Good morning to everyone here in El Segundo and to those joining us via web cast. Today we’re going to share with you some opportunities and strategies we see for our business as well as some of the challenges we are facing. As you know in 2007 Mattel retained its position as the world’s largest toy manufacturer with approximately $6 billion in net sales and a 17% share of the U.S. toy business.
Our diversified portfolio of core brands and license properties delivered solid 6% global revenue growth despite the many challenges we faced last year as the result of the product recall. International markets with a 17% increase once again led our growth and more than offset flattish U.S. results.
Each year to drive growth and retain industry leadership we have to adapt to kids and cultures that are constantly evolving. This morning I’d like to focus on how we are developing our brand strategies both in terms of toys and overall complementary brand development.
Toy sales continue to represent the majority of our business and our marketing and design teams are focused on creating innovative, relevant toys for our core consumers every year. This applies to both our owned properties and those we license from entertainment partners. However, building our brand beyond basic toys is also an important element of our strategy whether we create more demand for our toys through increased exposure and retail excitement or simply expand our brands among other profitable, relevant categories of consumer interest; development of intellectual property is a key focus for the future.
Hopefully today you’ll see that we are engaged in many brand development activities that are providing us good opportunities around the world both for toys and for our intellectual properties in general. Before we discuss those activities I’d like to spend a few minutes recapping how our portfolio has performed over the past seven years.
Since 2000 Mattel has delivered compound annual growth rate on revenues of 3.9% with growth each and every year. As you can see not every brand increases all the time but the overall portfolio has been able to deliver solid results each year. We have had especially good growth in the past two years driven by good core brand performance across the portfolio and the success of the entertainment property Cars.
International markets have been the main driver behind our growth. We have seen growth each year over the past seven years and our international business increases from about 31% of our total revenue in 2000 to 49% in 2007. We continued to believe that international provides our greatest growth potential moving forward.
As you can see, as international growth has been achieved across the globe both in developed and developing markets. In developed markets such as the larger countries in Western Europe the overall toy market has continued to grow. We have also benefited from improvements in categories where we are relatively undeveloped such as in Pre-School. In developing markets such as Brazil, Russia, India, China and Eastern Europe we are experiencing great growth thanks to rising incomes, growing toy consumption and rapid retail development. The strengthening Euro has also aided international results.
In the U.S. the toy industry is fairly mature but our target segment is still growing. In 2007 according to NPD the toy industry declined 2% and has declined at a 1.2% compound annual rate over the past three years. However the 0-8 year old segment which represents 85% of Mattel’s sales compared to 73% of the rest of the toy industry has grown at a rate of 1.6% over the past three years.
The good news here is that in 2006 the U.S. reported the largest number of children born in 45 years which should aid our Fisher-Price business in the near-term and trickle up to our other brands over the next several years. It is also interesting to note that the U.S. toy industry at $22 billion was essentially flat in 2007 even though the video game industry grew by more than $4.5 billion according to NPD.
So that is a brief recap of where we have been. Now let’s talk about where we are going.
As I mentioned earlier kids are constantly evolving and our brands are too. Whether through continued innovation of toys both for our owned brands and key entertainment licenses, creation of entertainment for our intellectual properties, utilization of complementary license products, adapting to online and digital forms of play or development of our brand image at retail, Mattel is positioning itself to be where kids are as the culture evolves.
First I’d like to provide some examples of how we are staying fresh and innovative in the toy aisle. In 2008 we have many exciting toys set to hit store shelves including the already released Barbie Magic Wings Mirror Poses, whose wings magically transform. In the fall Fisher-Price will introduce Elmo Live which comes to life and is already creating buzz as the candidate as the top toy for holiday 2008. We have cool track sets like Hot Wheels Trick Tracks that lets kids customize their own action-packed stunts and coming off last year’s top toy smart cycle, Fisher-Price introduces the Laugh-N-Learn Bounce and Spin Pony which responds to a child’s bouncing, spinning and rolling the handle bars with sound effects and animation that teach infants letters, numbers, shapes and colors.
