孩之寶 (HAS) 2003 Q2 法說會逐字稿

Good morning and welcome to Hasbro's Second Quarter Earnings Conference Call.

At this time your lines have been placed in a listen-only mode until the question and answer session of the conference.

We would like to inform all parties that this call is being recorded.

With us today from the company is Senior Vice President of Investor Relations, Karen Warren.

Thank you ma'am, you may begin.

Thank you, Laura and good morning everyone.

Thank you for joining us.

With me this morning are Al Verrecchia, President and Chief Executive Officer, and David Hargreaves, Senior Vice President and Chief Financial Officer.

On today's call we will be reviewing our financial results for the second quarter and highlighting the performance of some of our key products and brands.

We will conclude by opening the call to your questions.

To better understand the earnings results, it would be helpful to have the press release and financial tables available.

If you don't have a copy of the release it is available on our website, Hasbro.com.

Before we begin our formal remarks, let me note that members of Hasbro management may make forward-looking statements concerning management's expectations, goals, objectives, and similar matters which are inherently subject to risks and uncertainties.

There are many factors that could cause actual results and experience to differ materially from anticipated results or other expectations expressed in a forward-looking statement.

Some of those factors are set forth in the Company's annual report on Form 10-K, including, under the heading “Forward-looking information and Risk factors that may affect future results", and the company's quarterly reports on Form 10-Q, including, under the heading “Other information and Forward-looking statements and Factors that may affect future results”, in the company's current reports on form 8-K and in today's press release.

All listeners should review such factors together with any forward-looking statements made in this conference call.

The company undertakes no obligation to make any revisions to the forward-looking statements contained in this conference call or to update them to reflect events or circumstances occurring after the date of this conference call.

Now I would like to introduce our CEO, Al Verrecchia.

Thank you, Karen.

Good morning and welcome everyone.

Thank you for joining us.

Clearly it's nice to have my first quarter as CEO a good one.

It's been a busy couple of months since I assumed the role of Chief Executive Officer.

Along with managing the day to day business, I've spent time meeting with many of our key customers, investors, and employees.

Two questions that have come up repeatedly.

The first, "What will change?"

The good news is, not much.

As most of you know, over two years ago, we embarked on a strategy that focused on growing our core brands, reducing our reliance on major entertainment properties, improving our operating margins and reducing debt.

As you have tracked our progress over the past couple of years, I think you will agree it's a strategy that is working.

The second question was, "How will we grow the top line 3 to 5 percent?"

Later on in today's call I will share with you some of the elements of our revenue growth strategy.

As I suggested a moment ago, I am pleased with our second quarter performance.

Revenue was up 7 percent, and we reported net earnings of 6 cents per diluted share, compared to a loss of #15 cents per diluted share a year ago.

The strength in our top line is a solid indicator of how robust our business is.

We have a number of products that performed well and we believe our strategy of focusing on core brands and new product innovation is working.

As we continue to gain shelf space and improve our market share.

With that, I'd like to turn the call over to David to review the quarterly results in more detail.

David?

Thanks, Al and good morning everyone.

I too am very pleased with our second quarter performance.

Our expense reduction program remains on track and the balance sheet continues to strengthen.

In the quarter, even excluding the favorable impact of foreign exchange and despite the tough Star Wars comps, we grew our business.

The growth in revenue came from a number of product lines, particularly Beyblade, which has performed well both domestically and internationally.

Now let's take a closer look at the effect of foreign exchange on our business.

Exchange rates have had a positive impact on revenues due to stronger international currencies.

Specifically, the euro advertised $1.13 in the second quarter of 2003 compared to 92 cents in the second quarter of 2002, an increase of 23 percent.

Not only did this increase revenues but it also increased U.S. dollar expenses and masked some of the cost savings we are achieving.

In addition, it increased balance sheet amounts, including receivables and inventory.

Finally, because our international segment lost money during the quarter, the translation impact on earnings was negative.

Moving on to the P&L.

Second quarter worldwide net revenues were $581.5 million, up 7 percent compared to $546 million last year.

These results include a 4.3 percent favorable exchange impact.

For the second quarter, we reported a net profit of $11.4 million, or 6 cents per diluted share.

This compares to a loss of $25.9 million, or 15 cents per diluted share a year ago.

In 2002, the results included a net after-tax charge of $21 million, or 12 cents per diluted share related to the decline in value of the Company's investment in Infogrames entertainment, as partly offset by interest income on a tax estimate from the Internal Revenue Service.

Now, I'd like to review the performance of our three major segments.

U.S.

