Mattel Says Fallout from Recalls Could Continue into Holiday Season

October 17, 2007

Mattel Inc., which spent much of the past quarter dealing with fallout from massive toy recalls, said that the impact could hurt sales during the quarter that includes the holidays, even though it saw its third-quarter profit slip only 1 percent.

The world’s biggest toy maker said net income for the quarter ended Sept. 30 fell to $236.8 million, or 61 cents per share, from $239 million, or 62 cents per share, in the same period a year ago.

Latest-quarter results included charges of about $40 million related to recalls covering merchandise that contained small magnets or was tainted with lead paint.

Overall sales climbed 3 percent to $1.84 billion from $1.79 billion a year ago, with overseas sales aided by the weaker dollar.

Analysts surveyed by Thomson Financial had expected profit of 70 cents per share on revenue of $1.91 billion.

Mattel shares fell 23 cents to $22.22 on Monday.

“Despite the challenges the company faced during the third quarter, the business has performed fairly well, even with some supply chain disruptions that impacted our sales during the quarter,” Robert A. Eckert, chairman and chief executive, said in a conference call with analysts.

“U.S. Barbie performance was soft and remains an area of focus, although a good portion of the decline in the quarter was directly related to the supply chain disruptions,” he said.

Since August, Mattel has announced three separate recalls of some 21 million toys because of dangers to children from lead paint or from tiny magnets that can be harmful if swallowed.

The majority of the toys were recalled because they featured the small magnets.

“While product recalls clouded this quarter’s results, the company’s domestic business continues to underperform, a factor that we believe will continue to weigh on the stock,” Lehman Brothers analyst Felicia Hendrix wrote in a research note.

During the conference call, Eckert acknowledged that retailers were anxious about the state of the economy and the impact the toy recalls may have on consumers as the crucial holiday season nears.

The company also warned that its fourth-quarter sales could be hurt by a ban on imports of its products by Brazil.

Last month, that nation suspended all import licenses for Mattel products while the government evaluates whether the company is in compliance with the nation’s safety regulations.

If Brazil fails to reinstate the import licenses soon, it could result in a 2 percent hit to Mattel’s net sales in the fourth quarter, the company said.

Still, Eckert struck an optimistic outlook.

“There will be a Christmas and Mattel, Fisher-Price, Radica and American Girl toys will be under the tree,” Eckert said of his company’s brands. “I’m confident that this year’s toys will be the safest ever.”

El Segundo, Calif.-based Mattel has tried to reassure customers of the safety of its products in the weeks following the recalls.

“Overall, it looks like, from a consumer standpoint, I think the anxiety about the recalls is largely behind us,” Eckert said, citing consumer surveys by the company.

Mattel plans to spend more money on advertising to help lure consumers back this holiday season.

Mattel has also said it beefed up quality control and safety measures, including increasing random inspections of vendors. The company said it is testing every production run of completed toys for lead paint before the items are sent to stores.

Eckert noted he traveled to China earlier this month to meet with vendors and safety experts and came away confident that the safety monitoring is working.

Ongoing costs associated with its toy safety monitoring system will be well under 1 percent of its total cost of sales, the company said.

Eckert said international sales have driven overall growth, while U.S. sales were down slightly in the quarter. Mattel reported continued strong performance from its core Fisher-Price and Disney/Pixar “Cars” properties.

The “Cars” line and the addition of Radica games and puzzles helped produce a 29 percent increase in sales in the entertainment toys unit.

The recalls stung sales of Fisher-Price’s Dora the Explorer. Sales of the brand fell 34 percent in the U.S. and 21 percent internationally, compared to the year-ago quarter.

Global Barbie sales fell 4 percent, with increases in international sales partially offsetting a 19 percent decline in domestic sales of the fashion doll. It was the third consecutive quarter that Barbie sales were down in the U.S.

The company’s Wheels unit posted a 9 percent increase in global sales during the quarter, driven by sales of its Hot Wheels and Matchbox brands.

Analyst Sean McGowan of Wedbush Morgan Securities expects the toy recalls to impact sales in the fourth quarter but noted it likely won’t be severe.

Mattel appears to have managed the initial impact of shipping delays caused by the ramp-up in product testing. he said. adding the cost of recall-related litigation, advertising and testing should also be less of an issue going forward.

“Once we get past the beginning of December, you really have this thing in the rearview mirror and the outlook of this looks pretty good,” McGowan said.

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