Hasbro, Inc.
Q2 2011 Earnings Call Transcript

Published: 18 Jul 2011

[Operator:]

Good morning, and welcome to the Hasbro Second Quarter 2011 Earnings Conference Call. [Operator Instructions] As a reminder, today's conference is being recorded. If you have any objections, you may disconnect at this time. At this time, I would like to turn the call over to Ms. Debbie Hancock, Vice President of Investor Relations. Please go ahead.

[Debbie Hancock:]

Thank you, and good morning, everyone. Joining me today are Brian Goldner, President and Chief Executive Officer; David Hargreaves, Chief Operating Officer; and Deb Thomas, Chief Financial Officer. Our second quarter 2011 earnings release was issued earlier this morning and is available on our website. The press release includes information regarding non-GAAP financial measures included in today's call. Additionally, whenever we discuss earnings per share or EPS, we are referring to earnings per diluted share. This morning, Brian will discuss key factors impacting our results, and Deb will review the financials. We will then open the call to your questions. Before we begin, let me note that during this call and the question-and-answer session that follows, members of Hasbro management may make forward-looking statements concerning management's expectations, goals, objectives and similar matters. These forward-looking statements may include comments concerning our product and entertainment plans, anticipated product performance, business opportunities and strategies, costs, financial goals and expectations for our future financial performance and achieving our objective. 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, in today's press release and in our other public disclosures. We undertake no obligation to update any forward-looking statements made today to reflect events or circumstances occurring after the date of this call. Now I would like to introduce Brian Goldner. Brian?

[Brian Goldner:]

Thank you, Debbie. Good morning, everyone, and thank you for joining us today. The Hasbro team executed our global branded-play strategy to deliver not only a strong second quarter, but also continuing to create the framework to deliver meaningful growth for the year and in the coming years. Today, we are driving growth in our business through immersive brand experiences which are more innovative, more global and increasingly backed by media and entertainment, and in many cases, backed by digital and online gaming. In addition, we are licensing our brands in a growing number of relevant ways for global customers and consumers. We are executing our full brand blueprint for Hasbro brands, while working with great long-term partners to support their brands, including Marvel, Lucasfilm and Sesame Workshop. To execute this strategy we are leveraging the investments we have made and are continuing to make to expand the reach of our brands for the long-term growth of our business. Despite being in the early stages of unlocking both the revenue and earnings potential of our strategy, in some areas, we're already seeing positive results from our investments. For example, our International business is growing, posting 43% revenue growth in the second quarter or 30% growth, absent the impact of foreign exchange. This marks our third consecutive quarter of double-digit revenue growth in the segment. The growth this quarter comes not only from the continued strong performance in our emerging markets, where we are establishing Hasbro's presence for the long-term, but from other more mature markets as well. We are at an inflection point in our business, whereby you can no longer just look at the U.S. business and extrapolate that to represent all of Hasbro. International is as important to us now as the U.S. and will be even more meaningful go forward. In fact, we could see revenue outside the U.S. greater than our U.S. revenue in the coming years. A balanced global business not only provides incremental growth opportunities but has served to help offset some of the continued challenges in the U.S. economy. In the quarter, the profitability of the international segment nearly tripled as higher revenue more than offset investments in the segment. This profitability growth in the second quarter is very encouraging, given the segment generally contributes more to our profitability in the second half of the year. Specifically, over the last 5 years, the second half of the year has represented, on average, virtually all of the International segment's full year operating profits. From a brand and entertainment standpoint, the second quarter marked the theatrical release of TRANSFORMERS

[Deborah Thomas:]