Toys, Games, and International.

More detailed reporting will be included in our form 10-Q which will be filed in August.

In the U.S.

Toy segment revenues were $208.4 million, up 4 percent compared with revenues of $199.6 million last year.

Despite difficult comps from Star Wars, Beyblade, FurReal Friends, and core blends such as TRANSFORMERS and Playskool, more than offset the decline from Star Wars.

Toy operating profit was $12.9 million for the second quarter compared to $14.6 million last year.

The declining operating profit can be primarily attributed to a charge of $7 million related to exiting some of our unprofitable product lines.

In the Game segment, revenues were $148.6 million compared with revenues of $152 million last year.

The board game business remains strong, driven by the strength of TRIVIAL PURSUIT, 20th Anniversary Edition.

Non-licensed trading card games were up, but licensed trading cards, including Pokemon, were down.

Games operating profit improved to $24.5 million, compared to $22.4 million last year due to fixed cost reductions.

International segment revenues were $203.8 million compared with revenues of $174.3 million in the prior year.

This represents an increase of 3 percent in local currency and 17 percent in U.S. dollars.

The revenue growth can be attributed to Beyblade, which is strong in many international markets, and core brands such as Magic: The Gathering, Playskool, and TRANSFORMERS, which were all up double digits.

The International loss declined to $4.8 million during the quarter compared, to a loss of $17.3 million a year ago.

This improvement is attributable to the higher revenue, as well as, the impact of our cost reduction efforts.

Moving on to margins, let me provide you with some perspective on the second quarter.

Gross margin was 60.3 percent compared to 64.1 percent last year, reflecting changes in our product mix, a good portion of which was related to Star Wars.

Now let's look at expenses for the quarter.

Research and development expenditures for the quarter were $33.1 million compared to $36.8 million a year ago.

Royalties for the quarter, as expected, decreased by $13.1 million to $52.7 million, or 9.1 percent of revenues, due primarily to reduced shipments of Star Wars.

Advertising expense was $67.7 million, or 11.6 percent of revenue for the quarter, up in both dollars and when expressed as a percent of revenues compared to a year ago.

This is consistent with the strategy we shared with you where our advertising expenditures would increase as we continue to drive growth in our core brands and new product introductions.

Selling, distribution and administration expense was $150.4 million compared to $152.1 million a year ago.

Savings associated with our cost reduction programs are largely offset by the impact of translating international costs at higher foreign currency exchange rates.

Absence the impact of foreign exchange rates, SD&A would have been down $7.5 million or 5 percent.

Amortization expense declined for the quarter by $4.4 million to $18.4 million, primarily reflecting lower amortization of Star Wars property rights in a non-movie year.

Interest expense for the quarter decreased by $6.3 million to $12 million, reflecting strong cash flow and a repurchase and maturity during the last 12 months of $275 million of long-term notes that had a 7.95 percent coupon.

Now turning to the balance sheet.

Receivables of $485.1 million, are basically in line with last year, and days sales outstanding decreased by 4 days to 75 days.

Inventories at $273.8 million are $6.1 million lower than a year ago, reflecting our continued focus on supply chain management.

The balance sheet also shows the total debt net of cash decrease by $377.6 million compared to the end of the second quarter 2002.

Our debt to cap ratio improved to 40 percent from 51 percent last year, and our long-term goal remains to reduce our debt to cap ratio to a range of 25 to 30 percent.

Looking forward, as of the third quarter, we are required to adopt a new accounting standard, FASB statement Number 150, accounting for certain financial instruments with characteristics of both liabilities and equity.

This will require us to reclassify, from equity to current liabilities, approximately $108 million related to the warrant* agreement with Lucas.

The liability will be measured at fair market value, with changes in fair market value included in net earnings.

In the third quarter there will be a $17.3 million charge to the income statement, due to the cumulative effect of this accounting change.

More detail regarding this third quarter accounting change will be provided in our second quarter 10-Q.

In closing, we are very pleased with our strong performance year to date.

A number of core brands and new product offerings have performed well up against very tough comps from Star Wars.

Going forward, because of a challenging economic and retail environment, and with approximately two-thirds of our business yet to ship, we have not significantly changed our expectations for the year.

We will continue to be focused on our stated strategies and remain committed to improving profitability and enhancing shareholder value.

With that let me turn it back to Al.

Al?

Thank you, David.

For the next few minutes I'd like to discuss our strategy to grow revenue, followed by an update on the progress of our international business and conclude with an overview of new editions to our management team and Board of Directors.

As we have said, we believe we can grow revenues 3 to 5 percent over time.