We also continue to deliver innovative toys based on license properties from key entertainment studio partnerships. As you know this year we teamed with Warner Bros. for Speed Racer and Batman, The Dark Knight as well as DreamWorks animation for the recently released theatrical hit Kung Fu Panda. While the Speed Racer box office wasn’t what we had hoped the toys have continued to generate strong consumer response, at least in the U.S.
Our partnership with Disney and Pixar continue to build momentum. Cars remains a solid performer in its third year after growing more than 50% in 2007. In fact we recently expanded our agreement for the Cars toy rights through 2011. We also have other strong Disney properties like High School Musical, Disney Princesses, Winnie the Pooh and Disney Pre-School at Fisher-Price. In Europe and Latin America our efforts extend to the Hannah Montana doll.
We also continue our partnership with Nickelodeon with such favorites as Dora and Diego. The new hits like Wonder Pets and Wa Wa Wubsie and rounding things out is our previously announced World Wrestling Entertainment (NYSE:WWE) will be joining our Mattel brands portfolio in 2010.
But entertainment isn’t just about licensing from the studios. We have a strong portfolio of our own intellectual property which we believe presents tremendous opportunity to boost our brand. We have garnered great success with the Barbie DVD’s which have earned consistent Number 1 rankings from Nielsen and have sold over 50 million units worldwide since 2001. American Girl has also benefited from made for television movies which were later released on DVD and this week the much anticipated theatrical release of Kit Kittredge, An American Girl, is premiering on the silver screen in Los Angeles, New York and Chicago to be followed by a wider release across the country in early July.
We are exploring many more options for entertainment based on our intellectual properties. We have recently agreed to a live-action Hot Wheels theatrical release as well as a Masters of the Universe movie to support our He Man toy re-launch. Both movies will be developed by Joel Silver and distributed by Warner Bros. at dates to be determined.
Licensing our intellectual properties for products and apparel outside of toys also aids brand development and complements toy sales in addition to being a significant income generator. For Barbie alone our worldwide licensing business represents over $1.5 billion at retail sales. A great example of licensing complementary brand development is the Barbie Loves MAC cosmetic and accessory program which saw much success in 2007.
According to Estee Lauder’s annual report it was the largest color collection in the history of MAC and this year we are working with Patricia Fields, Hollywood’s most famous stylist and fashion visionary of Sex in the City. We are really excited about this collaboration.
Outside of classic toy play we know that kids are getting involved in digital play at younger and younger ages and we intend for Mattel’s brands to be there with them. Fashion is huge online. Let me share with you a few examples from Barbie. First, Barbie brings fashion play traditionally experienced with dolls into the new digital playground with the debut of the Barbie I-Design, an unparalleled, interactive gaming experience that allows today’s tech savvy girls to become the ultimate fashion stylist. BarbieGirls.com, the first global, virtual online world designed exclusively for girls now boasts nearly 13 million registered users worldwide and has been referred to as the fastest growing virtual world ever. In fact, the majority of girls on BarbieGirls.com, more than 85% are over the age of 8 so we are keeping older girls engaged with the core play experiences of the Barbie brand but with a new format; online content.
Launched earlier this month we have introduced the new subscription service for BarbieGirls.com which we are calling Barbie Girls VIP. For $5.99 a month girls can now get access to new locations to explore, new games to play and new experiences throughout the site.
Fisher-Price offers an array of interactive learning toys and activities including the kid friendly digital camera and DVD players. From Radica we have U.B. Funkeys, collectible figures which unlock different zones in games online. Funkeys is even creating some pretty cool license time. Hot Wheels Turbo Driver is a game controller that plugs into your computer’s USB and takes you right to an exclusive game on HotWheels.com. Plug in your stylized Turbo Driver Hot Wheels car, select a course and you are all set to race the world.