Thank you, Brian, and good morning. Hasbro is in a strong position, entering the important second half of the year. Our cash position is healthy, investments overseas are driving growth, and we have exciting innovation across our businesses for the holidays. The second quarter was driven by a number of strong brand performances, as worldwide net revenues increased 23% to $908.5 million versus $737.8 million last year. Foreign exchange had a positive $35.8 million impact on net revenues for the quarter. Excluding the impact of foreign exchange, net revenues grew 18%. As Brian mentioned, during the quarter, we announced the creation of our Center of Excellence for Hasbro Games in Rhode Island. As a result, we are relocating 59 employees to Rhode Island, and we had a reduction in force of 96 people. In the second quarter, we recorded $13.1 million of pretax expense or $0.06 per share for severance, relocation and related costs. These costs were approximately evenly split between product development and SD&A. We anticipate an additional $7 million in cost over the next 3 to 4 quarters. These remaining costs are primarily associated with the recruiting of additional talent and office space to support the expansion of our business and teams in Rhode Island. Excluding these costs, operating profit grew 17% for the quarter to $93.5 million or 10.3% of revenues versus $79.7 million or 10.8% in 2010. Looking at our segment results for the second quarter 2011. The U.S. and Canada segment net revenues were $505 million, up 14% versus $444.5 million last year. As expected, the Boys category posted strong growth in the quarter, which was partially offset by declines in the Games and Puzzles, Girls and Preschool categories. The U.S. and Canada segment reported an operating profit of $57.7 million or 11.4% of revenues. This compares to $58.7 million or 13.2% of revenues in 2010. The decline in operating profit margin reflects a higher volume of sales related to close out inventory, as we work down our carryover from last year. Although we wrote this inventory down last year, the subsequent sale has minimal to no profit. This more than offsets the favorable impact on profits from higher revenues of TRANSFORMERS and BEYBLADE. Net revenues in the International segment increased 43% to $374.5 million versus $261.4 million in 2010. Absent a positive foreign exchange impact of $34.1 million, net revenues in the International segment grew 30%. The results in this segment reflect growth in all major geographic regions, including the emerging markets, as well as growth in the Boys and Games and Puzzles product categories, partially offset by declines in the Girls and Preschool product categories. Operating profit in the International segment nearly tripled in the quarter, increasing 191% to $33.8 million, compared to an operating profit of $11.6 million in 2010. Operating profit improved on higher volume in the quarter, which leveraged our spending and more than offset our continued investment in emerging markets and international expansion. Historically, a greater portion of full year operating profit is derived in the latter half of the year, and we're encouraged by the second quarter levels. The Entertainment and Licensing segment net revenues decreased 11% to $27.2 million compared to $30.5 million in 2010. Revenue in the Entertainment and Licensing segment declined primarily due to lower movie-related revenue versus the second quarter 2010, which included a payment related to the BATTLESHIP film scheduled for release in 2012. This was partially offset by revenue associated with selling our television programming to The Hub and some international networks. As Brian mentioned, we have a strong licensing program for TRANSFORMERS

[Operator:]

[Operator Instructions] Our first question is from the line of Drew Crum of Stifel, Nicolaus.

[Andrew Crum:]

I want to start with the Games and Puzzles business, guys. Any savings from the reorganization you're expecting in 2011? And could you comment on the inventory levels in for that business, both domestically and internationally, heading into the second half?

[Brian Goldner:]

All right. Dave, you want to talk about inventory, and I'll...

[David Hargreaves:]

Certainly, at the retail level, we said both on our end-of-year call and on our first quarter call that inventories were high. Right now, on the Games, inventories at retail are down versus a year ago.

[Brian Goldner:]

And Drew, what we're really doing here -- and we took the opportunity this year to sort of do 5 things in the Games business. The first was to really accelerate the pace of the reinvention of that business, given where several of our other categories we're going. It was a perfect time to go do that. We had in our mind's eye to create a Center of Excellence around gaming, where we're able to marry the analog and the digital across a number of different formats, engaging more of the brand teams in that integrated and innovative manner. We have new leadership in the team, really proven global brand leaders who have reinvented and reimagined other brands for us globally. We have a whole new marketing approach for this fall, as well as a lot of new initiatives for the fall, but particularly, new marketing approach. We talked a lot about what we have done in marketing, particularly, in the U.S., with too many initiatives being supported and not a focus on kids marketing. And we're doing all of that. And then, longer term, in 2012, you will see more impactful and many more new initiatives and innovations. So really, it's a holistic approach to the business that we feel very good about, as we look towards 2012 and beyond.