There are three distinct areas I will cover that focus on revenue growth.

Core brands, new product introductions, and entertainment properties.

Beginning with core brands.

At the end of the day, the toy business begins and ends with product innovation.

When we talk about revenue growth, the starting point has to be innovation.

It's the basis from which we will grow both shelf space and market share.

We look to grow our core brand toy business in three ways, we enter new categories, new segments, and reinvent our existing product lines each year.

All of these are part of a strategy to not only maintain, but to expand current shelf space.

Let me share with you a couple of examples.

Identifying and expanding our core brands into new categories allows us to complete in additional aisles at retail.

The best example of this is a brand we just started shipping, BTR, or BUILT TO RULE!.

BTR is a new brick construction toy line that uses themes from three of our most well-known brands, and that's play elements especially important to the brick consumer.

With BTR we are bringing our G.I.

JOE, TRANSFORMERS, and TONKA brands to a new audience.

In addition, we added new play elements that brick consumers have never seen before.

Full-size action figures.

We have received tremendous support from our key retail partners, and have excellent space in the construction aisle for the fall.

Another way we grow our core brands is by identifying and entering new product segments.

The Playskool brand is a great example of this.

We have created a whole new segment called Little Big Kids that will ship this fall.

We have three branded product lines within this segment.

Go-Bots, and new this year, Major Powers and Speed Stars.

All targeted to little kids that want big kid play patterns.

These lines have helped us to significantly increase shelf space both domestically, and internationally, for Playskool for the fall.

Lastly, we reinvent our brands each year through new product innovation within our existing space at retail.

Over the past couple of years we developed all new themes for both TRANSFORMERS and G.I.

JOE, keeping these brands fresh and relevant has been key to their success.

The theme for the 3 3/4 inch G.I.

JOE this year is Spy Troops, a line that delivers the first new animation for G.I JOE in a decade.

G.I.

JOE Spy Troops will ship this fall and will include a 44-minute DVD movie.

From TRANSFORMERS, its TRANSFORMERS Armada, which will be backed up with television programming, comic books, advertising and internet related interactive play.

Building upon our strong heritage in board games, we have the most successful single new product in the entire toy and game industry last year with TRIVIAL PURSUIT, 20th Anniversary Edition.

This is another great example of extending an existing brand.

While this positive momentum continues into 2003 and comes to Europe at year end, as they begin to celebrate the 20th anniversary in 2004, we plan to continue to aggressively build the brand by introducing the TRIVIAL PURSUIT DVD, Pop Culture Edition, a new format that melds board game play with DVD enhancement.

Other examples of core brand extensions in the games group include Jenga Extreme, CLUE FX and Twist-a-moves.

Leveraging the Jenga brand, which has almost 70 percent brand awareness, multi generational appeal, and penetration in over 12 million households, Jenga Extreme is sure to further expand the reach and appeal of this brand.

CLUE, which has been in our line for over 50 years and sells well over a million units each year, is ready to go electronic with CLUE FX.

And Twister, a long time favorite, will be adding club-style dancing with Twister moves.

Obviously, we will continue to support all of our toy and game brands with aggressive advertising, promotional and public relations activities that support the company's overall strategy to grow core brands.

Now I'd like to shift gears and talk about how we respond quickly to new trends outside of our core brands.

As we've said so often, we are in the new product business.

This means consistently developing new products and brands that are meeting current trends.

Put another way, it means being where kids are.

A great example of this has been the Tween category.

We have all heard about kids getting older younger.

Our goal has been to keep the interest of young people who might otherwise leave the toy aisle with new innovative product offerings.

In 2003 we have a number of products targeted to this group.

I just want to take a moment and talk about one.

Video Now.

Video Now is a major plank in our Tween centered effort.

It's a personal disk based video player for young people that's positioned to sell for under $50 at retail.

We expect to launch with 24 titles from top-rated TV shows and have approximately 70 titles available for this holiday season.

Each disk will have 30 minutes of play time and will retail for approximately $7.99 each.

We have programming from Nickelodeon*, and American Idol, among others.

This product will be on store shelves this fall and it will be aggressively promoted by one of the most popular teens today, Hilary Duff.

Another product that's part of our hot trend, is Beyblade.

Our battling tops.

A product line we launched in just 90 days.

As David mentioned, it has become an important contributor to our first-half performance both domestically and internationally.

We will keep the momentum going with Beyblade Arcade Challenge and the BeyBlade remote control top.

FurReal Friends is another excellent example of new product innovation.

