Mattel Inc (MAT) 2002 Q2 法說會逐字稿

Welcome to the Mattel Incorporated second quarter 2002 earnings results conference call.

Today's call is being recorded.

With us today from the company is the Vice President of Investor Relations, Ms. Dianne Douglas.

Please go ahead.

Thank you, and good morning, everyone.

And welcome to Mattel's second quarter earnings conference call.

I'm Dianne Douglas, Vice President of Investor Relations and joining me today are Bob Eckert, Chairman and Chief Executive Officer, Kevin Farr, Chief Financial Officer and as our special guest we have Tom Debrowski, Executive Vice President of Worldwide Operations.

Earlier this morning, we issued a press release which detailed our second quarter results.

On the call this morning we -- you will hear brief remarks from Bob. Kevin will provide a review of the financial results, and Tom will give you some insights into our supply chain initiatives.

Based upon your feedback, and so we can make sure everyone gets an opportunity during the question and answer time, we would like to ask if you don't mind, please limit yourself to one question during the question and answer.

Obviously, if you have additional questions, you are welcome to get back into the queue.

Before we begin the call this morning, I wanted to let you know that certain statements made today may include forward-looking statements about management's expectations, strategic objectives, anticipated financial performance and other similar matters.

Forward-looking statements in this morning's call will include statements regarding growth in earnings per share, growth of operating margins of sales, market share, the Company's financial realignment plans, debt-to-capital ratios, supply chain management, and timing of shipments, capital expenditures, operations initiatives, inventory levels, receivables, media expense, reduced shipments and sales to certain holiday products, and SG&A expense.

A variety of factors many of which are beyond our control affect the operations performance, business strategy and results of Mattel and could cause actual results to differ materially from those projected in such forward-looking statements.

Some of these factors are described in our 2001 report on form 10-K filed with the SEC and Mattel's other filings made with the SEC from time to time.

As well as Mattel's other public statements.

Mattel does not update forward-looking statements and expressly disclaims any obligation to do so.

Now I'd like to introduce Bob Eckert.

Thank you, Diane.

And good morning, everyone.

The second quarter is just what we expected.

As I stated previously, we expected lower shipments in the first half of the year with no impact on the full year as we continue to better a line our shipments with consumer demand.

And when you look at our performance in the first half of the year, you'll recall that in the first quarter, we benefited from low levels of year-end retail inventories as well as an early easter.

And while the second quarter overall met our expectations, I was very pleased with elements on the balance sheet as well as our strategic use of cash.

While Kevin will provide additional details, we experienced a significant improvement in receivables for the second quarter and our efforts on supply chain initiatives continue to show tangible value as our inventory levels continue to improve.

We've also continued to reduce debt and are well on the way to achieving our long-term goal of reducing the year-end debt ratio to about 1/3 of total capital and our progress on reducing working capital and debt has allowed to us reduce interest expense. As I mentioned earlier, our sales performance for the second quarter met our expectations as we continue to match our shipments to retailers with consumer demand.

Improvement in gross margin also met expectations, as we continued to realize benefits of cost reductions from improved supply chain efficiency and the execution of the financial realignment plan that we announced in September 2000.

At our selling, general and administrative expense was flat in absolute dollars compared to the prior year.

But there are areas that need improvement including market share.

While I'm encouraged by the continued share momentum internationally, domestically following a solid first quarter, we haven't participated in the industry's growth in April or May.

And while I have said that the first half of the year in the toy industry is spring training for the holidays, frankly there is no question that I'd like to see us do better in the all-important second half.

But beyond the second half of the year, we're also developing our long-term growth plans.

As I mentioned at the pre-toy fair in June, we think about growth internally and externally.

The recent Warner Brothers licensing deal is a terrific example of realizing a hybrid of the two matching strong external entertainment properties with our internal creative and marketing forces.

As you know, we have a very disciplined growth strategy in place for all our entertainment licensing business, all of the entertainment properties in mattel's cache of brands must be toy ethic, have long-term brand potential, global appeal, broad demographic interest and must be obtained at the right price.

The new Warner Brothers licensing deal which grants Mattel the master toy licenses for several core franchises including Looney Tunes, Baby Looney Tunes, Batman, Superman and Justice League, easily meets all of our criteria.

We look forward to a mutually successful relationship for years to come.

As I see it, I'm pleased with the overall health of the Company, the second quarter met our expectations, we're concentrating our energies on the all-important second half.

We're making progress on strengthening the balance sheet, controlling costs, improving the supply chain, and continuing to execute our financial realignment plan.

Are there areas where there is opportunity for improvement?

Yes, there always will be.

But we're focused on the five strategies that have brought us success thus far: Improved execution, globalize extend the brand, catch new trends and develop our people.

Every day we take one step closer to achieving our vision of being the world's premiere toy brands for today and tomorrow.

There will be bumps along the way, but with our vision and strategies as our road map, we'll get there.

