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Mattel, Inc. (NASDAQ:MAT)

Q1 2008 Earnings Call

April 21, 2008 8:30 am ET

Executives

Mike Salop – Investor Relations

Bob Eckert - Chairman and Chief Executive Officer

Kevin Farr - Chief Financial Officer

Analysts

Tim Conder – Wachovia

Tony Gikas – Piper Jaffray

Greg Badishkanian – Citigroup

Sean McGowan – Needham & Company

Felicia Hendrix – Lehman Brothers

Margaret Whitfield - Sterne Agee

Linda Bolton Weiser – Caris & Company

Gerrick Johnson – BMO Capital Markets

John Taylor – Arcadia

Operator

Good day and welcome to today’s Mattel’s First Quarter 2008 Earnings Conference Call. [Operator Instructions] At this time I’d like to turn the conference over to Mr. Mike Salop.

Mike Salop

This morning we reported Mattel’s first quarter 2008 earnings. In a few minutes Bob Eckert, Mattel’s Chairman and Chief Executive Officer and Kevin Farr, Mattel’s Chief Financial Officer will discuss the results. After their comments we will open the call for your questions. Before we begin let me note certain statement made during the call and in the questions and answer session that follows may include forward looking statements about management expectations, strategic objective, anticipated financial performance and other similar matters.

Such forward looking statement may include comments regarding performance of our brands and product lines, new product introductions, new entertainment properties, theatrical releases, consumer take away relative to shipments, profits and margins, reducing controllable costs, litigation expenses, price increases, income tax provisions, foreign exchange gains and losses, legislation and regulation, cash flow and capital deployment and our capital investment framework.

A variety of factors, many of which are beyond control affect the operations performance, business strategy and results of Mattel and could cause actual results to differ materially from those projected in such forward looking statement. Some of these factors are described in our 2007 report on Form 10-K filed with the SEC and Mattel’s other filings made with the SEC from time to time, as well as in Mattel’s other public statements.

Mattel does not update forward looking statements and expressly disclaims any obligation to do so. Information required by Regulation G regarding non-GAAP financial measures is available in the investor and media section of our corporate website www.Mattel.com under the subheading Financial Information and Earnings Releases. Now I’d like to turn the call over to Bob.

Bob Eckert

Good morning. Results for the first quarter were not all that surprising. While Kevin will go into the details for key P&L lines moved in the wrong direction. First sales declined even with the benefit of foreign exchange with most of the decline attributable to Fisher Price. As a reminder in last year’s first quarter we were chasing demand for 2006’s high hot selling toys including T.M.X. Elmo and the Kid Touch Digital Camera and rebuilding the depleted retail inventory depressed several of brands including Fisher Price.

Despite the challenges there were some early bright spots. Our Wheels business was boosted by initial shipments of Speed Racer and High School Musical continues to help drive that growth for our other girl’s lines. American Girl is also off to a good start in the new year. Although sales declined in the quarter, consumer take away outperformed shipments across our portfolio so we do expect core brand growth to improve as the year progresses.

We are also anticipating additional contributions from this years entertainment properties. The Speed Racer movie our the first part of May, Kung Fu Panda in June, The Dark Knight, the sequel to Batman Begins, and the American Girl movie Kit Kittredge, An American Girl which will both be out this July.

Second, gross margins declined, cost of labor, materials, transportation and testing are all increasing while we continue to improve productivity we’ve also appropriately priced our fall product line to reflect new realities. Third, overhead costs increased. Largely driven by legal expenses related to product recall litigation and the MGA Carter Bryant case scheduled to begin trial later this spring. Finally, in an area we didn’t anticipate for the quarter we recorded non-operating expense related to foreign exchange.

With most of the year in front of us I remain optimistic about the business and all of us are committed to addressing the near term challenges and delivering profitable growth for the year. Later this week we’ll be mailing our annual report to shareholders. Every year you’ve come to expect the theme or word for the year. This year’s call to action is commitment. As I mentioned earlier we are committed to continuing to grow the business from a margin perspective.

While it’s true we are experiencing higher commodity costs we are committed to pricing our products appropriately and reducing controllable costs to address the challenges and ultimately build margins. We’ve continued our commitment to strengthen our efforts as a responsible corporate citizen with integration of new corporate responsibility organization reporting directly to me. Our commitment to realizing our vision of being the world’s premier toy brands for today and tomorrow is unwavering.