[Andrew Crum:]

And Brian, if I could shift gears to TRANSFORMERS, could you comment on the sell-in, sell-through performance, relative to your expectations, relative to TRANSFORMERS II? And then the follow-up to that is just going forward, what are the plans as far as media support for this franchise? And then I guess, I'm speaking specifically to another theatrical release.

[Brian Goldner:]

We're very expect excited about TRANSFORMERS. And what's so great about it, in particular, if you focus first on the global box office is the fact, the global box office is very compelling and growing in several of those emerging territories so Russia, Brazil, emerging markets, China. That's a lot of the growth you're seeing in the global box office, and certainly, 3D is also contributing to that. Our business looks very similar to 2009 in some ways, and then different in other ways, and that we have more international retailer support than we've ever had. We have more licensees, and we have several new categories of product, including 2 more significant new introductions

[Andrew Crum:]

And my last question, just a follow-up on that Brian. Is the guidance for the television initiative for the company still neutral to modestly accretive in 2011?

[Brian Goldner:]

Well, what we're seeing thus far is tremendous progress in our overall television strategy. We are very encouraged by what we're seeing in The Hub. June was our highest ratings month we had seen since last December. Lots of momentum around the new summer schedule and greater proportion of Hasbro brands and Hasbro-branded content are 7 of the top 10 shows. As we go forward, we are certainly seeing the halo effect of having our shows on The Hub and on international markets like MY LITTLE PONY. We don't yet have all of the product out there for the shows that are on the air. Most of that happens late this year. And it starts to become more clouded about which of these brands are growing as a result of the motion picture versus the TV. But what we do know is that overall, the TV strategy is certainly contributing to the business, both domestically and internationally. We don't really want to continue to talk about specific accretion, but suffice it -- and the reason for that, obviously, is because it's hard to delineate the specific cost and the specific results -- positive results, that we're seeing from TV-related -- to TV versus other marketing initiatives. But overall, we feel very good about the overall TV strategy in particularly about The Hub.

[Operator:]

Our next question is from the line of Eric Handler of MKM Partners.

[Eric Handler:]

First, when I look at your gross margin, you now put together 5 consecutive quarters of lower year-over-year margin. At what point do you think that we see an inflection point and start seeing that rise again? And then secondly, with The Hub, maybe you can give a little color on the advertising traction you're seeing there. And also the cable network upfront is pretty much wrapping up right now, and how you're seeing that did on a year-over-year basis.

[Brian Goldner:]

Yes, overall, Eric, we're going to still see our gross margins in that 58-point-something range for the full year. That's really where we've seen our business going. Deb talked about getting the leverage from the revenues growth you're seeing in second quarter. And we believe that fact to be the case. Good signs of that, unless you want to comment further.

[Deborah Thomas:]

The one thing that you're seeing impacting in the second quarter that normally it wouldn't have as much of an impact is the level of closeout inventory sales that we had particularly in the United States in the quarter. Because while we took all of the charges associated with writing that inventory down last year to the level we would sell it at, we had a higher level of revenue at little to no margin. Now typically, we always have closeout sales, but they come closer to the holiday period when revenues are higher, so you don't see that impact. So I do think you're seeing some of that in the quarter as well. But on a full year, as Brian said, we still expect our gross margins to be in that 58-point-something-percent range.

[Brian Goldner:]

Right. And on The Hub, what we're seeing is growth in advertising revenue, very consistent with our long-term plan and up several fold versus a year ago. Lots of advertisers that have come on board that had not advertised prior on Discovery Kids. And again, we are on track for our long-term plan on The Hub, as well as the International business, which is actually ahead of our expectations. And having our programming on the air in 30 markets -- 30-plus markets this fall is certainly as good as one could've expected and certainly better than our overall plan.

