah, I mean, we had a very profitable year both in the U.S. and a very profitable year overseas. The overseas cash really doesn’t get spent. The domestic cash does get spent in terms of Lucas warrants, in terms of the dividend, in terms of the buy-back -- that all comes out of U.S. cash.

Sean P. McGowan - Needham & Co.

Right. So in order -- if one were to assume a certain amount of a $500 million authorized repurchase gets done in 2008 and that cash that is sitting there is mostly outside the U.S., does that mean you’d need to repatriate more and could that have an upward impact on the tax rate?

David Hargreaves

I think I’ve almost just answered that question.

Sean P. McGowan - Needham & Co.

Okay, so it’s baked into that? In other words, when you say 30 to 31, you sort of bake that in already?

David Hargreaves

Yes.

Sean P. McGowan - Needham & Co.

Okay. A couple of other quick questions -- I think when you were going down the product breakdown, I think you were talking about the full year for everything. Would you care to give any of that product breakdown for the fourth quarter itself? I think Al might have been doing it -- you know, the increases in certain categories?

Alfred J. Verrecchia

We were talking about the year. We wouldn’t typically give that in any given quarter.

Sean P. McGowan - Needham & Co.

Okay. Could I ask just one thing -- could you comment on the U.S. board game business in the fourth quarter, your own shipments in?

Alfred J. Verrecchia

Again, the board game business overall was up I believe 6% for the year. A lot of that happens in the fourth quarter because the board game business is somewhat skewed to the back half of the year, which we felt was pretty good given the overall strength of the videogame business.

Sean P. McGowan - Needham & Co.

Okay. Thank you.

Operator

Thank you. Our next question comes from [Todd Divek].

Todd Divek - Bank of America

Good morning. I had a quick question for you on the balance sheet with respect to both the convertible note as well as the -- you have a small note that is due this summer. I was wanting to know if you have plans to replace those in your capital structure or if you just plan on paying those off.

David Hargreaves

Well, we did get an authorization from our board back in September to go to the market and raise $600 million in long-term debt. As we started to look at the market, we were thinking of going 10-year and 30-year and we really didn’t like the terms we could have got on the 30-year so we didn’t proceed with that. So we actually went with $350 million in 10-year, which means under our existing board authorization, we do have the opportunity to go out and raise a further $250 million of long-term debt, if indeed we find that rates are attractive.

So obviously we’ll keep monitoring it. It’s not something we need to do. We don’t need the cash immediately. It’s really as we look at our optimal capital structure, then we do believe that having some debt is a good thing.

Todd Divek - Bank of America

Okay, that’s fair enough. And then just tying that in to the share repurchase authorization, you had a $500 million authorization that I believe you announced last fall and then just last week you came up with another $500 million authorization. Just generally speaking, do you plan to buy that back, buy shares back opportunistically using free cash flow or would you also consider that being a leveraging event such as an accelerated share repurchase programs?

David Hargreaves

Well, we look at trying to get to our optimal capital structure in relation to our debt and debt-to-cap and total cap and some other measures of EBITDA to interest and total debt to EBITDA. And we will use cash once we’ve sort of achieved that optimal capital structure, we will use excess cash to opportunistically buy back stock.

Todd Divek - Bank of America

Okay, and again, your ideal capital structure, how do you define that?

David Hargreaves

Well, historically we have really been talking about a 25% to 30% debt-to-cap range. However, as we buy more stock back, our capitalization goes down and it’s also muddied at the moment as the converts are sitting in debt. In reality, as soon as they convert, they’ll be sitting in equity.

So we are looking much more at an interest coverage, EBITDA-to-interest of 12 to 1, or a debt-to-cap of 1.5 to 1 -- sorry, a debt-to-EBITDA.

Todd Divek - Bank of America

Debt-to-EBITDA, okay and then just one follow-up question with respect to the convert, that is at the discretion of the note holders. Can you give us an update on has any of that been converted or are the conditions for conversion --

David Hargreaves

Certainly it is -- the conditions for conversion have been met and the holders could convert if they so desired. You know, thus far I think out of the -- I think only about $2,000 worth or something that small has actually converted. We’re sort of somewhat surprised that more hasn’t converted but certainly as we increase our dividend, which we did last week, I would imagine that more of the convert holders convert.

Todd Divek - Bank of America

Okay. Thank you very much.

Operator

Thank you. Our next question comes from Thomas Russo.

Thomas Russo - Gardner Russo Gardner

Great quarter, great year. Good morning. David -- or Al, actually -- on the comments relating to the investment spending at the moment on Wizards with their online offering, I’m curious as to how you will go about developing that product and whether it falls into the EA online relationship. And then speak as well about your online activities, in particular as it relates to the virtual world that others in the toy industry have created for their children audience with abundant chance for the kids to spend lots of ongoing money. What’s your role in the virtual gaming area and then also what’s your plan for spending the money on developing Wizards?

Alfred J. Verrecchia

In terms of Wizards, let me start by -- I think you know that Magic Online has been up and running for a number of years now. Some of the money we are spending is to improve that, the technology that supports that offering. And then we are also investing in something we call Gleemax, which was an online gaming site for people who not only play Magic but are really involved in gaming in general. It’s a site that will have a -- it’s more of a building a community of game players. There will be the opportunity to play games. There will be the opportunity to communicate with other game players. It’s a place where people can go who are really interested in what we would call hobby or niche games. We’re spending a fair amount of money in that regard and that site is probably -- well, it is up now. We’ll be continuing to add games and new features to it throughout the year.