Thank you for your attention.

Now let's move on to the financial overview section of the call with our CFO, Kevin Farr.

Thank you, Bob.

And good morning, everyone.

To facilitate my review of the financial performance for the second quarter, I recommend that you refer to the exhibits of the press release.

I'll begin with the discussion of worldwide gross sales shown on the bottom of exhibit one.

I'll discuss the second quarter and first half as the first half results are not skewed by the early Easter.

Total worldwide gross sales were down 4% for the second quarter reflecting international sales growth of 3% offset by a decline in U.S. sales of 7%.

The lower U.S. sales primarily reflect our focus on narrowing the gap between our shipments into retailers and consumer take-away.

As expected, this put downward pressure on our first half shipments which is reflected in the 4% decline in U.S. sales year to date. We believe this initiative is healthy for the business in the long term, and should improve our partnerships with our major retailers.

Our strategic focus on globalization continues to generate good results for the Company.

International sales for the first half of this year are up 9% on top of last year's first half sales growth at 12%.

On a regional basis in this quarter, sales in Europe were up 15% or 9% in local currency.

Sales in Latin America were down 17%, or 13% in local currency.

While sales growth has been strong in Latin America, up 31% in the second quarter of 2001, we are now focusing more attention on initiatives to improve the cash flow and profitability of this region.

Asia Pacific was up 22%, or 18% in local currency for the quarter, and up 18% or 17% in local currency for the first half.

And sales in Canada in the second quarter were down 3%, or 2% local currency.

On a year-to-data basis, sales in Canada are up 1% local currency, on top of sales growth at 20% in the first half of last year.

I will now review our core categories and brands.

For the quarter, worldwide sales for the Girls Division were flat or down 1% in local currency.

Domestic sales were down 6% and international sales were up 9%, or 7% t in local currency. Growth in Polly Pocket, What's Her Face, Diva Starz and American Girl offset declines in worldwide Barbie sales resulting in flat sales for the division.

For the first half, worldwide sales for the division were up 4%, or 5% in local currency.

Worldwide Barbie sales were down 10% for the second quarter, and 4% for the first half.

International Barbie sales were down 1% for the quarter, compared with last year's second quarter gain of 25%.

For the first half international Barbie sales are up 7%, compared with an increase of 21% in the first half of last year.

Domestic sales for Barbie declined 17% in the second quarter with two-thirds of decline driven by the adult targeted collector and holiday lines.

As we previously said, we plan to ship about half as many holiday dolls this year as we did last year so you should expect to continue to see this to have an impact on Barbie sales in the U.S.

American Girl sales were up 13% in the second quarter, and 7% year to date compared to prior year reflecting strong performances for the Chicago flagship store as well as good book sales.

For the quarter worldwide sales for the Boys and Entertainment division were down 5% or 4% in local currency.

Core international sales were up 4% while domestic sales were down 10%.

On a year-to-data basis, worldwide sales for the division were up 1% versus a 9% increase in the first half of last year.

Worldwide sales for the Hot Wheels business were down 4%.

Domestic sales were down 10% and international sales were up 7%. Worldwide sales for the entertainment business declined 5% in the quarter and are flat for the first half.

That's as sales as Harry Potter products offset the Disney entertainment business.

Infant/preschool.

Worldwide sales for the infant/preschool division were down 6% for the quarter, and down 7% on a year-to-data basis.

Domestic sales for the division were down 7%, and international sales were down 5% or 7% local currency. Worldwide sales of core Fisher-Price were down 4%, domestic sales were down 5%, and international sales were down 1%, or 3% in local currency.

We believe that across all divisions, the primary cause of our U.S. sales decline was our strategy to better align our shipments with retail -- better align our shipments with retail demand.

And our data suggests that retail inventories continue to come down.

That said, as Bob mentioned, we are also focusing on improving retail take-away for the all-important second half.

We continue to believe we have a strong product line-up for the fall season and good marketing programs with our major retail partners.

Now, let's review the P&L which is shown on exhibit three.

I will focus my comments on our performance excluding the impact of non-recurring charges.

I'll discuss these charges later in the context of an update on our financial realignment plans.

Additionally, to facilitate the year-to-year comparison, prior year results have been adjusted to reflect the adoption of SFAS 142, which took place in the first quarter of this year.

So goodwill amortization and its related tax effects have been excluded from pro forma results.

The key categories in the P&L for the first half, sales, gross margin, and SG&A, are on track with our expectations for the year.

Gross margin was 44.5% for the quarter, reflecting a 50 basis point increase.

Gross margin was positively impacted by the execution of our financial realignment plan and lower product costs driven by our supply chain initiatives which Tom will talk about more in a few minutes.

While foreign exchange had a negative impact on the gross margin, it was more than offset by foreign exchange gains in -- and miscellaneous income.

Advertising expense was $82.9 million, or 10.3% of net sales, up 10 basis points from prior year.