[Operator:]

Our next question is from the line of Michael Kelter with Goldman Sachs.

[Michael Kelter:]

I just wanted to first off follow-up on the gross margin question. I guess, if -- because your margins were down 100 basis points, you mentioned that games production was slow, and you had to close out. Could you maybe tell us would gross margins have been flat, if not, for those 2 things? I guess, just give us some sort of a magnitude of how they impacted your P&L.

[Deborah Thomas:]

I think, gross margins would have been up absent those 2 things, Michael. Given the mix of our products in the sales we talked about the strength of TRANSFORMERS and BEYBLADE. And when we do have these entertainment-driven properties, we tend to have a higher gross margins to offset the higher royalty costs. So we will get those things together. And I think, if we had looked at those 2 things together, absent the closeout and the impact of the manufacturing slowdown on the game side, you would have -- we would've seen this be up.

[Michael Kelter:]

And then on board games, I heard, David, you mentioned that retailer inventories are now down versus a year ago. Can you talk about your own inventory levels, and if they're also in line, and inventory, really, at this point is clean going forward?

[David Hargreaves:]

We've got no problem with our inventory levels. If you look at our inventory, right now, it's $426 million. That's up 24% versus a year ago. Take out foreign exchange impact of that, and it's up 17.8%. That's fully consistent with the growth that we're having in our business. As we said, a lot of those inventories in new markets that we didn't used to be in. So we've opened up business in Columbia. We've opened businesses in Korea over the last few years. They need inventory. So we are unlike the end of the first quarter and the end of last year, where we weren't fully comfortable in our inventory levels, we are now very comfortable with our inventory levels.

[Brian Goldner:]

Michael, the inventory levels are really following the sales. So now our inventory is very split between domestic and international inventories. So it's not a -- not inventory in a place where we don't have sale.

[Michael Kelter:]

So now that you're inventories are clean, and you can kind of just look forward, what are -- and you mentioned the longer term confidence in the business, what about the back half of this year? I mean, you talked about getting back some support and displays at major retailers in the past. And do you think there's a reasonable chance that business could be up, or is it still just going to be one of those kind of transition years for board games?

[Brian Goldner:]

I don't want to guide within specific categories, within the year. And certainly, our view toward our business is certainly in the medium- and long-term versus just for the year. Having said that, we feel very good about our overall ability to achieve meaningful revenue and EPS growth this year. And that's inclusive of our re-imagination and reinvention in the Games business. And as we go forward, the number of new initiatives this team is bringing forward and a new approach of the Games business is very heartening for us and is very consistent with the kinds of re-imagination you've seen from us in other brands that have then gone on to have global success.

[Michael Kelter:]

And then one last one on -- you had mentioned TRANSFORMERS is tracking kind of towards '09, at least at this point, how about BEYBLADE? Is that still tracking directionally towards '03, or maybe not as great as that year?

[Brian Goldner:]

BEYBLADE is performing exceptionally well. And it's performing well all around the world in every country that it's in. We're in more countries around the world than we've been in before, with greater impact. You're seeing that uptake with kids. The show is on the air around the world. I'm not going to guide again toward a specific number, but TRANSFORMERS and BEYBLADE are certainly major contributors in the Boys arena.

[Operator:]

Our next question is from the line of Felicia Hendrix, Barclays Capital.

[Felicia Hendrix:]

Brian, touching upon something that you just talked about before, when you were giving us your overview for your business. You're rather optimistic, but if we look at the first half of the year, there were significant down -- declines in each of the segments other than Boys. You just talked about the Games. But I'm just wondering how you view the growth prospects for the non-Boy business for the second half of the year. Should we expect to see year-over-year growth?

[Brian Goldner:]

Well, we have -- within the Girls business, for example, we have significant year-over-year growth in several brands

[Felicia Hendrix:]

Okay. And then -- and I'm just curious, because your competitor, on Friday, said several times on their earnings call that they're gaining share. I know the industry's pretty fragmented, but there are 2 big players. And I'm just wondering if you can address that, and if there's any areas that you might be just being affected competitively.

