孩之寶 (HAS) 2004 Q3 法說會逐字稿

Good morning and welcome to Hasbro's third quarter earnings conference call.

At this time, I would like to inform all callers that you are on a listen-only mode until we open for questions and answers.

This call is also being recorded.

And with us today from the Company is the Senior Vice President of Investor Relations, Karen Warren.

And thank you, ma'am, you may begin.

Thank you, Kathy, 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.

To better understand our third quarter results, it would be helpful to have the press release and financial tables available that we issued earlier today.

The press release includes information regarding non-GAAP financial measures discussed on today's call.

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

On the call this morning, you'll hear opening remarks from Al, and a review of the financial results by David who will then open the call to your questions.

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

These forward-looking statements include expectations concerning earnings, operating margins, revenues and the retail environment.

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

Some of those factors are set forth in our annual report on Form 10-K including under the heading, "forward-looking information and risk factors that may affect future results."

And our quarterly reports on Form 10-Q, including under the heading, "forward-looking statements and factors that may affect future results."

And our 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.

We undertake 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 call.

Now I would like to introduce Al Verrecchia.

Al?

Thank you, Karen, and good morning, everyone.

As we have stated previously, our goal this year has been to grow both revenue and earnings.

In that context, we view our third quarter top-line performance as disappointing.

On the other hand, it's important to look at our performance in the context of last year.

You may remember we had revenue growth of 18% in the third quarter of last year, compared to 2002, with a significant amount of that growth coming from BEYBLADE.

With the difficult year-over-year comparisons, the challenging retail environment and the continued softness in our boy's business, it was clearly more difficult to grow revenue than anticipated.

Although we significantly closed the gap from the second quarter.

Absent the $65.3 million decline in BEYBLADE, revenue would have increased by 41.5 million or 4.7% for the quarter.

A good indication that much of the underlying business continues to do well.

I'm pleased with our earnings performance, as well as our efforts to manage expenses and focus on profitability.

As we look out at the remainder of the year, we continue to believe we will grow earnings in 2004 and achieve our goal of delivering an operating margin of 12% or better in 2005.

However, given our year-to-date top-line performance and the uncertain retail environment, it has become increasingly unlikely that we will achieve our goal of revenue growth for 2004.

Part of what makes it risky to forecast the top line is the increasing concentration of our business with mass-market accounts.

This change in retail mix has made our business even more weighted to the back half in fourth quarter.

These accounts tend to take a higher percentage of the full-year volume in the fourth quarter.

For example, last year Wal-Mart and Target on a combined basis, took over 40% of their full-year volume in the 4th quarter, while the pure play toy outlets tend to phase their business more evenly during the year, taking between 30 to 35% of their full-year volume in the 4th quarter.

As you know, there continues to be uncertainty with regard to the final outcome of the Toys "R" Us strategic review.

Although there is much public speculation that they will be closing stores sometime next year.

What impact, if any, this has on the fourth quarter remains to be seen.

In addition, KayBee has yet to clarify their go-forward plan.

Also making our business more weighted to the back half is the reluctance of many of our key retailers to take in inventory, as they remain cautious in consumer spending and the outlook for the holiday season.

Recently, several U.S. retailers reported comp-store increases at the lower end of expectations, with toys not being one of the stronger categories.

I believe this is in part attributable to higher gasoline and home heating oil prices and modest wage growth.

In a recent "Wall Street Journal" interview, Lee Scott, CEO of Wal-Mart stated that if 100 million customers, Wal-Mart's weekly customer count, are spending an extra $10 a week on gas, that's $1 billion in revenue that no longer exists.

Clearly, this has to impact consumer spending during the holiday season.

Contrary to this perspective, there is retail data that is more optimistic about the upcoming holiday season.

The National Retail Federation reported last month that they expect holiday sales to increase 4.5 this year.

Given the current variables, it's simply too early to know what the consumer will do.

We tend to be in the camp at the holiday season will be okay, but not a record breaker.

For us, year-over-year we have seen improvement in POS and a number of categories, which is reflective of good merchandise flow and consumer support of our products.