As expected, media costs remain soft in the first half of the year, but we expect the media market to firm up as we move into our peak advertising window later this year.

Selling general and administrative expenses were $$214.2 million or 26.6 of net sales for the quarter, up 100 basis points compared with last year's second quarter.

But... SG&A was flat in absolute dollars versus the prior year.

Improvements in SG&A this quarter were driven by the continued execution of our financial realignment plan.

These improvements were offset by a set of compensation accruals.

As most of you know, our incentive plans are based on net operating profit less the capital charge, and we have made substantial progress in improving this metric since this time last year.

Our expectations for 2002 is to improve SG&A as percentage of net sales, as we continue to execute the financial realignment plan and as our sales pick up in the second half of the year.

Operating income for the quarter was $69.7 million, up 7% versus last year.

As a percentage of net sales, operating income improved 90 basis points versus the prior quarter to 8.7%. The improvement was driven by stronger gross margins, the positive impact of foreign exchange, which more than offset the impact of lower sales.

Interest expense was $29.1 million for the quarter, compared with $39.6 million in the second quarter of 2001.

Compared it last year, this year's interest expense reflects the benefit of slightly lower short-term rates and lower average borrowing.

The lower borrowings are dealership by the progress we have made in reducing our working capital and strengthening our balance sheet which I'll discuss in a few minutes.

So to summarize the P&L for the quarter, we reported income excluding the impact of charges of $29.6 million, or 7 cents per share, versus last year's second quarter income of $18.5 million, or 4 cents per share.

While sales were down as expected, improvements in gross margin, foreign exchange benefit, and lower interest expense drove higher profits.

As we look forward, there continues to be uncertainty in the retail environment, so we are being cautious in our planning for top line growth in 2002.

In addition to our focus on improving retail take-away, we continue to focus on better execution of our business to improve cash flows and profitability.

As you all know, this is the second half of the year business.

So our profit outlook for the year has not changed based upon the first half results.

Now, turning to the balance sheet, our receivables at $721 million, or 73 days of sales outstanding, decreased by 21 days versus last year.

Accounts receivable reflected improved cash collections and higher factory excluding the year-to-date change or the year-to-year change in factory, which was up $75 million versus the prior year, receivables were down $152 million, with day sales outstanding improving by 13 days.

Inventories at $568 million were down $125 million, or 18% versus last year's second quarter.

Inventories represented 59 days of supply, which is 14 days lower than last year.

Compared to last year, inventory levels were positively impacted by the execution of supply chain initiatives and the reduction of pre-build inventory related to the closure of our Murray, Kentucky, plant which was completed this quarter.

Excluding the pre-build, days of supply would have been down 12 days compared with last year.

Improvements in the performance of our supply chain continue to be a key initiative going forward.

As a result, we expect to show continued improvement in receivables and inventory levels.

Our total balance sheet debt decreased by over $620 million, and our debt net of cash decreased by over $750 million from second quarter 2001.

This reflects a strong cash flow generated by our operations including significant improvements in working capital and our efforts to reduce short-term debt.

Our debt-to-total capital ratio was 44.3%, versus 57.1% last year.

We continue to target a long-term goal of reducing the year-end debt ratio to about 1/3 of total capital.

We believe we'll make significant progress towards our targeted debt-to-total capital ratio by the end of 2002.

Capital expenditures for the quarter were approximately $36 million, slightly less in depreciation for the quarter.

These expenditures are in line with our expectations of capital spending for the full year, of $180 to $200 million, as we execute our long-term strategic plan for information technology and then -- in the next phase of the financial realignment plan.

Now, let me update you on the status of the financial realignment plan.

If you look at exhibit two of the press release, you can see that in the second quarter we recorded a $15 million pre-tax charge related to financial realignment plan.

The charge consists of a $3.8 million charge to gross margin primarily related to the closure of the Murray, Kentucky plant.

A $2.1 million charge to SG&A related to streamlining back office functions.

A restructuring charge of $6.9 million which primarily relates to severance and other compensated-related costs for the Murray, Kentucky, plant closure and the consolidation of international locations.

And a $2.2 million charge to other expense primarily related to the closure of the Murray, Kentucky plant.

Since we announced a realignment plan in September of 2000, we have taken $211 million in pre-tax charges and we expect to record the remaining $39 million over approximately the next year.

Of the after tax charges taken thus far, $102 million were cash.

We anticipate that approximately $110 million of the total $170 million after-tax charge will be cash.

We continue to take the actions necessary to achieve our targeted cost savings and we are on track to achieve the $65 million in savings expected for 2002.

As I said earlier, we are focused on executing in the all-important second half and our outlook for the year has not changed based upon the results of the first half.

We believe we are well positioned to deliver our long-range goals of revenue growth in the mid single-digit range and EPS growth in the low double digits of the low end of the range to mid-teens at the high-end of the range over the 3 to 5-year planning horizon.