Last year we had great success with both the cat and the kittens, which continue to do well.

This year we have extended the brand and enhanced the technology with our new release, Go-go, My Walking Pup.

Early test-market results have been outstanding.

Innovation also keeps our games portfolio vibrant and relevant, enabling us to appeal to a greater number of consumers each and every year.

In 2003 we're implementing a number of new initiatives including Battle Ball, Bullseye Ball, and Elefun.

Elefun is a solid of example of innovation driving greater value for everyone, consumers, the trade, and Hasbro.

We have re-engineered the original game play design to make it much more appealing.

In addition, this redesign enabled us to put the game in a modular box and reduce the price.

It's already our number-one selling new offering for the preschool game market.

Our strategy also involves entertainment properties.

As we have said, we will not be dependent on hot movies but we need to be where kids are and the economics of the deal have to be right.

Recent examples of successful movie properties include Star Wars, Monsters, Inc., and Finding Nemo.

Coming later this year from Disney are Brother Bear and the platinum release of Lion King.

As you know, major movie entertainment properties will always be a part of our mix.

This year, in keeping with our longer term strategy, we expect major movie entertainment properties to represent less than 10 percent of revenue.

Now let me talk a bit about the International segment.

As most of you know, it has been a key area of focus.

Throughout the first half we have seen strong performance from our core brands, specifically Play Doh, TRANSFORMERS, MY LITTLE PONY and Magic: The Gathering, as well as from new product introductions such as Beyblade and FurReal Friends.

Additionally, expenses are down in local currency, a key part of our effort to return the business to historic profitability levels.

We believe we are making significant progress growing core brands, improving our market share, and delivering a solid bottom line.

Overall, I'm pleased with our accomplishments to date and believe we are well positioned for a much improved year in this very important segment.

Lastly, we had a couple of announcements in recent weeks regarding our Board and Senior Management.

Frank Bifulco, has joined us as President of U.S.* Games, managing our Milton Bradley and Parker Brother business.

He reports to Dave Wilson, who has responsibility for the U.S.

Games segment which also includes Wizards of the Coast.

We were also very pleased to announce the appointment of Jack Greenberg, who was Chairman and CEO of McDonald's Corporation, to the Hasbro Board of* Directors.

Jack brings a wealth of knowledge and experience with public companies in consumer markets and will make a great addition to our Board.

These are important additions as we remain focused on strengthening and diversifying both our management team and Board of Directors.

In closing, our second quarter and first half performance demonstrates that we are creating value for our shareholders.

We experienced good growth in many of our core brands, as well as, in new product introductions.

Through innovation, we are creating and entering new categories and segments in both toys and games.

We believe we are well positioned for the all important second half of the year.

All of this increases our confidence in Hasbro's ability to deliver on its plan for the year.

Although I would agree with David, with what David said a moment earlier, thus far it's been a challenging retail environment, and we have a lot of product yet to ship.

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

Thank you.

Thank you.

At this time we are ready to begin the question and answer session.

If you would like to ask a question please press star followed by 1 on your touchtone phone.

You will be announced by name prior to asking your question.

To withdraw your question, please press star 2.

Once again, If you do wish to ask a question, press star, followed by 1.

Your first comes from Tony Gikas.

State your company name.

U.S.

Bancorp ,Piper Jaffrey.

Good morning, guys.

Good morning, Tony.

A couple of questions for you.

Could you just discuss a little bit about what categories, including some of the new ones you're talking about, in the second half of this year could have the most favorable impact to margins looking forward.

Second, could you comment a little bit on the possible changes to shelf space in the second half of this year compared to the prior year?

Is it up five feet or ten feet, or, you know, maybe you could state it in terms of a percentage change.

And then, you know, one of your key competitors has talked about a very difficult retail environment.

Would you characterize it as, you know, difficult and challenging or *extremely difficult at this juncture?

Tony, I'm going to let David talk about margins for the second half, and then I will pick up there with the last two.

David?

Yeah, Tony, I think the question was which new lines or categories as we come into the second half would help margins.

The answer is all of them are designed to be obviously fairly profitable for us and have pretty good margins.

BUILD TO RULE!, which we really just started to ship, is where we're going into a new category.

Good margins there.

In Playskool, we're going into Little Big Kids, with Major Powers, Speed Stars, and Go-Bots in the margins are all pretty good there.

And in the Tween area, it's Video Now.

The margin isn't so great on the video player, we're hitting a very sharp price point with that.

But the software we certainly make a good margin on.

And assuming we can have a ratio of about 3:1, in terms of software to hardware sales, that will be a good margin business for us.