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

Kevin Farr

Good morning everyone. I’ll begin my review for the first quarter with a discussion of worldwide gross sales shown on exhibit two of today’s press release. Total worldwide gross sales for the quarter were down 2% including a five percentage point benefit from changes in currency exchange rates. US sales were down 11% while international sales were up 8% including 11 percentage point benefit from foreign exchange.

On a regional basis sales in Europe were up 5% including a 10 percentage point positive impact from exchange rates. Sales in Latin America were up 18% including a 15 percentage point positive impact from foreign exchange. Sales in Asia/Pacific were up 23% including an eight percentage point positive impact from changes in exchange rates.

I will now review our core categories and brands for the first quarter. Mattel Girls and Boys Brands. Worldwide sales for the Mattel Girls and Boys Brands segment were up 5% including a seven percentage point benefit from changes in currency exchange rates. World wide Barbie sales were flat compared to last year including a sever percentage point positive impact from foreign exchange. Barbie sales in the US were down 12% while Barbie sales in international markets increased 6% including 11 percentage point benefit from foreign exchange.

This spring’s key fantasy line Mariposa performed well worldwide but was offset by declines in My Scene which has been discontinued in the US. Worldwide sales of other girl’s brands were up 16% including an eight percentage point positive impact from exchange rates. Sales in the US were up 13% while international sales of other girl’s brands were up 17% including a 12 percentage point positive impact from foreign exchange.

The sales growth worldwide was driven primarily by High School Musical. Worldwide sales in the Wheels category increased 15% including a six percentage point positive impact from changes in currency exchange rates. Double digit increases in both the US and international markets were driven primarily by the addition of Speed Racer. Our Speed Racer sales reported in both Wheels and the entertainment category depending on the type of product.

Core Hot Wheels which does not include Speed Racer grew 2% worldwide including a seven percentage point positive impact from foreign exchange. Matchbox grew double digits. Worldwide sales in our entertainment business which includes games and puzzles were down 5% including a six percentage point positive impact from changes in foreign exchange. Although CARS declined in the US its remains a very strong property in its third year and the decline was offset by Speed Racer shipments. The overall entertainment category decline was driven by several smaller properties such as Naruto.

Fisher Price brands. Worldwide sales for Fisher Price brands were down 13% including a four percentage point positive impact from changes in currency rates. On a regional basis international sales of Fisher Price brands increased 7% including a 10 percentage point positive impact from foreign exchange while sales in the US declined 24%. Worldwide core Fisher Price was down 1% including a five percentage point benefit from changes in currency exchange rates.

US sales in core Fisher Price were down 17% and international sales were up 23% including a 12 percentage point benefit from foreign exchange. Fisher Price brand sales declined 49% including a two percentage point benefit from foreign exchange rates. Sales at Fisher Price brands in the US were down 55% while international sales were down 41% including a three percentage point benefit from foreign exchange.

As Bob mentioned earlier Fisher Price benefited in the first quarter of 2007 from extremely low retail inventory levels as well as heavy demand for hot products such as T.M.X. Elmo and Kid Touch Digital Camera. You may recall in the first quarter 2007 Fisher Price overall grew 27% and Fisher Price brands grew 45%.

American Girl brands, sales of American Girl brands are up 10% primarily as a result of the contributions from our new Boutique and Bistros in Atlanta and Dallas which opened in the second half of 2007 as well as continued strong sales of the Julie 1970’s character introduced last year and an earlier Easter in 2008.

Now let’s review the P&L which is shown on exhibit one. Gross margin was 43.2% compared to 44.5% last year. The decline was primarily due to cost pressures from commodities, Chinese labor rates, the appreciating Chinese currency and incremental product testing costs which more than offset favorable foreign exchange and some price increases in international markets. As previously stated the majority of our global price increases will not be effective until June.

Advertising expense was $103 million or 11.2% of net sales flat with 2007. Selling, general and administrative expenses increased approximately $37.5 million to $330.3 million. As a percentage of net sales SG&A expenses were 35.9% compared to 31.1% last year. Approximately half of the increase in SG&A expense is due to higher litigation fees. The impact of foreign exchange and increases in equity compensation expense from $3.7 million in last years first quarter to $7.1 million this year also contributed to higher SG&A.

Operating loss during the quarter was $36.5 million compared to operating income of $20.6 million last year due primarily to slightly lower sales, external costs pressures, and higher litigation expenses. Interest expense was $16 million versus $14.5 million in 2007. The increase in interest expense versus last year is due to higher average borrowings partially offset by lower average interest rates. Interest income was $8.5 million versus $12 million last year. The lower interest income is primarily due to lower average invested cash balances during the quarter.