Now I'd like to introduce Tom Debrowski, our Executive Vice President of Worldwide Operations who is going to discuss our supply chain.

Tom?

Thanks, Kevin.

Good morning.

The Division of Global Operations is to deliver sustainable competitive advantage to the global business through a world class supply chain by providing products and services of superior quality, with exceptional service at the lowest possible cost. With agility and speed.

And while there are many promises within that vision, agility and speed just may be the most important phrase.

As it describes not only our commitment but also our ability to be responsive and flexible to the needs of the business.

There are also five operational performance metrics against which we measure ourselves and our vendor partners.

These are cost, quality, service, people, and environment.

And while each of these measurements is weighted equally when making business decisions and evaluating our performance, this morning I'd like to focus on two.

Cost and service.

Let's start off with defining the supply chain.

Very simply stated, the supply chain is the movement and value optimization of our products from ideation to a delighted consumer, it's the sharing of information and this includes product ideas, forecasted demands, global sourcing and logistics alternatives, consumer purchase information and product feedback.

In other words, the supply chain provides a continuous loop of information to ensure that we have the right products to the right consumers at the right time, all with the lowest possible cost and maximum asset efficiency.

This includes extending operations beyond its traditional functions of procurement, conversion and distribution, into the design and development groups to ensure we have optimized all facets of the supply chain.

We partner with the units throughout the entire process.

We were contending with the designers to ensure we provide optimal play value and have the right design to deliver lowest cost and leverage our infrastructure and manufacturing capabilities.

For instance, we provide value by identifying alternative materials which meet required technical specifications early on in the design process, driving increased manufacturing efficiency and lower costs.

We also work beyond the toy itself by leveraging the expertise of our packaging vendors. We are utilizing new packaging technology to reduce one category of our folding carton costs by 15%.

This new technology reduces packaging thickness and weight while maintaining structural integrity.

By moving to the back of the supply chain, and working with our customers, we can identify ways to lower landed costs by optimizing the supply chain after our product leaves our manufacturing sources.

For example, understanding customer requirements provides opportunities for packaging redesign to optimize shelf and warehouse configurations.

Knowing customer infrastructure and replenishment requirements provides opportunities to eliminate entire distribution legs or provide new logistics opportunities.

For example, by listening to and working with our customers, we recognize an opportunity to reconfigure our Hot Wheels packaging.

This rapidly implemented change resulted in better stackability, more efficient handling and reduced transportation costs to both Mattel and our customers.

By improving communication systems, and sharing ideas, we intend to optimize every linkage in our supply chain and deliver the right products with exceptional levels of service at the lowest possible cost.

As Kevin mentioned earlier, we as a Company strive to improve operating profit as well as our capital structure.

At Mattel, we focus on three levers to drive it and they are the same throughout the Company including profitable growth, driving margin improvements, and increasing asset efficiency.

Operations is focused on several strategic initiatives to deliver against those three levels.

We enable profitable growth by partnering with the business units throughout the supply chain process to have the right people and manufacturing capacity in the right place at the right time to respond to changes in the business.

There are three key strategies we have implemented to deliver profitable growth.

One, we have developed a global sourcing strategy to leverage our worldwide supply system and minimize our landed costs.

For example, by changing the mix and volumes between our China vendors and our fashion doll manufacturing facilities, we were able to increase Mattel's capacity utilization and reduce product costs in excess of $5 million annually. Two, the goal of our global logistics strategy is to optimize our supply chain channel worldwide by consolidating and leveraging the scale of our worldwide ocean freight volume, we were able to provide efficiencies to both Mattel and our carriers resulting in cost reductions of over 10%.

Also, by combining the efforts of our various brands and companies, and negotiating as one Mattel, we were able to conclude a series of small package freight contracts that will save us over $3 million annually.

And third, our flexibility and responsiveness initiatives will provide competitive advantage in our ability to quickly respond to changing consumer trends and provide improved product availability to customers and consumers.

For example, by piloting these innovative capabilities, we were able to reduce product lead time on key Harry Potter products by 50%.

That's the first lever.

What about margin improvement?

As you know, margin is a combination of product mix, price and cost.

And operations of course are focused on cost, and we are aggressively driving out costs through improving manufacturers efficiencies, technology improvements, and vendor partnering.

Our global procurement strategy allows to us consolidate our purchases wherever possible to build mass scale, to provide the greatest leverage possible.

We are doing this not just within Mattel, but we are also looking outside of Mattel for partnerships and alliances and we're constantly reviewing opportunities to further improve our internal cost competitiveness and identify new ways to team with our vendor base to drive mutual cost advantage.

And last but not least, asset utilization.

As you know, our asset base is shrinking as we consolidated our North American manufacturing facilities with the closure of the Murray, Kentucky plant.

Through process improvements and plant reconfigurations, we are able to drive efficiency and create additional capacity without capital expenditure.