So, you know, there are three of the major new categories we're going into next year and I think the margins on them all are pretty good.

Tony, in regards to shelf space, I don't have a specific number that I would want to discuss, you know, here on the conference call.

I can tell you, though, that we're getting significant increases in shelf space in particular with our preschool brand, Playskool.

All of the space we're getting in the construction aisle through BTR is obviously new.

Our boys shelf space has held up because even though we expected some to come down because of this Star Wars movie, BeyBlades has replaced that as well as the strength in TRANSFORMERS.

So overall we're seeing significant increases in shelf space, not only domestically, but internationally.

In terms of the retail environment, I think the retail environment in the U.S. has been more difficult than it has in Europe.

As to say is it challenging or extremely challenging, that's, I guess, sort of in the eye of the beholder.

I think the comment that we're trying to make, as well as some of our competitors, is that it has been a challenging retail environment, and the question is what will it be like the second -- during the second half of the year.

Certainly if the economy picks up and the consumer feels good and they're in the store, that's going to make life a lot easier.

On the other hand, if it remains what it was in the fourth quarter of 2002, it's going to be extremely challenging.

I think we're seeing some positive signs, but time will tell.

Okay.

Thanks and great job.

Thank you.

Thank you.

Your next question comes from Sean McGowan, and please state your company name.

Hi.

From Harris Nesbit Gerard.

New name there.

I had a couple of questions as well.

Most of them quickies.

How much longer would you expect that the Pokemon comparison will actually have an impact on the games business?

Number two, David, what would you estimate international profits would have been excluding currency?

You said it had a negative impact.

Would you quantify?

Three, a general question, David.

The distribution expense in the SD&A line, is that a number that's about 4 or 5 percent?

If I remember correctly in the past, that's about what it was.

At some point I think you will explain this FASB 150 and what it all means.

Right?

Thank you.

Sean, good morning.

I'll take the first question on Pokemon, then--*I'll obviously let David handle the rest.

The Pokemon comparison should end this year, in particular because we will not be going forward with the Pokemon trading cards next year, and the Pokemon business this year is not all that significant.

So I would not think it would be an issue to be raised in future meetings.

Will it be in the third and fourth quarter?

Not significant.

Regarding FX, International lost about $4 million or $5 million in the second quarter.

So if you say there was a -- kind of a 20-percent translation impact on there, it would only be about a million dollars.

So it's not that it was a big negative.

The important thing is it was negative, whereas the impact on revenues was a very positive.

So important point, but it was negative, although only by about a million dollars.

And with regard to distribution and warehousing expenses, we're probably in a range of 5 to 6 percent between warehousing and shipping to the customer within our* SD&A.

Thank you.

Thank you.

Your next question comes from Felicia Kantor and please state your company name.

Morning, guys.

Lehman Brothers.

Just a couple of questions.

First, on the gross margins, I realize Star Wars had an impact versus last year, but they were still lower than we were expecting and we did try to adjust for that tough comparison.

I was just a little bit surprised to see that they were only, if you look at more normalized, year second quarter '01, that they were only 20 basis points higher than that.

So I'm just wondering how we should look at kind of an ex-Star Wars gross margin and maybe there were other things affecting that number.

Also, you guys are talking about increasing shelf space.

Mattel* is launching aggressive product roll outs.

I'm wondering, at whose expense are all these initiatives coming from?

That's it.

This is David.

I'll take the gross margin question.

I think coming into the year we told people that our gross margins would be down, because Star Wars did have a very high gross margin, but then you kind of gave it back in terms of high royalties and high amortization.

We're not at all surprised by the 60 that it came into.

I think if you go back and you look at prior years, prior to the non-Star Wars movie years, that's fairly consistent.

The cost savings that we've been taking, if you would recall, have largely been in SD&A over the last two years.

That's where we took 100 million out and are taking a second 100 million out.

I think with regard to cost savings within gross margin, we closed a lot of factories and moved production off-shore, back in kind of '97, '98, '99, and that's when we got some significant improvement in costs in the gross margin line.

So would it be fair for just modeling purposes, and I know you don't give guidance, but if we wanted to look at prior years, Xing out '02, then we shouldn't really expect to see significant increases over those years?

Well, I haven't got the specific numbers in front of me, but I would say absent any exceptional charges that have been in there, '03 should be much more like '01 than, obviously, '02.

Okay.

Good morning, Felicia.

This is Al.

In terms of your question at whose expense is shelf space increases coming from, I really can't comment about any other company, only our own.