Another part of our brand development strategy involves the experience at retail. We have had great success at our flagship stores from American Girl in Chicago, New York and Los Angeles. This fall our Chicago store is moving to a larger location right in the heart of Michigan Avenue. The smaller formats we seek in bistro shops we opened in Dallas and Atlanta continue to perform well and we recently announced plans for a third boutique in Boston. We are also in the midst of finalizing plans to open a fourth boutique to be opened in the Midwest.
With Barbie license stores have opened in global locations that encompass not only the toy but the extensive lifestyle collection important to girls. There are 25 young-adult shops in Japan, Korea and Taiwan and more are expected. In China we are developing an experimental flagship store, a Barbie store called House of Barbie which is scheduled to open in Shanghai later this year.
Of course these strategies for toy innovation, entertainment, license products, digital play and retail presentation can be even more impactful when executed together. Today Barbie provides the best example of the possibilities of melding these strategies. Toys create fun play experiences for younger girls. DVD’s introduce stories that generate interest in particular items and characters. Licensing partnerships like MAC and Patricia Fields fashions at Cache with teens and adults can tend to have a halo effect on the brand.
The online component such as Barbie.com and BarbieGirls.com offer updated and on trend interactional opportunities and play patterns for the older girls. Boutiques and creative retail merchandising add to the brand’s statement and bring the many elements together. For these strategies to be successful we must continuously understand our consumers and where they are headed. At Mattel we feel we have a real competitive advantage on such insight as we invest more in understanding our consumer than any other youth-oriented products company.
We speak with 100,000 kids and parents in more than 20 countries each year and employ state-of-the-art proprietary tools and expert researchers. Our consumer insights efforts underpin the many strategies we employ to help ensure play time is relevant and rewarding for our consumers around the world.
This morning I have provided just a small glimpse of the many activities and strategies in which we are engaged to leverage our portfolio of global brands and keep up with the evolving culture.
At this time I’d now like to turn things over to our Chief Financial Officer, Kevin Farr, who will address some of the challenges and opportunities we are seeing with cost and margins.
Thanks Bob and good morning everyone. Before discussing 2008 and beyond I would like to briefly recap some key financial metrics from the past seven years. As [Fab] mentioned, our portfolio brands have generated revenue growth in each and every year since 2000. We had particularly good growth in 2006 and 2007 aided by continued contributions from core brands such as Fisher-Price and Hot Wheels, the success of the Cars entertainment property and newly expanding international growth partially aided by favorable foreign exchange.
Our profitability over that time period can be segmented into three separate intervals. In the first interval from 2000 to 2003 we were able to make significant improvements by executing supply chain and cost reduction initiatives including consolidating and migrating manufacturing to lower cost locations, exiting unfavorable licensing arrangements and fixing or removing products and brands that were not generating positive value.
As a result, our gross margin improved from 34.7% in 2000 to 49% in 2003 and operating margins advanced from 8.1% in 2000 to 15.8% in 2003.
The next interval occurred over 2004 and 2005. During this period our gross and operating margins declined due to rapid increases in input costs particularly resin and declines in the sales and profitability of our U.S. Barbie business. By 2005 our gross margins were at 45.8% and our operating margin had declined to 12.8%.
The third interval began in 2006. Although input costs remained high we were able to improve margins largely by increasing prices, supply chain initiatives, sales leverage and the benefits of foreign exchange. However, some of these gains were offset by recall related costs in 2007. As a result our gross margin improved in both years ending 2007 at 46.5%. Operating margin last year was 12.2% but this was impacted by recall costs of $110 million or 180 basis points.
As we previously stated, some of these recall related costs such as incremental product testing and legal fees will continue but most other recall expenses should not be repeated. Despite the headwinds of our input costs our cash flow has remained strong. From 2001 to 2007 we generated almost $6 billion in cash flow. We have been opportunistic and disciplined in deploying this cash flow. We have utilized the cash flow to both strengthen our balance sheet and deploy funds for the benefit of shareholders.