I hope this has provided a useful overview of operations and our global supply chain initiatives.

Thank you.

Thank you.

Operator, now we are ready to take questions, please.

Thank you.

Today's question-and-answer session will be conducted electronically.

To ask a question, press the star key followed by the digit one on your touch-tone phone.

Again, that's star one for questions.

Our first question from Jill with Salomon Smith Barney.

Thank you. Good morning.

I was hoping to get a sense of what your expectations are for Barbie for the full year and any impact that the holiday Barbie might have on the second half.

Secondly, I was curious if you could give us a sense of some of the key events that are likely to be tied with the Warner license over the next one to a couple of years.

Thank you very much.

Hi, Jill.

It's Bob.

Hi.

Good morning.

As Kevin mentioned, two-thirds of the sales decline that we experienced in the second quarter in Barbie was due to the adult targeted holiday and collector segments.

Our expectations are for continued softness in the adult targeted segment for 2002. As I mentioned previously, there are really three issues with the holiday doll that we are addressing.

First, in recent years, particularly last year, we made too many dolls.

Our plan in 2002 is to ship about half as many dolls as we had last year.

Secondly, we shipped too early.

Through June, we have not shipped any holiday dolls this year.

Last year, we had shipped about 35% of the full year's sales.

And third, the holiday doll just wasn't special enough.

We have had very good reception to this year's doll from retailer -- retail buyers.

But we'll just have to wait and see.

We think we have significantly upgraded the doll.

The drivers of the same major third of the decline include the overall Company initiative to ship closer to retail take-away and competitive performance including our own doll brands.

As you heard, we had growth in brands like Diva Starz, Polly Pocket and What's Her Face.

The second part of your question on Warner Brothers movies, in the year 2003, there is going to be a Looney Tunes movie and in the year 2004, there will be a combined Batman and Spiderman movie. There will be a lot of television entertainment across many of the properties throughout the horizon of the licensing agreement.

And there may be additional movies beyond the ones I just talked about.

Just as a follow-up, so overall, if were you to [INAUDIBLE] girls in aggregate, would you anticipate that that division would grow in line it your overall corporate objectives?

You know I don't give guidance for quarters or halves or anything like that. That said, very clearly over the long term planning horizon, 3 to 5 years, we expect revenue growth for the Company to be in the mid single digits and I have also said we expect all of our brands to contribute to the Company's growth.

Thank you.

Our next question from Brian McGovern, Morgan Stanley.

Great.

Thanks.

Actually have a couple of quick accounting questions.

One I was hoping could you elaborate on the accounting for xp -- fx, what shows up in the gross margin and what shows up in other.

I understand you lowered your expected return rate on your pension assets in order to be more conservative.

What kind of impact is that having on your P&L?

Okay, Brian.

I'll answer the question on foreign exchange.

With regard to the impact of foreign exchange, it showed up in a number of places in P&L.

As you know, every line item that P&L's impacted the result of international subsidiaries are translated into dollars for consolidation and then gross margin included the impact of foreign exchange related to intercompany product flows and that was negative.

And then miscellaneous income included foreign exchange related to intercompany exposures that are natural hedges for future settlements. So what we have for the Company is positive for the quarter.

With regard to pension accounting, as you know, we worked with third party actuaries to determine appropriate assumptions for our pension accounting.

We believe our assumptions for pension accounting are appropriate and in 2001, we reduced our pension assumptions on returns from 11% to 10%.

And [INAUDIBLE] I am -- profit impact of -- would be about $2 million annually.

It's likely we'll reduce this to 9% assumption on return later this year.

Great.

Thanks, Kevin.

Our next question from Chris Cox, Goldman Sachs.

Good morning.

Bob, you had commented earlier that in April and May, you felt like you hadn't gained the share that you were hoping to in domestic markets and that actually internationally had done quite well.

I was hoping if you could just comment on what areas do you think you were particularly weak in the U.S.?

And then maybe the areas of strength in the international markets.

Thanks.

Good morning, Chris.

There are three primary drivers of our share decline over the last couple of months. First, are things that we have proactively initiated.

For example, one of the side effects of improving the supply chain and lowering inventories is that we have fewer closeouts on the marketplace this year than we have had in prior years.

That I am packets things like our low-end doll business, for example.

Secondly are things that we anticipated but we really didn't drive.

That's the competitive environment.

Spiderman and "Star Wars", for example, accounted for -- I'll say that category.

The action figures category, I think, contributed almost 60% of last month's -- last month's growth across the entire industry.

As you know, most of our properties like Harry Potter and He-Man Masters of the Universe are second half properties.

Third are things we just need to do better.

We didn't get our fair share of growth in the spring so we are focused on making sure we do better in the all important second half.

Products like Barbie as Rapunzel say, the Microbus, Holiday Barbie, those are a few in that line.

We have our entertainment properties.

We have a very strong line-up in our Boys Division.