[Brian Goldner:]

Actually, if you look at shares around the world, our shares throughout Europe are growing in every country. The U.S., especially, early this year, had stepped back within terms of share. More recently we're seeing better results out of the U.S. But if you go all around the world -- in major regions around the world, our shares are growing. We did have to work through issues in our U.S. business, which we've talked about. And go forward, we feel that we will gain market share in the U.S. as well. But in every territory, in every country around the world, we are growing market share and doing so fairly significantly. And so again, as a global company now, we look at our global market shares and feel that we are on track.

[Felicia Hendrix:]

And then my next question has been asked, but I'll touch on it a different way. I mean, obviously, you look at everything globally. A lot of folks have been kind of doing their own channel checks. There's just been talk about sell-through of TRANSFORMERS. Just wondering, what do you think the end consumer takeaway is, and are you comfortable with the sell-through?

[Brian Goldner:]

I think, for a lot of reasons, again, the overall size and scope of the brand that we've talked about is being more comparable to 2009 than 2007. But there are some market differences, and they're positive ones. We have more new innovation and new categories

[Felicia Hendrix:]

Great. Final question, just curious on the -- on your Entertainment and Licensing, the profitability just seem to be a lot lower year-over-year. Deb touched upon the BATTLESHIP payment. Was that, primarily all of it, x the BATTLESHIP payment? Should we be -- should we have expected to see a more normalized margin there?

[Brian Goldner:]

Yes. If you look overall for the year, Felicia, you'll -- it's partly what you're seeing in terms of revenues, obviously, that could cover the cost. I mean, just timing around when you get payments on royalties for licensed properties. They happen in arrears, and we'll follow in the third and fourth quarter. You have program amortization in that, in the cost there that's different than the year ago. That accounts for some of the profitability, the investment in licensing personnel, accounts for some of the profitability. But overall, again, by year end, you see a segment that again returns the kinds of profitability we've seen historically.

[Operator:]

Our next question is from the line of Sean McGowan of Needham & Company.

[Sean McGowan:]

Deb, where do you expect the full year tax rate to be?

[Deborah Thomas:]

We think the full year tax rate, we still expect it to be in the 28% range.

[Sean McGowan:]

That's normalized. So that will be excluding the adjustment?

[Deborah Thomas:]

That's correct.

[Sean McGowan:]

Okay. Second, Brian, you mentioned a couple of things that was strong and just wanted to drilled down on a couple of other product categories. How is NERF performing?

[Brian Goldner:]

Yes. Overall, that -- what we're seeing in the U.S. has been the restaging of the business in early in the year, probably a little bit too much inventory. Internationally, significant growth overall. For the quarter, it was relatively flat, because you've got strong International growth up against the U.S. staging and preparing for VORTEX. The second half of the year we have a major launch from VORTEX, the VORTEX line coming in the market, as well as new initiatives within the dart side of the business. So that's where we are thus far, and we feel very good about that business. The other part of that business now is Super Soaker, which has performed very, very well, up significantly versus year ago in second quarter. And that's true particularly in the U.S., That's the brand that's done very well in the second quarter. And so for the full year, again, NERF looks very strong.

[Sean McGowan:]

Okay. Now regarding the impact of closeouts on margins, do you think that, that's now been normalized, or should we expect that to continue in the second half? The impact from gross margin, that is.

[Deborah Thomas:]

No. I mean, we do expect to have more closeout sales in the second half of the year, but as we get closer to the holiday season, it really gets leveraged against the revenue growth -- the additional revenue growth of some other parts of the business. So we don't expect -- well, we have more, we don't expect that we'll see an impact similar to what we saw this quarter.

[Sean McGowan:]

So in other words, you always have some, right? I think, it's now...

[Deborah Thomas:]

Right. Yes, we always have some.