We are increasing shelf space significantly, and I guess, unless the retailer adds more toy space to the aisle, it has to come from competition.

Okay.

I was hoping for more, but thanks.

Thank you.

Your next question comes from Margaret Whitfield and please state company name.

Brean Murray.

Good morning.

Good morning.

I was wondering if you could comment on the charge to the U.S.

Toys segment in terms of what lines exactly were included in that charge?

Also, what time frame do you think you might achieve the targeted debt level, and you've mentioned a lot of new products, but Thintronix*, I've seen it at retail.

I wondered if you'd comment on the- you know, how it's going at this very early stage?

Thank you.

Okay.

With regard to the $7 million, it was to some extent in terms of obsolescence in terms of some movie writers and some admin charges, and they were primarily related to getting out of some product lines, not major ones, but some primarily in the RC area, which is not a big area for us, and in the outdoor product area.

Again, not a major area for us.

Okay.

So without giving specific products, that's where they were.

In terms of debt to cap, if you look at our net debt, it's reduced significantly.

On a net debt basis, we could be sort of, if our cash generation keeps going like it is, we could virtually have no net debt in early '05.

But we do have long-term bonds, and none of them are callable, which means that we would be going out and perhaps buying on the open market.

So it obviously depends what kind of price we can get on that and whether they're economic to bring them in.

I think we could probably reach our debt to cap target again either by late '04, early '05.

Okay.

Margaret, as it relates to Thintronix, you probably saw it in the New York market, because we went to a test market in the spring, in New York.

And as a result of that test market we learned a lot of things.

We've stepped back, we've changed the packaging, merchandising, the advertising, and the pricing as well.

We're going to go back into test in the next week or two and if things work out well, then we'll do a National roll-out, and if not we won't go forward with the product.

This is something we've done in the past.

We think it's a smart way of managing -- taking some of the risk out of new product introductions, but also demonstrates our ability to be flexible when we market-test something and find out that it's not working correctly the first time we can go back and make some changes.

So we'll see what happens as we get into the third and fourth quarter.

As a follow up, this morning Mattel announced a buy back.

I wondered now if you could you comment on your thoughts on the appropriate use of strength in balance sheet once those debt levels are achieved, in terms of dividends, buy-backs, M & A activity?

As you know, our first call for cash has been to reduce debt.

Once we get to our targeted levels, I'm sure the Board will give due consideration to all the potential uses of cash and we'll keep you posted.

Okay.

Thank you.

Thank you.

Your next question comes from David Lebovitz and please state your company name.

Burnham Securities and congratulations.

Thank you, David.

The brand line extensions, CLUE* FX, Jenga Extreme, et cetera, are they going to cannibalize the sell of the core product?

We don't believe so.

It certainly has not happened when we've done that in other areas.

When we've introduced different versions of Monopoly, it has grown the entire Monopoly brand.

So, we don't think so.

Okay.

And in response to your answer-- to the last question about Thintronix, if you do not go forward with the line after the retest, what is the magnitude of the dollar write-off you would have to take?

I don't know offhand, but it's not significant--.

That's the major word, is significant.

Lastly, the retailing fraternity is once again under consolidation, and there seems to be questions, how large the toy effort will be at certain formally large retailers at this holiday selling season.

Do you have any read on that and what it might imply for you?

I'm not quite sure I understand your question.

You know, to my knowledge, [the] key retailers are going to be enthusiastically supporting toys, as they have been the last couple of years.

Unless you know something I don't know --

Well, they're carrying fewer SKU's.

That is public knowledge.

That's been something that has been going on for a number of years, and certainly we've been trying to focus on fewer stock keeping units and trying to get more value out of each and every SKU that we ship.

I have not seen any significant decline in shelf space from our major retailers.

In fact, I've actually seen it going up as I go, you know, throughout the United States and parts of Europe.

Last question about the international and the loss that you sustained in the quarter.

The turnaround in Europe seems to be a bit long in coming.

Are you on trend line, or are you still behind trend line in terms of where you would like Europe to be?

I think Europe has made a lot of progress this year.

In terms of the degree of progress, I think we're about where we expected it to be.

In terms of where we want Europe to finally be from a profit standpoint and market share standpoint, we have a long ways to go yet.

One thing I'd add*, David.

I mean, our European business is very rear-end loaded.

It ships a half portion in the second half, [than] even when we do domestically.

In addition, because you don't have economies of scale, because you're dealing in so many different geographies, with an infrastructure in each geography, your fixed costs tend to be a bit higher, which means during the early part of the year when you are shipping less, your cost base is really not fully covered.