With Hot Wheels and new track sets and the like.

And as you know, the point of sale growth across Fisher-Price has been very consistent for the past several years.

Okay, thanks a lot.

Our next question from Margaret Whitfield, Breen Murray.

Yeah, Bob.

I wondered if you could amplify on what the market share was for your brands in the period and what the growth of the key categories was and could you elaborate on your statement about cautious retailer, uhm, retailer buying over the second half?

Hi, Margaret.

I mentioned most of the category growth was in the action figures business.

Our share of market across all of our categories is 19.8% on a year-to-data basis.

That's 1.2 share points below prior year in the U.S.

In Europe, where we also have similar sorts of market share data, we have gained about a half a share point to 11.1% in a growing market.

Let me address your second one about the retail environment.

We did expect our second quarter U.S. sales to be down due to a variety of factors, primarily our initiative to better align shipments with consumer take-away, as well as other factors including Spiderman and "Star Wars" and store closures.

As we look forward, there continues to be uncertainty in the retail environment.

You know that some retailers have reported very strong results lately.

But we have seen a continued increase in unemployment and I would characterize consumer confidence as uninspiring.

So with that said, our outlook for the year has not changed based on the first half results.

We are being cautious in our planning for top line growth in 2000, given the short term uncertainty in the retail environment.

And we believe that any benefit from potentially lower interest expense due to the lower-than-originally planned short-term rates needs to be balanced with revenue risk due to the retail environment.

Just a follow-up.

Could you give us an update on the K-Mart situation and to what extent, if any, this affected your second quarter?

Well, with regard specifically to K-Mart, you know we don't disclose sales by customer.

But as we have said before, there is uncertainty in the environment at K-Mart as it restructures and has closed almost 15% of its stores.

I would characterize our business with K-Mart as having stabilized, but it's very early in K-Mart's planned turnaround.

And across all of our retailers, as you know, this is the second half of the business year and our outlook really hasn't changed based on the first half results

Thank you.

Our next question from Felicia Cantor with Lehman Brothers.

Hi there.

Kevin, you touched on this and actually, Bob, you just touched on this a little bit but I was wondering if you could be more specific, and that is getting to the point you just made with the declining, uhm, consumer confidence.

And you have said that you are being cautious.

But I'm wondering if you're seeing anything specifically in the change in terms of demand from the retailers or through them if you are getting an indication of changing consumer buying patterns or demand.

And then, uhm, also, I was wondering if you could -- how you could characterize your channels given the potential for continuing deterioration of the consumer and then just a quick housekeeping item.

Other income was higher than I thought it would be.

And I'm wondering if that was because of the foreign exchange?

Let me start, Felicia, trying to answer the first couple of questions.

And then I'll turn it over to Kevin.

As it relates to channels, we always suggest that you directly contact retailers.

But our own calculations based on what shipped in, what is sold through, and what has happened at inventory, suggests that across the retailers, we have seen inventory reductions in the mid to high teen double digits rate.

And you know my view on that is that it's a continuing moving target.

Inventory is not a good thing for the business system whether we hold it or retailers hold it.

And it was an important part of our plan this year to try and help retailers reduce inventories in the first half.

As it relates to the overall environment coming up to the holidays, I think I'd continue to say that I don't see or hear the pessimism that we heard last year about the holidays, but I would continue to say we haven't really seen a lot of optimism, either.

I think retailer response to our product line has been very strong.

We have some very good items that retailers are now buying and will be promoting extensively.

But I think it's going to be one of those years where it's a continued iffy environment and we have planned accordingly.

Felicia, as I'm sure you expected foreign exchange gain did have a positive impact on the Company.

The interest and miscellaneous income relates primarily to foreign exchange gains and assayed that relates to intercompany exposures that -- that are natural hedges for future settlements.

And this gain was partially offset by exchange losses in gross margin related to intercompany product flows.

Thank you.

You're welcome.

Our next question from Linda Bolton with Fahnestock.

Thank you. Perhaps you can comment a little bit more about the shifting of the sales into the second half from the first half and how it relates specifically to the retailers.

I'm wondering if there could be execution risk actually on the part of the retailers, uhm, based on what you are trying to do?

Hi, Linda.

There is always execution risk.

And environmental risk out there.

But we have worked very hard and extensively for many months now with our retailers on the shipping pattern for this year and on the programs for the second half of the year.

So I would characterize it as everything is as we expected and we are counting on retailers to merchandise our products aggressively and based on everything we know, they have strong plans in place to do so.

Okay.

And is the shift happening internationally as well as domestically?

Yes.

I would say it's not as dramatic overseas as it has been in the U.S., but the continued reduction in retail inventories, which I think is across the consumer goods and retail industries, is a good thing.

It is continuing in foreign markets just like it is in the U.S.

Okay.

Thank you very much.

Our next question from Tony Gigac U.S. Bancorp Piper Jaffray.