Other non-operating expense net was $15.8 million versus $2.4 million in 2007. The current year expense relates primarily to foreign exchange losses caused by our local currency reevaluation of US Dollar cash balances held by Latin American subsidiaries. Income taxes provided benefit of $13.2 million which translates to an effective rate of 22% compared to prior years expense of $3.7 million. Overall we reported net loss of $46.6 million or $0.13 per share versus last year’s net income of $12 million or $0.03 per share.

To summarize the P&L the 2008 net loss primarily resulted from lower sales, higher costs for commodities, labor and product testing, higher litigation expenses and non-operating foreign exchange losses. We expect improvement in some of these areas and are addressing the issues that are ongoing.

Turning to the cash flow and balance sheet. Cash used for operations for the quarter were $264 million driven primarily by the use of cash for seasonal working capital requirements. Cash on hand at the end of the quarter was $624.9 million down from $984.2 million in the prior year primarily due to deployment of excess capital during 2007. We did not complete any material share repurchases in the first quarter and still have $501 million remaining on our authorization.

Receivable were $728.2 million or 71 days of sales outstanding one day higher than last year. Factory increase from $41 million to $86 million prior to factoring in dates of sales outstanding increased six days. Inventories at $534.2 million were up $85.6 million or 19% versus 2007 and represented 79 day supply which is three days higher than last year due to higher interest costs and earlier productions to meet supply chain requirements.

Our total balance sheet debt increased by $260 million from the prior year. In the first quarter the company paid down $40 million on medium term notes and repaid $349 million of short term borrowings. The company also issued $350 million of 5.625% five year senior notes to maintain our desired capital structure. Our debt to total capital ratio ended the quarter at 28% versus 19.8% in last years first quarter. Capital expenditures were $33 million up from last years $24 million.

To summarize, despite the benefit of foreign exchange overall revenues declined due to success of several hit products and low retail inventory levels in the first quarter 2007 particularly at Fisher Price. However, by the end of the first quarter our retail inventory levels at our top US accounts were back below prior year levels across our portfolio. We are looking forward to core brand growth and additional contributions from our three key entertainment properties Speed Racer, Kung Fu Panda and Batman: The Dark Knight, as well as the American Girl movie Kit Kittredge An American Girl.

In the quarter gross margin declined due to external cost pressures and incremental product testing costs. To combat these costs we’ve implemented mid to high single digit price increases effective in June across most of the world. SG&A was negatively impacted in the quarter by incremental litigation expenses. These expenses are likely to continue for the next few quarters until the legal matters are resolved.

In other non-operating expense reflects a foreign exchange loss in 2008 related to revaluation of the US Dollar cash balances held by Latin American subsidiary. Going forward our US Dollar asset and liability exposures now largely offset each other in the subsidiary. Although the offsetting gains and losses may appear on different line items in the P&L we would not expect a significant net revaluation impact from any future currency movements.

Our balance sheet remains solid and we completed a $350 million senior note offering in the quarter to replace maturing debt. As we advance through the year we look to drive operating improvements from the mentioned actions and as always generate profitable growth in strong levels of free cash flow which we plan to effectively deploy for our shareholders. That concludes my review of the financial results. Now we’d like to open the call to questions.

Question-and-Answer Session

Operator

[Operator Instructions] We’ll go first to Tim Conder with Wachovia.

Tim Conder – Wachovia

Could you give us a little more color the legal expenses, the breakdown between, you mentioned the MGA ongoing suit there and then also the related to the recalls and how do you see somewhat those expenses going forward?

Kevin Farr

I’m not going to be able to give you more color on the legal expenses other than say that half of the increase related to SG&A did relate to litigation matters. We believe expenses will be ongoing for future quarters until these matters are settled.

Tim Conder – Wachovia

Should we see them at the type of rate or pace that we did in the first quarter?

Kevin Farr

We’re not going to project those. I think what we are doing is we are making investments and legal expenses and we’ll make the appropriate investments as these legal matters progress through the year. That’s all the guidance we are going to give you.

Mike Salop

When you get to the second half of the year we did have expenses related to the recall litigation in the second half of last year so the counts won’t be the same as the first half.

Tim Conder – Wachovia

You mentioned that your take away was below your shipments and that’s setting you up nicely for the balance of the year assuming trajectories of sales hold on a seasonal basis. Just to clarify, is that true both in the US and international or are we seeing—also could you give us a little bit of color as to how the sales progress both accelerating, decelerating as the quarter progressed from January to March?