I believe we are delivering innovation to the market and we have seen strength in many of our new introductions, including LAZER TAG, VIDEONOW COLOR, LUV CUBS FurReal Friends, and WEEBLES.

Over the weekend Playskool launched VIDEONOW JR. with the Wiggles in Times Square.

Like VIDEONOW COLOR, the strength of VIDEONOW JR. is in our content partners.

We have the very best programs for Nick Jr. including Dora the Explorer, Blues Clues, plus other popular programming from HIT Entertainment and Sesame Workshop, making VIDEONOW JR. a great gift for the holidays.

MY LITTLE PONY continues to be a strong performer around the globe, building on last year's relaunch.

In the boy's area, Star Wars has been a solid contributor all year, in the trilogy DVD release in September added to the momentum, which we expect will continue next year with the release of the final Star Wars movie in May.

During the 3rd quarter, we had very successful launches of TV MISSION: PAINTBALL, a new plug-and-play game and the latest from TRIVIAL PURSUIT, the '90s.

This strong global brand has continued to draw a growth across both our domestic and international businesses.

In the U.S., we just began shipping TRIVIAL PURSUIT Saturday Night Live, and internationally we've had a great year thus far with our TRIVIAL PURSUIT 20th Anniversary Addition.

In closing, as I said at the beginning of the call, given our results year-to-date and the challenging retail environment, it's increasingly unlikely we will achieve our goal of revenue growth this year.

However, we plan to be aggressive in our advertising and in-store promotional programs, driving more consumers to our brands during the all important holiday season.

And we continue to believe we will grow earnings this year, and achieve our goal of operating margins of 12% or better by 2005.

With that, let me turn the call over to David.

David?

Thank you, Al, and good morning, everyone.

Given the decline in revenue, we are pleased with the profitability we have achieved for the quarter and year-to-date, which reflects the positive impact of our expense reduction initiatives.

Over last 3 years, we have delivered on our commitment to take 200 million of expense out of the business, and we've established a culture which is focused on profitability.

Reflecting this, SD&A expenses are down 10% for the quarter and 6.5% year-to-date.

In addition, we continue to be focused on generating cash from paying down debt.

Which has resulted in our interest expense being down 34% for the quarter and 38% year-to-date.

This has also strengthened the balance sheet by reducing debt net of cash by 462.3 million during the last 12 months.

Now, let's take a look at our third quarter results.

Worldwide net revenues were $947.3 million compared to $971.1 million last year.

These results include a 17 million positive impact from foreign exchange, and a 6.7 million decline in revenue related to the closing of the WIZARDS OF THE COAST retail stores.

As Al mentioned, we had tough year-over-year comparisons, in the third quarter of 2003, we grew revenue 18% compared to 2002, driven by a strong performance from BEYBLADE.

The performance of our 3 major segments, U.S.

Toys, Games and International was mixed.

In the U.S. choice segment, revenues were 369.7 million.

A decrease of 2% compared with revenues of 377.3 million last year.

We had solid performance from a number of our core brands, including MY LITTLE PONY, LITE-BRITE and NERF, supported by strength from new-product launches, including VIDEONOW COLOR, LAZER TAG, and BOOHBAH.

However, this growth was offset by weakness in the boy's business including a decline of 30.4 million from BEYBLADE.

U.S. toys had an operating profit of 20.8 million compared to 45.8 million last year, reflecting lower sales as well as a decline in gross margin and higher advertising expenses.

The gross margin decline in part reflects significant shipments of VIDEO NOW COLOR hardware.

As previously noted, there was a relatively low gross margin on the hardware, but a very good gross margin on the software, which will ship in more significant quantities in the fourth quarter.

In addition, we had a higher proportion of shipments made on a direct import basis.

These shipments have a lower gross margin but also have lower expenses.

In the Game segment, revenues were 236.5 million.

A decrease of 5% compared with revenues of 250.2 million last year.

Primarily related to a decline in trading card games, due in part to one less release of the Magic: The Gathering this year.