Good morning, guys.

Just a quick housekeeping question.

The tax rate was 23.4%.

That was about 400 basis points better than we had been expecting.

Maybe could you do a quick comment on that and then, uhm, my real question, looking at, uhm, international sales in the second half of the year, the counts get a little bit tougher.

Any comment on the breakdown of sales and where the growth is going to come from in the second half of the year domestic versus international?

Let me talk about the international sales and then ask Kevin to talk about the tax rate.

We have seen in the first half of the year internationally 9% growth on top of last year's 12% growth.

You know, as I have mentioned now for several quarters, we are sooner or later going to get to the law of higher basis, and it becomes more difficult to grow.

That said, this is now our 8th consecutive quarter of growth in constant dollars.

We continue to benefit from having the global business units. We have better communication and coordination for product development through launch so things like Harry Potter or this year's Barbie as Rapunzel, are doing well on a global basis.

Secondly, we have made specific improvements in our customer account planning.

We have pro-active partnerships with the key retailers throughout the world.

Our pre-toy fair session in Hollywood in June was like a U.N. meeting.

We had more customers from around the world than I have ever seen before.

And third, the things that Tom talked about, our supply chain improvements, shortening the product development cycle, improving the performance of our distribution system, have benefited our international subsidiaries, as well.

I continue to believe that our international business will outperform our domestic business.

We have a greater opportunity for growth in those markets.

If for no other reason, than we have a lower market share base from which to begin.

And we clearly have momentum going on our side.

So I'll continue to say that the law of higher basis will catch up but I know some of you are getting tired of me saying that now for sometime and I think we'll continue to experience growth.

And on the -- Tony, on the tax rate, if you look at exhibit three the rate on our profit before charges is 27.2%.

Which is the rate we expect for the full year.

Thanks.

Our next question from Dean Janukas with J.P. Morgan

Hi, just two quick questions.

First, Kevin, maybe if you could provide us some interest guidance for the full year, where you end up and then secondly, when you talk about your supply chain, initiatives and all the cost savings you get, how much of that do you keep and how much if any do you pass through to the retailers?

Okay, Dean.

Let me answer your question interest expense.

I think interest expense for the second quarter was down from the prior year driven by lower average debt outstanding and lower short-term interest rates.

As discussed on our last conference call, we believe interest expense for 2002 would be down compared with 2001.

We believe any benefit from potentially lower interest expense due to lower than originally planned short-term rates needs to be balanced with revenue risk due to the retail environment.

Dean, on your very good question on the supply chain, we want to keep all of the savings.

Our retailer partners want to take all the savings.

So we usually end up someplace in between.

That said, I'll tell you that it is in our best interests to raise the profitability of our brands with retailers.

So we don't mind the idea of cutting costs across the entire supply chain and sharing in those cost reductions.

All right.

Any sense as to how much maybe you keep versus -- is there any kind of....

No.

I wouldn't I wouldn't want to get into those sorts of calculations.

Sort of our margin relationship with customers.

Dean, this is Tom.

Suffice it to say that it behooves us both to work together with as much of an open book as we can because that's where we get the most savings.

Okay.

Great, thanks a lot.

Good quarter.

Thanks, Dean.

Our next question from Mr. Johnson of Gerard Matheson.

Maybe some quick comments on the Boys Entertainment Division, in particular, Harry Potter.

How much do you plan to ship relative -- this year relative to last year?

And in the Wheels division, retail take-away has been a little weak lately throughout the year.

Overall, are we seeing a secular down turn or is this more of a function of lost shelf space due to action figures?

Hi, Garrick.

It's Bob.

A couple of things.

First on Harry Potter, I don't believe we have made a specific projection for the year.

We shipped about $160 million last year worldwide.

We felt very good about its performance.

Retailers felt very good about its performance.

And I'll tell you, we both feel very good about Harry Potter's performance right now in the face of everything else that's going on in the entertainment business.

As it relates to Wheels, I don't see anything that looks like a secular change.

Our market share in vehicles is up but the Wheels category is down.

As I mentioned with the kind of growth we have seen in the action figures category and with all the action that's going on over there, I think this is a shift right now in what's hot.

By the time our own entertainment properties come out, by the time we get into sort of the peak season for our regular boys toys, I think we'll be in good shape.

Okay.

Great.

Thanks.

Our next question from John Taylor with Arcadia.

Good morning.

Next year, if you look at the three major divisions, I wonder, could you give us a sense of -- and I guess based on reaction you got from the spring preshow in June, could you give us a sense of which one you think is going to be the largest revenue growth driver?

J.T.!

[ laughter ]

Come on!

I'm having a hard time picking the toy of the year, although I continue to like Chicken Dance Elmo!

[ laughter ]

I would say that clearly the retailer reaction from pre-toy fair was quite strong.

I was particularly encouraged by retailers' reaction to Barbie.