Bob Eckert

Let me start with the first part of the question. In the US we did end ’07 with about 10% or 15% more inventory at retail than we did in the prior year which put us at about the two year ago level. You’ll recall last year at this time we had very low levels of inventory both our sellers and retailers.

Tim Conder – Wachovia

That was just getting you back up to what you said was a normal level correct?

Bob Eckert

Correct, our shipments in the first quarter this year in the US excluding American Girl were down 14% and our point of sale was a bit north of flat and maybe we had some Easter benefit in that. We finished the first quarter with retail inventory here being a bit below prior year. In essence what happened in the first quarter of ’08 retailers burned of the inventory they had and in the first quarter of ’07 they had to buy inventory to support the demand that they had. That was true in both the US and in international but really only in a handful of markets internationally.

Last year’s first quarter international was up 29% all of the markets and all the brands did well a year ago. This quarter we were up about 8% and all of that was due to currency. Again, most markets did well and most businesses did well, the exception was the Friends business internationally which was down 49% and a handful of markets like the UK and Germany and Canada also had the inventory change like we had here in the US. The one exception to all that was Brazil, we also had a decline in Brazil but it seemed to be more related to getting import approvals which affected our shipments in the quarter.

When you look across the business CARS, High School Musical, Fisher Price all did well internationally and I continue to expect international to be driver of growth for us both this year and continuing as it has for the last seven or eight years.

Tim Conder – Wachovia

Last question related to Fisher Price, Friends and that. I think he had mentioned before that maybe you missed a little bit on the product as far as having the product right. How do you see that shaping up as the year progresses and now you are through some of the most challenging comps there? How do you see that unfolding?

Bob Eckert

In Friends the biggest decliner in the quarter this year was Sesame Street because a year ago we had T.M.X. Elmo which continued to be a hot seller in fact everything Elmo was doing quite well. This year we have Elmo Live this fall. I think it might start shipping in September or thereabouts. It’s a really cool product and I’m optimistic about it and I think that will improve prospects for the Friends business in general and Sesame Street specifically.

Tim Conder – Wachovia

In Dora, in particular?

Bob Eckert

Dora did decline, its wasn’t as big a decline as you saw in Sesame Street but it continues to be an Evergreen property for us that continues to be a great brand for us. The core doll business side of Dora did pretty well for the quarter.

Operator

We’ll go next to Tony Gikas with Piper Jaffray.

Tony Gikas – Piper Jaffray

A couple questions, maybe just to follow up on that, anything else in Fisher Price that created some weakness during the quarter would love to have more color on that. Second question, any update on the increased costs related to testing product during the manufacturing process and what that expectation is on a year over year incremental basis, I know you’ve helped us with that in the past. Maybe just your quick thoughts on industry sales overall with the economy softening a little bit, what are your expectations both US and international.

Bob Eckert

I’ll try and do the first and third and let Kevin take the middle one. Last year in the first quarter Fisher Price grew 27% and this year Fisher Price declined 13% and it was really related to T.M.X. Elmo, the digital camera and very low levels of retail inventory last year compared to this year. Despite not having those products like T.M.X. and the camera to chase our POS was pretty close to flat for the quarter. I think you can see the impact of last year’s retail inventory reload which obviously wasn’t repeated this year. We are not seeing anything across retail sales that is particularly concerning a certain time of year. I think it’s really more a function of the year ago comparison.

Kevin Farr

With regard to testing costs our incremental testing costs in the quarter were consistent with our expectations about one percentage cost of goods sold and that’s really our expectation that’s ongoing. If you look at year on year we expect to see year over year increasing in testing costs until we get into the fourth quarter where we are incurring in last year.

Bob Eckert

Your third question I think that last years concerns around the consumer, the overall economic environment has continued into this year. That said, as you know, the toy industry has historically held up very well in tough economic times. We remain committed to being focused on innovation and engaging toys to the marketplace and I haven’t seen anything early this year that causes me concern about this coming holiday season as it relates to the toy business.

Mike Salop

Looking at MTD data the first few months are small for the year but there is showing a decline in the US and MTD, there was an extra week in the MTD data in 2007 which is really accounting for all the decline the first couple months of the year.

Tony Gikas – Piper Jaffray

Any update on your market share both domestic and international and then could you help us with the net interest expense number for the year.

Bob Eckert

I haven’t seen any market share information yet it’s a little early with a lot of small numbers. We tend not to get it until after the quarter. Mike told me about the industry wide number which must have been published by MTD or somebody. That’s not consistent with what I’ve heard talking with retailers about the state of the business. It might be either small numbers or the extra week event.