Partially offsetting this was significant growth in the electronic adult games and preschool categories driven by Elefun, the TRIVIAL PURSUIT and of the new product launches of Whac-a-Mole and PAINTBALL.

Operating profit in the Game segment was 46.4 million compared to an operating profit of 58.3 million last year.

This reflects a decline in trading card games volume, as well as a reduction in licensing income related to a game plan patent.

International segment revenues were 331.6 million.

Compared with revenues of 328.1 million in the prior year.

This represents an increase of 1% in U.S. dollars and a decrease of 4.3% in local currency.

We had strong performances from a number of core brands, including MY LITTLE PONY, PLAYSKOOL and the Dual Masters trading card game.

Offsetting this was a decline in BEYBLADE, which was down approximately 34.9 million compared to a year ago.

International segment operating profit was 48.8 million for the quarter, compared to an operating profit of 38.5 million last year.

Turning now to consolidated earnings.

For the quarter we reported earnings of 88.7 million or 45 cents per diluted share.

This compares to earnings of 85.8 million or 48 cents per diluted share a year ago, prior to an accounting change.

I also want to remind you that diluted earnings per share we are reporting differs from the amount you get when you calculate EPS using the net income and share count from today's press release.

Accounting rules require that we calculate diluted earnings per share 2 different ways: Treating the Lucas warrant as a liability, and treating the warrant as equity.

When you use the liability method, the favorable mark to market of 5.2 million from the warrants is included in the net income number and the share count excludes the impact of the warrants.

This gives the diluted earnings per share of 50 cents for the quarter.

When you use the equity method, the mark to market is excluded from net income and the share count is increased to reflect the warrants being converted to stock.

This gives a diluted earnings per share of 45 cents for the quarter.

Accounting rules require us to report the more diluted earnings per share amount, which is why we reported diluted earnings per share of 45 cents.

This calculation is something that unfortunately is not easy to model.

The reason being, that it changes every quarter due to factors such as changes in our stock price and interest rates.

We will be including a table in our 10-Q that details the computation of diluted earnings per share.

Earnings before interest, taxes, depreciation and amortization were $168.6 million.

Compared to EBITDA of 170.3 million last year.

Moving on to margins, gross margin was 55.3% compared to 56.8% last year.

This primarily reflects the margin changes in the Toy group which have already discussed.

Now, let's take a look at expenses for the quarter.

Research and product development expenditures were 39.3 million compared to 38.8 million last year.

Royalty expenses were down 21% to 65.1 million compared to 82.5 million last year, primarily due to BEYBLADE.

Advertising expense was 129.4 million.

Or 13.7% of revenue for the quarter, compared to 105 million or 10.8% of revenue last year.

This is consistent with the strategies we shared with you where advertising would increase as we continue to invest in both our core brands and new product introductions.

Selling, distribution and administration expense at 151.2 million was down 10.3% or 17.3 million as we continue to execute on our expense reduction initiatives.

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

Absent the impact of the foreign exchange rates, SD&A would have been down 20.6 million or 12.2%.

As I mentioned at the beginning of the call, interest expense was down significantly to 8.3 million, reflecting the paydown and repurchase of 215.9 million principal amount of long-term debt during the last 12 months, including 20 million in the third quarter.

The tax rate for the third quarter was 25.7 million reflecting the fact that income from the adjustment of the Lucas warrants is not tax effected.

The tax rate without Lucas adjustment would have been approximately 27%.

This is a decrease of 1 percentage point from the 28% assumption previously used in the first 2 quarters.

The decrease is attributable to a shift in projected operating profits to lower tax jurisdictions.

This might be a good time to mention the Homeland Investment Act, which is part of the American Jobs Act of 2004 that was passed by Congress last week.

Obviously, we are pleased with the passage of this legislation, while I believe it is yet to be signed by the President.

We will be studying the various provisions of the Act, including the incentive to reinvest international earnings in the United States.

As we have said, a large amount of our cash is overseas and this legislation could potentially impact our ability to bring cash back to the United States at a favorable tax rate.