Since we initiated our capital investment framework in 2003 we have returned more than $3 billion to shareholders in the way of share repurchases and dividends. Over the last five years we bought back 104 million shares at an average price of $19.23 representing 22% of our outstanding shares. We have steadily increased our dividends to payout levels consistent with blue chip consumer product companies. Our dividends paid out annually at December of each year and in 2007 our dividend per share was $0.75 up 15% from 2006.
So that’s where we have been the last seven years. Now I’d like to talk about 2008 and beyond. We continue to benchmark well run consumer product companies. Consistent with well run consumer product companies our long-term targets are to achieve single-digit revenue growth, over 50% of revenues in international markets, gross margins around 50% and operating margins in the 15-20% range.
Despite the cost pressures we are facing we continue to believe these targets are achievable over time. To get there we must continue to drive innovation in our product line and price for that innovation. We must also price for the new realities in cost and continue to look for efficiencies in the business in areas like supply chain, global procurement, lean, IT strategies and the back office.
Bob has reviewed some of the brand and innovation strategies and international growth opportunities so I’ll focus my comments on some of the cost challenges we are facing and margin initiatives we are employing. As you are well aware we are currently facing a very challenging cost environment. Over the last year we have experienced double-digit increases in key input costs such as resins, Asian labor rates and Asian currency. As a reminder, materials are our largest component of cost of goods sold at approximately 40% and resin is our most important raw material at approximately 10-12% of cost of goods sold.
Labor represents about 15% of cost of goods sold and in addition to rising raw material labor costs as previously mentioned we are incurring incremental testing and other quality control costs to ensure we meet all regulatory standards for our products. In addition to the incremental testing cost for lead which we previously announced would amount to approximately 1% of cost of goods we have recently enhanced our testing and quality control procedures for a variety of heavy elements and other chemicals.
In total, we now estimate total incremental testing and other quality control costs at approximately 1-1.5% of total cost of goods sold. So that is the cost environment we are dealing with. Now let’s talk about some of the programs we are utilizing to drive efficiencies and margins.
As most of you know we began implementing lean methodologies in our manufacturing facilities in 2005. Since that time lean has spread throughout the supply chain into other areas of the organization. We estimate that lean processes currently contribute approximately $30 million in annual savings. As we move forward we believe one of our biggest opportunities is to expand lean knowledge to our third part manufacturing partners in Asia. As most of you know, third party vendors represent more than half of our total production. This program is part of a larger operations effort aimed at improving efficiency from our vendor base largely through deeper cooperation.
Such efforts include, again, sharing lean methodologies, more global procurement on behalf of vendors for key materials and packaging, smoother plant loading through consolidation of orders and migrating vendors to lower cost regions. We currently manufacture product in the Pearl River Delta in Southern China. Over the last several years demand for labor has intensified and raised costs significant. So we are currently exploring longer term options in Northern China and Viet Nam which offer cost savings of 5-10%. While this is a multi-year effort we are planning pilot test programs with vendors and are confident in our opportunities.
We also continue to review overhead structures and continuous improvement opportunities across the organization. As you are aware, in recent years we have executed several initiatives. We have created shared service centers for back office, accounting and human resources functions in North America; North, South and Latin America; in Europe for Eastern and Western Europe and the Middle East/Africa region.
Later this year we will add Asia to this shared service center structure.
We have also leveraged our scale by consolidating management for girls, boys and Fisher-Price and created regional clusters among our international subsidiaries. We have improved tooling efficiencies and completed many other initiatives. We continue to seek improvement in many of these areas and other such as SKU efficiency, advertising return on investment, trade spending and IT strategy execution.
Despite our efficiency programs the magnitude of the cost inflation has also required us to significantly adjust our prices to customers. I’d like to spend a few minutes discussing pricing.