Kevin Farr

We don’t give guidance for interest expense but as you think about the variance from 2007 as you do your calculations you should consider your expectation for revenue growth and operating earnings, short term interest rate trends, debt maturities, capital deployment assumptions including share repurchase and acquisitions and our existing cash and debt balances coming into 2008.

Operator

We’ll go next to Greg Badishkanian with Citigroup.

Greg Badishkanian – Citigroup

In regards to the cost in pricing environment you had implemented a mid to high single digit price increase is that similar to what your competitors out there are implementing as well?

Bob Eckert

It’s hard to say because different people look at it differently and because so much of the toy business is new products. One can certainly say this is a new product and is priced at this level. Last year we had a different product priced at a different level. They both may be three inch action figures or eleven inch dolls but they are different products so people may not look at it that way. It’s even hard for us to look at it because of the fact that it’s all new products and each product is a little bit different than the prior year. We try and look at the entire portfolio and if it were apples to apples that is like sorts of products that’s when we talk about a price increase which is pretty much across the board and around the world.

Greg Badishkanian – Citigroup

Retailers are pretty open to that because they read the papers; they see what’s going on in the cost environment as well, right?

Bob Eckert

I don’t know if I’d use the word open. These are always difficult conversations the fact is not only do they read the papers most of the major retailers are in private label toys and they are seeing the exact same cost increases coming at them. I don’t think they are at all surprised by this and we sort of moved past those discussions and into the discussions of how we are going to sell the toys this holiday season.

Greg Badishkanian – Citigroup

Can you talk a little bit about some initiatives that you do have in place to eliminate some of the increasing costs, the top one or two that you think are really going to be meaningful over the next four to six quarters?

Bob Eckert

The most important one is, from an operations standpoint it’s now moved beyond operations in the company is lean manufacturing or lean systems or ties in events. We’ve seen dramatic double digit improvements in productivity as measured by costs going through the system and space utilization inventory investment and the like. Having work groups work on specific activities under their control has had big payoff to us and not only are we now doing this in our own manufacturing plants we are also extending that to some of our vendor partners plants and we are doing it in some of the business units in some of the corporate functions around the company so there not just confined to operations given the success we’ve had. That’ll probably be the biggest driver of productivity improvements over the next couple of years.

Operator

We’ll go next to Sean McGowan with Needham & Company.

Sean McGowan – Needham & Company

I just wanted to follow up on the cost and pricing issue to ask you how confident you are at this point that the price increases that you do get will be sufficient to offset the cost increases. In other words, what is your overall expectation for a run rate on year over year gross margin by year end?

Bob Eckert

That would sort of be a projection of our guidance so I won’t specifically answer your question.

Sean McGowan – Needham & Company

That’s why I put it as a run rate to say do you think that by the end of the year you’ll see an equilibrium there? Not for the full year but just do you expect the price increases to offset the cost increases on a run rate basis?

Bob Eckert

Yes, I understand the question but again I think that a direct answer to your question would lead to some sort of guidance which I’m reluctant to do. Let me just say this, we’ve been looking at the costs for some time, we’ve studied them very hard. We’ve tried to price appropriately. You never know if it’s enough until you have the benefit of hindsight to see exactly what the costs were and the ingredients when you used them and those sorts of things.

Clearly we had to step up in pricing this year and we’ve done so. The cost environment has been un-relentless whether its commodity costs, resins and oil continue to be high. Labor costs are increasing dramatically in China but those are things that we’ve been expecting as the year unfolded.

Sean McGowan – Needham & Company

A question on Barbie, now that we are well past Toy Fair and you’ve gotten feedback from major customers, how do you feel about major Barbie initiatives and some of the bigger themes for the second half?

Bob Eckert

I feel better than the first quarter numbers would suggest. Our POS here in the US on Barbie was down in the quarter low to mid single digits excluding My Scene which we did discontinue here in the second half last year our POS was actually up a little bit again low to mid single digits. I think that’s encouraging in the light of strong performances by High School Musical which we make and Hannah Montana which is licensed to a competitor.

Importantly the spring entertainment line as Kevin mentioned Mariposa has done well suggesting that the ’07 experience when we had entertainment trending down may have been more related to the specific product instead of the business model. Fashion Fever has done well, core Barbie careers and furniture, skus have done well. The new iDesign which is fashion play delivered electronically is doing well. Across the board I’m encouraged by the progress we are making on Barbie particularly in light of some great competitive products out there.

Sean McGowan – Needham & Company

Last question, when will you, or have you already announced the pricing on the subscription for BarbieGirls.com?