I know the next question you're going to ask, if you bring the cash back, what are you going to do with it?

I can't give you a definitive answer at this time.

As I said, we will be reviewing the Act to try to understand what the permissible uses are under the Act.

Additionally, what we do with our cash is ultimately a decision for our Board of Directors.

Now, turning to the balance sheet.

Receivables were 697.4 million, down 182.3 million compared to 879.7 million last year.

Day sales outstanding reduced by 16 days to 66 days.

Absent our securitization program, receivables would have been 825.7 million and DSO's would have been 78 days.

This compares to 82 days last year, an improvement of 4 days.

Inventories increased by 27.7 million from a year ago to 317.1 million.

Reflecting higher anticipated shipments in the latter part of the year.

As I mentioned, the balance sheet also shows total debt net of cash of 345 million.

A decrease of 462.3 million compared to a year ago.

This is a result of both our strategy to deleverage, as well as strong cash-generating ability of the underlying business.

Our debt-to-cap ratio declined 30% compared to 43% last year.

Our long-term goal remains to maintain our debt-to-cap ratio within a 25 to 30% range.

In closing, given the uncertain retail environment, it has become increasingly unlikely that we will achieve our goal of revenue growth this year.

That said, we have a strong product lineup, and given where we are year-to-date we continue to believe we are on track to improve operating margins and earnings this year.

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

(Operator Instructions).

Our first question comes from Jill Krutick.

Your line is open, please state your company name.

Thanks very much, good morning.

Smith Barney.

I was wondering if you could give us a sense of what kind of point of sale activity you're seeing across your key brands, where your inventory levels stand at retail?

And it seems like you have many more launches of new products coming this year compared to last year, which at least raises our confidence that you'll see higher revenue growth in the fourth quarter versus last year.

Is that a fair assumption?

Thank you.

Good morning, Jill, Al Verrecchia.

How are you doing?

Good thanks, Al.

You're correct, we have many more new product launches this year than last year, and thus far, the launches are, as I said in the conference call, are performing well.

VIDEONOW COLOR, LUV CUBS from FurReal, WEEBLES, the PAINTBALL game from Milton Bradley, as well as the TRIVIAL PURSUIT games, they are all doing very well.

Our concern about the fourth quarter is just the overall sluggishness at retail, as well as the increased price for both home heating oil and gasoline and the impact it's going to have on consumer spending there in the fourth quarter.

That's not to say we'll be unable to grow revenues, but it's become increasingly unlikely given the performance at retail that we've had through the first 9 months and the cautiousness that we and the retailers have for the fourth quarter.

In terms of our inventory levels, I don't think there's any substantial difference in our inventory level this year compared to last year at retail.

Flatish, you're saying.

About.

Excuse me?

Yes.

Okay.

And point of sale?

Point of sale has been good.

As I said, the recent launches we've had, initial response has been very good.

We've had a softness in the boy's business, both internationally and domestically.

Action Man, GI Joe and Transformers have performed below expectations at retail.

On the other hand, Star Wars has done better than expectations.

Our core brands year-to-date are down about 4.5% for the year, and that's reflective of what's going on at retail.

Although MY LITTLE PONY, NERF, Super Soaker, KUN [ph] are up, whereas the boys business has been down.

The core brands have done well, better internationally than they have domestically, so it's a bit of a mixed bag.

Okay.

Thank you.

Thank you.

Our next question comes from Tony Gikas.

Your line is open, please state your company name.

Piper Jaffrey.

Good morning, guys.

A couple questions for you, you indicated that it's unlikely you'll reach your revenue goals for the year.

Could you just maybe elaborate on that a little bit?

Will we still see an increase in sales this year, or is it possible we could see a relatively flat or down number?

And then second, I know it's pretty early to tell, but could you give us a little early view on the rollout of the Star Wars product sales?

How big could that be in general?

And the product shipments, are they weighted towards the March or June quarter of next year.

Good morning, Tony, it's Al Verrecchia.