In terms of the virtual world for children, I’ll let David talk about the VIPs which were recently launched and we’re going to start to go nationwide with that. David.

David Hargreaves

Certainly the idea of the VIPs is similar to sort of a Webkinz idea where the plush toy that you can buy is coded and connects to an Internet site. We’ve developed that. Hasbro has sort of had a partner develop that and that will be not a revenue generating site -- that will be based on -- we will make our money selling the toy.

At a later date, EA will certainly develop a much richer like persistent state world based around Littlest Pet Shop which will be a revenue generating site for EA.

Thomas Russo - Gardner Russo Gardner

Okay. Thank you very much. Congratulations on the quarter.

Operator

Thank you. Our next question comes from David Leibowitz.

David Leibowitz - Burnham Securities

A few questions -- David, how much money did you repatriate out of foreign profits last year?

David Hargreaves

Well, we haven’t said exactly how much and I’m not sure we really want to.

David Leibowitz - Burnham Securities

Okay. Second, what is the rating on the Indiana Jones movie and when do you start shipping?

David Hargreaves

It will certainly be PG-13 or -- not above that.

Alfred J. Verrecchia

Yeah, I don’t know specifically but I suspect it’s PG-13 and it’s due to launch in May of this year.

David Leibowitz - Burnham Securities

And when do you start shipping?

Alfred J. Verrecchia

My guess is we’ll start shipping in the second quarter.

David Leibowitz - Burnham Securities

Okay. Next, your third-party manufacturing in China -- several companies have been talking of moving some manufacturing to Vietnam and other lower priced production centers in Southeast Asia. Have you been doing that yet?

Alfred J. Verrecchia

No, we haven’t and I don’t see any meaningful move to Vietnam. I think they are -- when you look at the total cost of the product, I think you’ll find certainly the vendors that we deal with, most of them are moving more inland into China as opposed to Vietnam. When you look at Vietnam, you have a couple of issues there. One is just the overall size of the country. It’s a lot smaller than just the southern province of China, so the overall capacity is certainly an issue. You have a language issue, which you don’t have when you move inland into China. The support services and the infrastructure still isn’t there and you are lengthening the supply chain. You start to develop new vendors in places like Vietnam, you’ve got to start all over again with issues of quality and safety and product reliability.

So I think you are liable to see more people moving inland into China and again probably over a longer period of time, you’ll see some sub-assemblies, some painting operations moving inland, and then final assembly continuing to be done at existing factories.

So while there are some people who are moving into Vietnam, I don’t see that as a major initiative, certainly in the near-term and by that, I mean over the next two, three, four, five years.

David Leibowitz - Burnham Securities

Excellent. Just to more brief ones -- Wal-Mart and Lego had a bit of a tussle up in Canada. Have you had a similar issue with them?

Alfred J. Verrecchia

No, we haven’t. Our relationship is outstanding with Wal-Mart.

David Leibowitz - Burnham Securities

Does that mean you repriced your product, given the effect of the Canadian dollar’s increase?

Alfred J. Verrecchia

Well, I’m not going to comment about our pricing. All I will say is we don’t have the same issues that were mentioned in that release between Lego and Wal-Mart. You know, certainly there has been a lot of publicity up in Canada not just about toys but prices in general and we’ve certainly dealt with that in a variety of ways.

David Leibowitz - Burnham Securities

Okay, and lastly, do you expect to have -- well, first off, what was the licensing income last year in licensing?

Alfred J. Verrecchia

We don’t release that number.

David Leibowitz - Burnham Securities

Okay, and in terms of ’08 versus ’07, do you expect the licensing income figure to increase?

Alfred J. Verrecchia

Again, we wouldn’t forecast but I would keep one thing in mind -- we had a very strong year with Transformers and licensing around the movie, so all else being equal, that could slow down a bit. That’s about the only comment I’d make regarding licensing income for ’08.

David Leibowitz - Burnham Securities

Thank you very much.

Operator

Thank you. Our final question comes from Gerrick Johnson.

Gerrick Johnson - BMO Capital Markets

I just wanted to follow-up on the Star Wars animation and what’s going on with the theatrical release and has Lucas announced when that will be coming out in theaters, or if it still is?

Alfred J. Verrecchia

They have not announced anything regarding the theatrical release in theaters.

Gerrick Johnson - BMO Capital Markets

Okay. Do we anticipate one?

Alfred J. Verrecchia

I’d rather leave that with Lucas. Right now, we’re looking at the animation, the television animation. We know that’s going to be coming and in terms of their marketing plans, that’s something that you’ve got to get from them.

Gerrick Johnson - BMO Capital Markets

Okay, and if I could sneak one more in there -- I know you are going to talk about Cranium on Friday, but was it profitable in 2007?

Alfred J. Verrecchia

Let’s see -- their year ended March --

David Hargreaves

Well, I think what might have been profitable in us or them is very different to what is going to be the situation with Hasbro. As we go forward, we will resource their product into our supply chain, which has probably had some efficiencies. And some of the non-core game product that they developed, we may not carry forward with that and focus on that so much in ’08.

So I think if your question is do we anticipate it will be profitable and contribute to -- accretive to earnings per share for Hasbro in 2008, the answer is yes.

Gerrick Johnson - BMO Capital Markets

Okay. That would have been my next question. Thank you.

Operator

At this time, I’m showing no further calls. I’ll turn the call back over to your speaker for closing remarks.

Karen A. Warren

Thank you, Shirley. I’d like to thank everyone for joining the call today. The replay of our call will be available on our website after 2:00 p.m. Thank you so much.

Operator

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

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Source: Hasbro Q4 2007 Earnings Call Transcript
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