Bob Eckert

We have not announced the pricing; it will have to be soon because we are going to the subscription model next month. Its one of those things where people are moving very quickly. I can tell you we will be competitive with our pricing but we don’t want to get out in front of it so that others can see it too soon. We’ve been studying it and I don’t think there’s going to be any big surprise in there for anybody.

Sean McGowan – Needham & Company

Can you give us an update of where those numbers are in terms of users and active subscribers?

Bob Eckert

I guess 11 million.

Operator

We’ll go next to Felicia Hendrix with Lehman Brothers.

Felicia Hendrix – Lehman Brothers

A lot of my questions have been asked so I just have two smaller ones. One, I know this is just 2% of overall revenues but it could be a trend of overall industry revenues. Washington State, the decision there I was wondering how does that affect you and what are you guys doing to offset potentially similar decision in other states and is any kind of lobbying cost involved with that also in your SG&A?

Bob Eckert

Several states including Washington have either passed or proposed or they’re at least considering legislation that would result in a variety of different standards for lead or phthalates or other sorts of ingredients. We’ve certainly worked with the states as have some of our competitors and the toy industry association to education legislators and regulators on the fact that if they go too far in these things some electronic components aren’t going to be able to be used. We would all be unable to ship some toys into certain states.

Our real hope here is that the house and senate will be able to work on a compromise federal bill so that we can alleviate the pressure on the states to pass either duplicative or inconsistent legislation and we are working at both the state level to inform legislators there and at the federal level trying to encourage them to finish the project they’ve been on now for several months.

Felicia Hendrix – Lehman Brothers

Have you basically stopped shipping certain products into Washington State?

Bob Eckert

No. The legislation is effective I think July 1, 2009 and there are some opportunities between now and then hopefully to influence how that legislation is either interpreted or enforced because I don’t think people in the State of Washington including the regulators and legislators really want their children not to have the benefit of some of these educational toys. That’s something we have to work through.

Felicia Hendrix – Lehman Brothers

Final question, can you give us the international release dates for the Speed Racer movie?

Bob Eckert

It varies by country but I don’t know them off the top of my head.

Kevin Farr

I would guess they’d be rolling through May into early June.

Mike Salop

I’ll get back to you.

Operator

We’ll go next to Margaret Whitfield with Sterne Agee.

Margaret Whitfield - Sterne Agee

I was curious on the price increase does that go into effect at the beginning or the end of June and would you expect a lot of purchases of products by retailers prior to these price increases?

Bob Eckert

Generally speaking the price increases are effective June 1st. It does vary somewhat by market and by item and by brand but as a rule of thumb I would think about June 1st. Historically speaking we have not seen a large amount of trade inventory buying in advance of prices because the way we do this is on fall line and the fall line ships the ships. It’s not available until its available and buying the old spring line really isn’t a function of what the price increase of the new fall line. We don’t see a lot of trade loading in advance of a price increase.

Margaret Whitfield - Sterne Agee

On the three entertainment properties we’ve apparently had good response to Speed Racer already. Any thoughts on the other two movies and how they might do at retail?

Bob Eckert

Yes, Speed Racer looks very good at retail. Like many of you I’ve been in stores recently including this weekend and it looks good. It’s too soon to tell how the product will do but I’m certainly hearing more good things than not as it relates to the early performance. Kung Fu Panda has gotten a lot of good buzz as a movie and I think we have some pretty cool toys. Batman is a pretty clear consistent performer so I guess my expectations are pretty high for that one too.

Margaret Whitfield - Sterne Agee

I’m told that MGA is expended about $50 million in legal expense thus far. I’m wondering if the bulk of the legal costs for this case are ahead of us, behind us or how would you characterize it?

Bob Eckert

The trial begins; I believe it’s scheduled to start at the very end of May or thereabouts. It will probably last some time because there are some pretty heavy issues. We are certainly investing a lot of money to make sure our case is presented well which I’m sure it will be. I would suspect that once we get past the trial phase, whenever that is expenses may not be as high as they are right now.

Margaret Whitfield - Sterne Agee

Q2 might be a heavy quarter for that case in particular?

Bob Eckert

Yes, Q2 will be a heavy quarter for that case in particular. We are working pretty hard on that case.

Margaret Whitfield - Sterne Agee

On American Girl, good to see the positive numbers. Are there any thoughts about opening additional Boutiques in the near future, this year or next?

Bob Eckert

Yes.

Margaret Whitfield - Sterne Agee

Can you say where?