[Sean McGowan:]

But it won't be something that you need to call out? That's your expectation, that it's not going to have...

[Deborah Thomas:]

Yes, that's our expectation.

[Sean McGowan:]

And just to -- I hate to come back to this horse and take another whack at it, it seems to be dead. But I just want to be clear, sell-through on TRANSFORMERS, is that up or not up versus 2009?

[Brian Goldner:]

Sell-through on TRANSFORMERS in the U.S. is probably down a bit versus '09, but internationally is up. So particularly up significantly in the emerging market businesses.

[Sean McGowan:]

Okay. And you've mentioned all those other additional revenues sources that you might not have had last time around.

[Brian Goldner:]

Right. Probably that what you have there, Sean, and it's a good point is we've purposely created a more diffused product line. So KRE-O is new business, and you wouldn't have those POS comparisons. So you're taking a category that we plan differently in the Boys action arena, this time than last time and again in the U.S. in particular, where POS is down a bit in the U.S. It's up significantly in several markets around the world. We really much -- take much more of a global view to this, the number of licensed products, categories that are performing well is there as well. So it's hard to make an apples-to-apples comparison, but broadly speaking, that's what we think we're seeing.

[Sean McGowan:]

Okay. Great. And then my last question is we've asked about earlier about the impact of The Hub. I think Drew asked them. You said, you didn't want to get into what the exact impact was. But you had said, I think, earlier this year that you to continue to believe that it would be neutral. Are you not commenting, because that's not true or you're not commenting, because you just don't want to comment?

[Brian Goldner:]

No, no. So if you took -- but thank you for asking. If you took last year's dilution of about $0.30, we're not going to see that kind of dilution this year. I think that's what you guys want to know. So what the relative thoughts is, if it costs us a few million dollars or if it's flat or its slightly accretive, the point is the contribution that it makes now becomes melded into the rest of the marketing initiatives of the product lines. And so the reason I try not then try to tease it back out is because it's really hard to tell exactly all the contributors to something and why it's selling. But having said that, we're not going to see that kind of dilution you saw a year ago.

[Sean McGowan:]

Okay. But is your outlook essentially the same as it was at the beginning of the year?

[Brian Goldner:]

Yes. It's essentially what it was the beginning of the year. We don't have any reason to believe differently. In fact, some of the more recent ratings are very positive.

[Operator:]

Our next question is from the line of Greg Badishkanian of Citigroup.

[Gregory Badishkanian:]

Just two questions. First, you mentioned the Games inventory is lower versus last year. Are there any other categories or any other brands where maybe inventory is higher, if you kind of exclude the movie-related toys?

[David Hargreaves:]

Greg, the answer is no. I think I talked about -- already about our inventory. Our inventory absent FX is only 17.3% about a year ago compared to the first quarter, when we were looking at like 77% above so. I think between strong production then in our Games business, which is of course a little bit of the under-absorption of margin immersion, I think moving anything which was slow-moving, which has caused a bit of margin -- not profit, but margin dilution. We've done everything we needed to do to get our inventory back in shape which is what we told you we're going to be in February. I think the retailer inventories, we're comfortable with the level of inventory in our retailers. We're down single digits, we're down double digits in terms of Games inventory at our 4 major retailers in the U.S., where we get good data. So inventory had been an issue at the end of year. It had been an issue at the end of the first quarter. We don't regard it as an issue now, either our inventory or our retailers.

[Gregory Badishkanian:]

All right. Good. And as you talk to major customers, is there any difference between now versus last year this time, as you -- as they start to plan for holiday, in terms of how much they plan to stock up in terms of inventory? Are they being more conservative? Are they buying later? Any change -- any differences?

[David Hargreaves:]

I think, again, they came into the year, hoping to grow their business. They see this is a strong entertainment and product year. I think, at the end of the day though, they have to be a little bit cautious about what's happening with the U.S. economy. Now that's very different with the international markets, where a lot of the economies, Brazil, Russia, China are sort of surging ahead. But I think in the U.S., we're 2 years after out of recession, unemployment is increasing, underemployment is increasing, house prices are still going down. I think retailers will be appropriately cautious as they go into the end of the year. And certainly, we are appropriately cautious, but it doesn't change our guidance that we've have given you.