You know, just based on the qualitative comments I have heard from customers, they feel very strong -- they feel very positive about our strong line-up for next year.

I was also pleased with the feedback we received on Hot Wheels.

You know, this year, Matchbox is doing very well with its 50th anniversary and Matt and his team have put together a really any [INAUDIBLE] theme for all of next year on Hot Wheels and in the Fisher-Price business, we continue to have very good POS on core Fisher-Price.

You know we are working hard on character brand.

You know I think we are going to turn the corner on character brands any day now.

But we haven't done that yet.

Even though we have seen some good retailer response from things like the Pooh line this year, and Barney and others.

But until we have turned the corner, I don't want to get too optimistic.

Yeah, it just seems like, you know, the Boys Division is subject to some more short-term challenge this is year because of competitive stuff and what not.

And Barbie, of course, we have all been keeping our eye on it.

You know, I guess what I'm asking is, is there any way to handicap which of those might turn first?

Well, I wouldn't want to do that because I tell Neil, [INAUDIBLE].

And Adrian, they all have to grow.

Everybody has to contribute.

All of our brands have to contribute and you know, we have fortunately, we have a strong portfolio of brands so even in Adrian's area, I know you're all watching the Barbie decline but our strategy is to expand our portfolio on a worldwide base, we're up 4% Kevin mentioned in sales for the first half of the year and Polly Pocket is hot right now.

We have some new dolls coming out this fall that we are very excited about.

And we'll see what's hot next year.

But I would characterize retailer response to Barbie as being very strong.

Thank you.

Thanks, [INAUDIBLE].

Our next question from Gary Cooper Bank of America.

Just a couple of questions and maybe Tom can answer this. Your inventory line is down pretty significantly here in the first part of the year.

And I'm wondering if you have any sort of alternative plans for if there is a strike at any of the ports in the U.S?

And how you might manage around that.

And whether or not we might see inventory tick up if only temporary at the end of Q3.

That's the first question for Tom or Bob.

And then secondly, Kevin, just wondering, your cash flow from operations is about $200 million, a little bit more, maybe above last year's levels for the first half.

Do you think that's sustainable through the second half, that kind of improvement?

Thanks.

Gary, it's Tom.

I'll handle the question on the inventory situation and the strike.

First of all, important to note we are monitoring this every day and it is a day-to-day issue.

But we have been planning for this for a long time because obviously we knew the contract was up so we have been selectively moving product that we could forward to get it under our control as fast as we can so we believe the actions we have taken are prudent and we have seen very little uptick in our inventory.

We don't think it will have a major impact on our inventory, yet we believe that we're in very good shape and that's about as far as I want to go on inventory at this time.

Good.

And Gary, with regard to the cash, I think we have said we'll make progress and that inventory is going to be the source of cash in 2002.

I think we have made good progress here in the first half of the year with regard to working capital.

We are focused in on it.

And we expect this to be a source of cash in 2002.

Okay.

Thanks.

Our next question from David Liebowitz with Burnham.

Yes.

Let me add my congratulations to all the others.

One -- in terms of something that was said earlier, is there any way we can quantify the value of the dollar to what earnings mean to the Company in the sense that if the dollar drops five cents against the Euro, it means x dollars worth of earnings to Mattel?

And second of all, given the inventory cutbacks, et cetera, do you think you put out too much markdown money in the budget you might be able to recapture some of that at year's end?

Okay.

With regard to the Euro and a 5% drop to the Euro, 5% drop to the Euro with regard to EPS has about a 2 to 3-cent impact on earnings.

David, let me try and handle the markdown.

We're right as we expected in terms of markdown this is year. As I mentioned in the shipment or post decline, not the shipment decline, we had fewer products markdown and on closeouts at the beginning of this year than we have seen in prior years.

I walked into some large retailers shortly after the first of the year.

And you all know, you do this, too and some of the retailers have very specific aisles full of marked-down product that I was pleasantly surprised that I would see two or three Mattel items in a whole aisle of marked-down items.

So that impacted our position because we are not getting our share of that business but from an income statement standpoint, obviously, that's a very healthy thing so we are right on plan with markdowns.

Thank you very much.

Operator, we have time for one more question.

Okay. Due to time constraints, our final question from Abe Bronstein with Glenview Capital.

Mr. Bronstein, your line is open.

[ pause ]

Operator: We will take our final question from Eric Fell, Taza Capital.

Hi.

Just wondering if $600 million or roughly in operating cash flow is still reasonable for the year?

Yes.

We haven't given guidance on that but I think if you look at your models as well as you assume that we -- that working capital is a source of cash, that directionally I think that number is correct.

Okay, thank you.

Ms. Douglas, I'd like to turn the call back over to you for any additional or closing comments.

Thanks, operator.

I'd like to thank everyone for their participation in the call today.

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And the number for the replay is 719-457-0820.

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Thank you.

This does conclude today's conference. Thank you for your participation.

You may now disconnect.