Bob Eckert

We’ve had very good success in both the Boutiques, Atlanta and Dallas and we are looking at a couple properties as we speak. There’s nothing to announce yet but we are pleased with the performance of the Boutiques. The concept of having something a little bit smaller than the flagship stores but generating good profitable revenues seems to have tested out well. We are going to be in a slow steady expansion mode on that.

Margaret Whitfield - Sterne Agee

Given what you just said it seems unlikely that you’d be able to open this year.

Bob Eckert

I don’t know that I’d draw that conclusion but I don’t want to get ahead of any announcement we might make.

Operator

We’ll go next to Linda Bolton Weiser with Caris & Company

Linda Bolton Weiser – Caris & Company

I was just curious about share repurchase in the quarter. I believe that when you did the large share repurchase back in third quarter ’07 your average purchase price was around $22 per share and certainly your stock has been below that in the first quarter ’08 is it just your working capital needs that you held back on the share repurchase or can you elaborate a little bit more.

Kevin Farr

In the quarter we repurchased approximately 7,000 shares at an average price of $18.99 totaling around $129,000. As you know we don’t comment on the valuation or stock nor do we disclose the detailed execution parameters for our capital investment framework. We’d caution any one from trying to draw conclusions purely from the timing and/or magnitude of our share repurchases. We believe its most important for our shareholders to understand that we will be disciplined and opportunistic with Mattel’s capital and less important to know exactly when and why we announce the next share repurchase program will provide our detailed execution parameters but over the last five years we’ve repurchased 104 million shares two billion, 2% of our shares outstanding at an average price of $19.23.

Linda Bolton Weiser – Caris & Company

Can I also ask you a little bit about China and obviously the ongoing inflationary cost pressures there are something that we all are aware of. We’re hearing some additional operating issues related to the Beijing Olympics including plant closures which may not apply to you so much but also shortage of some containers and all kinds of logistical problems in shipping product out of China. Are you experiencing any of that or do you expect to later on in the year?

Bob Eckert

No, we’re not experiencing anything like that today and I don’t have any reason to believe that would be an issue going forward. Obviously its something important and something we are focused on but we haven’t had any issues and I don’t know that anything is coming at us. Also recognize on the receiving end we have an issue which is it’s the third or fourth year of the longshore contract here in Long Beach in Los Angeles. That’s a set of negotiations that needs to take place. At this point I don’t see anything disrupting the supply chain for us.

Linda Bolton Weiser – Caris & Company

On Barbie and the My Scene discontinuation, can you remind us when that was discontinued and when you anniversary that discontinuation?

Bob Eckert

It will be in the US in the second half of this year, we’ll anniversary the discontinuation. We continue to sell My Scene internationally. It’s a pretty big contributor to the brand portfolio there and I think it may end up like our experience in action figures with the brand called Maxfield which sort of ran its course here in the US but continues to do very well in Latin America generally, in Mexico specifically. I think My Scene may end up as something that remains viable in some or all international markets but it will cycle through here in the US.

Linda Bolton Weiser – Caris & Company

On Speed Racer, can you give us a rough idea of what portion of the product line is being booked in Wheels versus entertainment?

Kevin Farr

Anything that’s related primarily to vehicles is in Wheels if vehicles in the main focus of the product. All the other products are in entertainment.

Linda Bolton Weiser – Caris & Company

Probably more than half if Wheels, right?

Kevin Farr

Most likely, yes.

Linda Bolton Weiser – Caris & Company

Are you expecting that the Speed Racer product will detract from consumer demand for your core Hot Wheels type vehicles?

Bob Eckert

It hasn’t to date but it’s very early and we have some good things going on in our core Hot Wheels business. The Crashers product line is off to a good start, the Trick Track is probably the best track set we’ve had since I’ve been around Mattel. We also have the experience when CARS came out it was a lot of incremental business to us and Hot Wheels held up okay and I feel better about our core Hot Wheels business today than I have in my tenure here at Mattel. I don’t know that we will necessarily see a lot of cannibalization, we certainly may but I don’t think that way.

Linda Bolton Weiser – Caris & Company

On the Latin American item that was in the other expense line, I didn’t catch if you specifically quantified that item, did you?

Kevin Farr

With regard to the line item I think the non-operating expense was $15.8 million and that was primarily related to revaluation of US Dollar cash balances held by our Venezuelan subsidiary. The Venezuelan currency appreciated about 50% in the quarter which caused our US dollar cash balances to be translated into less Bolivar’s creating a paper foreign exchange loss for Venezuelan subsidiary. There were some minor offset to this loss elsewhere in the P&L but going forward our US Dollar assets and liabilities in the country should largely offset. Although the offsetting gains and losses may appear on different line items in the P&L in future quarters.