So, we have always lost money during the first two quarters of the year in International, and I think, as you can see, we’re* substantially reduce for losses in the second quarter of this year, down from 17 to about 5.

So good improvement I think.

fine.

Thank you very much.

Thank you.

Your next question comes from Thomas Russo and please stated your company name.

Hi.

Good morning.

Gardner Russo Gardner.

Thomas Russo.

Good morning.

Let's see, the question about the new hires.

Could you describe Frank's relationship with David and then the relationship between Milton Bradley and Parker Brothers and the person or people now running Wizard.

That's the first question, how that group will organize?

And then what will be Frank's early marching orders at that important part of your business?

And then the third point will be whether that business sees any signs of weakened margin?

Sorry for that background noise.

Weakened margins in the games business that might have led to this personnel change?

Let me start with the last question.

Yeah.

The hiring of Frank Bifulco is not a result of any dissatisfaction with what's going on in our game business or with Dave Wilson.

Dave is 66 years old, and we need to make sure has we have good young people in all facets of our business.

So that's the reason for the hire.

Frank's relationship with Dave is excellent.

He was started about two or three weeks ago, comes from Timberland, and we're excited about his joining the business.

The Milton Bradley and Parker Brothers business is one games unit.

It is based in East Longmeadow, just outside of Springfield.

And Frank will have responsibility for that unit.

Chuck Hubner has responsibility for the Wizards of the Coast unit out in Seattle.

Both of those people report directly in to Dave Wilson.

In terms of margins, again, we have not seen any deterioration in our games margin.

Again, the reason for hiring Frank was succession planning, not any dissatisfaction at all with the business.

Oh.

Thank you, Al.

Al, the other question, on the International side, you did mention certain basic [inaudible] the launch* of some new products, but talk for a second about steps to structurally -- if there are any steps to structurally reorganize the way you go to business in the International market, really coming off of David's comment, about the infrastructure burden that exists across so many different markets within Hasbro.

So, any structural changes envisioned for International looking forward?

We've made a lot of structural changes during the last couple of years.

In fact, when David talks about the cost reductions efforts, part of that has been to regionalize Europe, where we were dealing in somewhere between 17 and 20 countries, now we have three regions.

We had shared service centers in Europe.

And as we get deeper and deeper into our SAP environment, we will be able to continue to work in that area.

So, I don't see any major structural changes today since those were made, but we continue to tweak it as the business conditions warrant.

Thank you.

Good numbers.

Thanks a lot.

Thank you, Tom.

Yeah.

Thank you.

Your next questions comes from Dean Gianoukos, and please state your company name.

Just a couple of questions.

First, can you talk about the unprofitable product lines that you wrote off?

And secondly, can you give us a sense of on the momentum of Beyblades and FurReal Friends?

Is the growth *still accelerating or is it slowing down at all?

And can you compare the U.S. versus International?

Thanks a lot.

David, do you want to talk about the profit lines?

Yeah, I really have not got much to add from what I just said.

We're doing $2.8 plus billion of revenues, and we have hundreds and thousands of SKU's, and not all of them work.

Occasionally you take some unprofitable ones and you say, okay, let's write them off.

Sometimes that means writing off inventory that you have, it means writing off maybe royalty commitments or writing off development work that you've done.

So these are not big lines.

We just -- some of them in the RC area, which isn't a strength for Hasbro, and some of them are in the outdoor product areas.

Really that's kind of all I can say.

Dean, in terms of the momentum behind both Beyblades and FurReal, you have to look at it by country*.

Some countries we just started shipping Beyblades a few months ago, so there the momentum is clearly building and it's on an uptick.

On the other hand, if you look at a country like the U.K., which was shipping Beyblade in the fourth quarter of '02, it's leveled off.

Certainly we have not seen a decline, but it's leveled off.

It depends upon when we have new SKU's coming into the line.

We bring new SKU's into the line and you get an uptick.

FurReal, the business is nice and steady.

We would expect an uptick when we start shipping this year's new product, Go-Go, My Walking Pup, which is a fourth quarter item.

Okay.

Thanks.

Thank you.

Your next question comes from Brett Jordan and please state your company name.

Advest.

A couple have been asked.

But just a couple of follow ups.

One on the shelf space, as you enter the BTR product, is that a category that is growing enough that this is expansion of retail space, or is it likely being displacing existing product on the shelf.

Secondly, on the marketing spin, clearly a large competitors of yours plans to advertise fairly aggressively on the second half of this year, and with a lot of new products coming out for yourselves, do you see any material *strategic* change in your marketing and advertising expenditure in the second half?