In terms of our revenue goals, we had had a goal to grow revenues this year.

As I said earlier, it's becoming increasingly unlikely that we'll be able to do that.

So I'm not going to get into a forecast, but I think clearly you can read from that that it's more likely to be flat to down than it is to be flat to up.

And that's based upon the conservatism we're seeing at retail, and the impact I think of both fuel oil and gasoline prices on consumer spending.

In terms of the rollout of the Star Wars line, Star Wars has done very well for us this year, and they've got a nice boost from the DVD release of the Trilogy.

It's performing above expectations.

We'll probably ship a little bit of the new product, but most of that will ship at the -- towards the end of the first quarter, and the second quarter of '05.

Okay.

Thanks.

Thank you.

Our next question comes from Sean McGowan.

Your line is open, please state your company name.

Good morning, thank you.

I was wondering you could talk about what you're seeing at retail, regarding shelf space allocation for some of your major brands?

Thank you.

Good morning, Sean, Al Verrecchia.

In terms of our shelf space, if I look back to where we were at the beginning of last year and the year before that, we have been gaining shelf space each and every year.

In terms of doing a specific analysis as to whether we have more shelf space this year versus last year, I would say that we have probably about the same to a little bit more shelf space than we had last year.

Some of that is driven by clearly product introductions and depending upon the size of the given line, so we'll probably pick up more space next year with the launch of the Star Wars movie, and then in the year when it's not a movie, you give back some of that space.

In general, we have been gaining shelf space as we have been increasing our product offering and having more success with our product line.

Clearly it varies by retailer.

And that I think has a lot to do not only with the success of our product line, but with the emphasis that a given retailer will be placing on toys in a given season.

Thank you.

Okay.

Thank you.

And our final question comes from John Taylor.

Your line is open, please state your company name.

I'm with Arcadia.

Good morning.

Good morning, John.

I have 3 questions here, I think.

You mentioned Dual Master, specifically in -- as an international revenue driver.

Any other products, categories?

I think you also mentioned maybe TRIVIAL PURSUIT.

Could you talk a little bit about the Duel Masterpiece of that?

And then I'm curious, if there are any other specific drivers in there.

Second question has to do with gross margin, David, maybe talk a little bit about the price of oil and the impact that it's had so far, which may be minimal.

But kind of how you think about it next year, for maybe -- if you could size it like for every $10 per barrel or something, what impact that might have on margin, how we should think about that next year, whenever your future's run out.

And then let's see, the third question is Transformers and Joe have been a little weak on the core side.

Maybe talk a little built about what you're doing to stabilize those, get them going again.

Thank you.

Thanks, J.T.

In terms of Duel Masters, Duel Masters is performing just about as we expected it would do.

It's been strong in the international markets, where it was on television earlier in the season.

It's performed very well in the specialty channels here in the U.S.

I just went to strip about a week and a half ago.

We've seen a -- you know, a good uptick in sales.

It has not got a lot of traction yet at the mass market, which we wouldn't expect it to have gotten that much traction yet.

So there's been, you know, some concern in terms of mass markets as to how strong Duel Masters will be, but I think that's a little built of the desire for the larger players to want that instant gratification.

It is still doing very, very well in Japan, where it's the number 1 trading card game, so we're quite pleased with its performance and it's on track as to where we thought it would be both here and internationally.

Our overall game business is one of the key drivers in Europe.

With the TRIVIAL PURSUIT 20th Anniversary addition, having the same kind of success that we had here in the United States during the last 2 years.

Along with some other new games in a we've introduced.

We're very pleased about the overall board game business, and we've seen strength in our trading card game business, as well as some of the other product lines.

The preschool business is doing pretty well internationally.

MY LITTLE PONY continues to be a driver internationally as well.

In terms of Transformers and Joe.

I think transformers got off to a poor start because we weren't able to match the new product offering with the TV programming, the new TV programming went on air a few weeks ago.

We've seen a nice uptick in the business for Transformer and we're looking for a, you know, a good fourth quarter at retail.