Linda Bolton Weiser – Caris & Company

The vast majority of that $15.8 million was that item?

Kevin Farr

That is correct. The $15.8 million was that item.

Operator

We’ll go next to Gerrick Johnson with BMO Capital Markets.

Gerrick Johnson – BMO Capital Markets

CapEx, did you say that was $33 million in the quarter?

Kevin Farr

Yes

Gerrick Johnson – BMO Capital Markets

Versus $24 million last year, why was that so much higher this year?

Kevin Farr

It really related a couple of things. It related to the House of Barbie Shanghai that we’re in the process of building. It also related to the movement of our American Girl Place in Chicago to a more prominent location at Water Tower Place on Michigan Avenue. We are renovating our design center here in the US and finally there is some incremental expenses related to manufacturing implementing low level automation and manufacturing.

Gerrick Johnson – BMO Capital Markets

Should these be ongoing throughout the year, should we be planning our CapEx a little bit higher than we did last year?

Kevin Farr

Yes, I think 2008 spending should be above our 2007 spending but we’ll likely be below our long term range of $180 to $200 million. Again, I think we’ll continue to be spending in House of Barbie, American Girl Place in Chicago as well as renovating our design center.

Gerrick Johnson – BMO Capital Markets

Your decision to change the Barbie Girls business model to a subscription based model I guess that means that the MP3 player is somewhat obsolete now so has there been any impact of that in your first quarter numbers or do you foresee any impact from that flowing through maybe in the second quarter?

Bob Eckert

No, I think any impact will be minor.

Gerrick Johnson – BMO Capital Markets

American Girl, what was the catalog business doing, was that up or down for the quarter?

Bob Eckert

I think it was, if I recall it was pretty close to flattish. We got most of the growth from the retail side of the business. I think flattish is probably a little better than the trend has been the last several quarters. That is the one business where we probably do benefit from an early Easter since we are selling directly to consumers.

Gerrick Johnson – BMO Capital Markets

Lastly, I just wanted in inquire about your supplier based in China and is it pretty much where you want it to be or are you still in the process of finding or switching suppliers, finding new suppliers after what happened over last several months.

Bob Eckert

It will continue to evolve. We have fewer suppliers today or vendors than we did in prior years and my expectation is that trend will continue. That’s going to be a long term trend.

Gerrick Johnson – BMO Capital Markets

Should that have any impact on how you flow goods. Should it take you a little bit longer perhaps to get things to market or should it be pretty much business as usual.

Bob Eckert

It should be business as usual. We incorporate those kinds of things in when we make the specific decisions.

Operator

We’ll go next to John Taylor with Arcadia.

John Taylor – Arcadia

Actually, Gerrick just asked my question so let me try it a different way. In talking about Chinese capacity or capacity in general manufacture I wonder if the concentration and maybe just less excess capacity in the system over there has any implications for putting a cap on up side. Should one more of your products actually do better and start to take off a little bit?

Bob Eckert

Yes it does, I think that’s a good way to look at it. My belief is there is less capacity in the system than there used to be and as a result of that and several other things you’ll probably see our inventory rising a little faster throughout the year than usual. We’ll be bringing in goods earlier than we have been in historical years. I don’t know if that will change our total inventory position but I think we’re going to be flowing goods earlier here in the US.

John Taylor – Arcadia

In terms of the theatrical properties, are any one of those three that you’ve got do you think excellent candidates for solid second bite of the apple in the holiday time frame DVD release?

Bob Eckert

Your guess is better than mine on that. Certainly CARS did very well through the second year and despite the fact that we had a decline in the US. It continues to be one of our most important brands across the portfolio. I’d love to see one or more of these continue. Batman is an Evergreen property and we sell some of that even in non-movie years. I think Batman will be here. I’d love to see one or both of the other ones continue to do well.

John Taylor – Arcadia

If you were to tie those two questions together and look at potential up side capacity is any one or more of those better or worse off?

Bob Eckert

I don’t think either one is particularly better or worse off.

Kevin Farr

I don’t think so either.

Operator

It appears we have no further questions at this time. I’d like to turn the call over to Mr. Salop for any additional or closing remarks.

Mike Salop

[Replay Instructions] Thanks for participating in today’s call.

Operator

This does conclude today’s conference we do appreciate your participation you may disconnect at this time.

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Source: Mattel, Inc. Q1 2008 Earnings Call Transcript
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