As you know, over 80% of our product is new each year. We have two toy selling seasons, spring and fall. So let me explain how pricing is generally set each year. The spring toy product line is introduced to customers at our own Toy Fair here in California generally around June. In fact we just completed our 2009 Spring Toy Fair last week. The fall line is introduced around October at our own toy fair which is also here in California.
To establish our prices for spring and fall toy fairs, we need to make cost assumptions for the products in advance of showing our products to customers. So, cost estimates are made months before the toy fairs and almost 6-8 months before manufacturing of product begins. Last year after we set our 2008 spring pricing in the summer and fall pricing in October of 2007 we experienced significant acceleration in key input costs such as resin, Chinese currency and Asian labor rates as well as the incremental testing costs. Consequently we felt compelled to make an adjustment to our pricing and in March we announced a mid to high single-digit increase effective June 1, 2008.
While this increase is higher than the 1-4% increases we have been implementing the past three years we do not believe our price increase will have a significant impact on consumer purchase behavior. This belief is based on several studies we have conducted over the last couple of years.
First, our research indicates that price is an important factor in purchase selection. However, several other product factors are even more critical to consumers like quality, durability, toys that are fun and enhance imaginative play and toys that hold a child’s attention.
Second, our studies reveal consumers have limited knowledge in estimating toy prices. Generally the level of prices does not change the consumers purchasing behavior based on cost at magic price points like $9.99, $14.99 or $19.99. In fact, we know that retailers were increasingly pricing non-TV promoted items above manufacturers suggested retail prices. Retailers were implementing this action to offset the price reductions they were taking on TV products to drive store traffic.
Third, about 70% of our retail price points are below $25 so mid to high single-digit price increase is not significantly increasing actual money spent by consumers. A couple of other points should be considered as well. First within the toy industry almost 2/3 of all toy purchases are planned. Second, less than 10% of all toy purchases are made by the ultimate toy recipient. Finally, almost 70% of purchases are made by a parent or grandparent for their child or grandchild respectively. So we believe these factors should bode well for a fairly in-elastic response to our price increases. Depending on how the business performs this year it is likely we will make additional price adjustments for the 2009 product line.
So, to summarize our overall financial picture we made good progress in margins and profitability from 2000 to 2003. However, our profitability declined in 2004 and 2005 primarily due to rapid input cost inflation where our price increases lagged the actual increases in our costs and to a lesser extent the impact of unfavorable product mix.
Our profitability began to rebound in 2006 and 2007 as we benefited from our price increases, supply chain initiatives, sales leverage and foreign exchange partially offset by recall and related expenses in 2007. With most of 2008 ahead of us we remain optimistic about the business and we are committed to addressing the near-term challenges and delivering profitable growth for the year.
We expect core brand growth and anticipate additional contributions from this year’s entertainment properties, Speed Racers, Kung Fu Panda, Batman, The Dark Knight and The American Girl Movie: Kit Kittredge, An American Girl.
From a margin perspective we face significant cost headwinds in 2008 due to external cost pressures and incremental product testing costs. As I said, to combat these costs we have implemented mid to high single-digit price increases effective June 1 across most of the world.
We also continue to incur incremental litigation expenses. These expenses are likely to continue until the legal matters are resolved. As we advance through the year and beyond we look to drive operating improvements through the mentioned actions, generate profitable growth and strong levels of free cash flow which we plan to effectively deploy for our shareholders.
We continue to aggressively pursue efficiency programs such as lean, overhead management and long-term vendor strategies for manufacturers. We also continue to monitor pricing and make adjustments as necessary in future years. Despite the headwinds we remain committed to achieving the long-term aspirational benchmarks of well run consumer products companies.
As always we will continue to manage our business for cash flow generation and to deploy it in a disciplined manner for the benefit of our shareholders. We will continue to actively review value enhancing MNA opportunities, remain committed to providing an attractive dividend and pursue opportunistic share repurchases.
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