Joe is still soft.

The video is out.

It's doing well, meeting expectations.

But we need some more work behind Joe and we're looking forward to a much better year next year when we have some new product offerings.

With that, I'll turn it over to David to talk about the gross margin issue and fuel.

Yeah, clearly the price of oil is having an impact on gross margin and it will probably have a bigger impact as we go into next year, because you're correct that a lot of our third party suppliers give us a price at the beginning of this year, which are holding despite their increases in costs.

That said, I don't think you can automatically assume gross margin would deteriorate next year, because I think there's a number of other factors, certainly exchange rates have an impact.

This year, for example, our European and international affiliates, which is about 1/3 of our business, are actually showing a lot of favorable material price failures [ph], because their currencies are much stronger than the U.S. and Hong Kong dollar.

Also, we have to look to our ability to pass any of these increases on to our customers and eventually the consumers.

And perhaps the most significant impact on gross margin will be mix of products.

I talked about the mix of VIDEONOW hardware bringing our gross margin down in the third quarter, in a quarter where we have higher software shipments and certainly as we go into next year where we're shipping quite a bit of Star Wars, which has a pretty high gross margin, all these factors will contribute, I believe, but you shouldn't expect to see a gross margin deterioration next year.

When we do a mix, old price is part of the challenges.

One thing you guys have that is a point of strength as well is the mix of product between paper and plastic-based toys, is there a percentage of the portfolio that's kind of highly exposed to, you know, price changes on the oil front versus not?

I think our toy business is more -- clearly more exposed than our game board business, which tends to be much more paper and board and print, obviously.

I think the other major component of the toy business as we are increasingly doing items like VIDEONOW, so we'll send electronic components as well.

So I think between resins and paper and board, and electronic components, those 3 different categories of raw materials are roughly equally weighted for our business overall.

John, this is Al, it varies an awful lot by product.

You can have some products that you take a Tonka steel truck, that's going to be more significantly impacted with the significant cost increases in steel than other products that don't have any steel or don't have as much of a plastic component.

So we've seen our product lines expectations for next year go from, in some cases no cost increases at all to other products where we have double-digit cost increases.

So a lot will depend upon the mix next year as well as what happens to some of the raw materials prices.

Okay.

Thank you.

Okay.

Thank you.

And we do have one final question.

It comes from Felicia Kantor Hendrix.

Your line is open.

Please state your company name.

Hi, guys, Lehman Brothers.

I just have a few quickies for you.

First, just going around the stores, and again, you know, we're just in the New York area, so it's certainly anecdotal.

But we are seeing a bunch of buy 1 get 1 free promotions for the board games -- for your board games, I was wondering you could address that?

The second question is, I'm just wondering when the comps against BEYBLADE are going to stop being a function, and what is the year-to-date decline in BEYBLADE?

And finally with Mattel's Juice Box launch, I'm wondering if that is a concern at all vis-a-vis the VIDEONOW COLOR.

Good morning, Felicia, this is Al.

In terms of the buy 1 get 1 free or as we refer to it the bogo's in the game business.

That's a promotion we have been doing for several years, we've done them in the spring, we've done them in the fall.

So there's nothing new there at all.

In terms of the BEYBLADE comps, that should have much less impact beginning in the first quarter of '05.

Year-to-date, I believe the decline in BEYBLADE is around $258 million, that's a --.

No, no.

Sorry.

I think the decline year-to-date is running at just about a quarter of last year's level.

Okay.

Okay.

In terms of the Juice Box, I mean, the key to success for any of the personal video players is content.

I don't think there's any question that we have the strongest offering of content.

Nickelodeon, HIT Entertainment, Cartoon Network, it goes on and on.

If I take a look at the success we had last year, with VIDEONOW black and white, we sold a little over 1.2 million pieces, so I'm very pleased with our product offering, and we're looking forward to an awful lot of success here in the fourth quarter regardless of the competition that's out there.

Okay.

Thanks.

Thank you.

Thank you.

That does conclude today's teleconference call.

You may all disconnect at this time.