Okay.

In terms of the shelf space in the construction aisle, my guess would be we're probably replacing.

I don't know that the overall amount of shelf space dedicated to construction is increasing.

Certainly it is for us, but my guess is we're replacing.

In terms of advertising and promotion, we said early on that we were going to be very aggressive in the marketplace, both domestically and internationally, and we will be.

So I don't think we're going to be playing second fiddle to anyone during the second half of the year.

Thank you.

Your next question comes from Joe Yurman, and please state your company name.

Bear Stearns.

Nice job guys.

Thank you.

Two questions.

I guess both for David.

David, if you could give us any update on action at the rating agencies during the quarter and particularly what you think those guys may be looking for, for an upgrade?

And what you think you need to do operationally to show them that they should give you back some operational control over deploying capital in some value-enhancing ways.

And as far as HPG, I don't necessarily expect you to break out the contribution this quarter, but just curious if you have internal audit benchmarks such that, when the profitability of the business becomes meaningful enough, you'll have to break it out?

Thank you.

Firstly, regarding the rating agencies, we have not been down and seen them during the last quarter.

We do believe that certainly the way we're going, we may be overdue now in terms of having the negative outlook taken off by two of the three that follow us.

Clearly by the end of the year, we look at some of our ratios, and we could see us getting back to an investment grade rating.

We will probably be going back to them sometime during the second half of this year and meeting with them and giving them an update on the business.

Regarding to the operational issues with the banks.

Really some of the restrictions on us at the moment, in terms of not being able to do acquisitions or not necessarily increasing the dividends significantly, those really aren't hindering our business in any way at the moment.

We're really not out looking for acquisitions, we're not looking to [buy our] stock buyback.

Obviously, we'd like to get them released as soon as possible, but I certainly don't think that any operational restrictions by the banks are in any way hurting our business.

And I also think that given our performance over the last two years, if we found something was problematic, we would go back to them and probably negotiate whatever we needed to with them.

Finally, with HPG, we really haven't, you're right, split that business out, and until we really meet the threshold requirements under the SEC segment reporting, then we probably won't do.

Thank you.

Your next question comes from Jill Krutick, and please state your company name.

Thanks very much.

Good morning from Smith Barney.

On the SD& A line you had a nice strong 120-base-point improvement there this quarter.

Should we anticipate that to accelerate as your sales volumes continue to increase in the second half of the year?

That's question one.

And secondly, on the operating margin, I know you guys have been targeting about 10 or 11 percent getting back to sort of historical levels.

Looking beyond that now, what do you think is the potential from the operating margin from a longer term basis?

Thank you.

David, you want to take the first one?

Yeah.

First SD&A, the answer is clearly yes, we do look to our SD&A to be reducing year over year.

That's a function of two things.

Firstly, most of the second hundred million of cost savings that we're talking about taking out are on the SD&A line.

If you will recall, we talked about the second hundred million having taken 50 million through last year and that being an incremental 30 million this year, plus we wouldn't have as many one-time charges.

So, yes, we are expecting it to come down, but as expenses are coming down, and in addition, as you can see, our revenues certainly aren't coming down thus far, and we don't expect they will for the year.

So, in other words, you anticipate it to accelerate in terms of its year-over-year improvement in the second half versus the second quarter?

The rate of improvement.

In other words, 120 basis point improvement, in the second quarter we should be looking for an acceleration of that relative improvement.

Our full year, year on year, improvement would probably exceed what we experienced in the first half.

Thank you.

Jill, with regards to operating margins, we have a stated goal to achieve the 10 percent operating margin for '03.

We've also stated we want to get to 12 or a bit better by '05.

Longer term, we think we can do -- we need to do better than that, and we need to do significantly better than the 12.

I'm not going to forecast a specific number, but we need to have operating margins above 12.

Thank you.

And your final question comes from Sean McGowan, and please state your company name.

Hi.

Silly little question.

Have not heard much about Nemo.

Could you talk about the sales of Nemo relative to Monsters, Inc. and what we can look forward to in the balance of the year?

The movies been great, and the sales are about at, maybe a little bit better than our expectation.

We're not going to give you a specific number, but the movie has been great and we're pleased with the way the product is moving in the marketplace.

In terms of relative to Monsters, I don't know.

I haven't done any comparison.

Probably be not quite as strong as Monsters.

Nemo has not really broken in a lot of International markets.

Thank you.

Thank you and have a good day.

Thank you.

This does conclude today's conference call.

We thank you for your participation.