[Operator:]

Our next question is coming from the line of Tim Conder with Wells Fargo Securities.

[Timothy Conder:]

Just a couple of clarifications. Besides the negative hit that you took on gross margins due to selling product at virtually no related margin, I just want to clarify, were there any incremental inventory charges that you took during the quarter? And if so, how much were those?

[Brian Goldner:]

There weren't any, Tim.

[Timothy Conder:]

Okay. And then, also to clarify, you said that you expect SD&A as a percentage of revenues to be under 20%, including the charges related to the Games division?

[Deborah Thomas:]

That's correct.

[Timothy Conder:]

Okay. Great. And then on TRANSFORMERS, so far, year-to-date, how are retail sales trending year-over-year of TRANSFORMERS product? I know the question was asked related to '09, but just any color on a year-over-year basis at the end of the second quarter, or however you want to answer the question there.

[Brian Goldner:]

Great. If you look at our POS on TRANSFORMERS, in our overall business for the second quarter, TRANSFORMERS' POS year-on-year is up significantly. Significant double digits, which you would expect. Our overall POS, as a company, was up in the second quarter, driven by our Toy business, with improving trends in our Games business. So that's, particularly, in the U.S. In International markets, TRANSFORMERS' POS was up significantly where we have data and where we have more proprietary sell-through information, similarly in emerging markets where you don't have as much published data, but we have our own results. The overall -- obviously, the TRANSFORMERS movie is -- has contributed significantly. The product lines are selling very well, although with different strategy than we employed in 2009 purposely.

[Timothy Conder:]

Okay. And then Brian or whoever wants to answer this, related to The Hub and the change in the agreement as far as how The Hub compensates Hasbro Studios for content. Can you give us a little bit more detail there, and what triggered that? And then also, a filing by Discovery indicated that there would be a reevaluation of the carrying value of The Hub. Just little more color around both of those issues.

[Brian Goldner:]

I'll deal with the payments, and Deb can talk about the value. On the payment side, what we -- we started and we made an agreement prior to producing any programmings. And so as we produce the programming and put it on the air, it was quickly realized that Hasbro shows were 7 of the top 10 shows -- were really driving ratings for the channel and were the most successful shows for the channel. So we, with our partners, agreed to make a change to the licensing fees that we are being paid, particularly, for animated programming. And that license fee was raised to Hasbro -- to Hasbro Studios, that was more commensurate with the market rate for animation. So we got increased monies for our production of shows domestically from The Hub and was consistent with what people pay for animated programming. So that, of course, changed the economics for Hasbro Studios and for Hasbro, but of course, caused this change in the agreement.

[Deborah Thomas:]

And because of that change in the agreement, it just triggered The Hub management to do a review of -- for impairment of their goodwill. And they have completed that review of goodwill impairment, and we don't expect any write-downs to be reported by The Hub in connection with that. They just have to have their auditors need to finish auditing the procedures, and that's nearly complete.

[Operator:]

Our next question is from Robert Carroll with UBS.

[Robert Carroll:]

Just a quick one on international. I mean, just given the strength in consumers in particular, just the divisional, overall. I mean, how do we think about the profitability progression over time? I mean, how much of the delta between North America and International profitability is just structural, and how much can be -- I guess, how much of that spread can be closed as some of brands really build up scale internationally?

[David Hargreaves:]

So I think, firstly, in the short-term as Brian mentioned in the script, historically, much more of our profit internationally comes in the second half of the year. So if you look at the relative calendarization of profitability between the U.S. and Europe, it comes later in Europe. So I think the fact that it's less profitable during the first half of the year, even when we had a lot of growth of sales, is not a representative of the annual.

[Brian Goldner:]

But if you look over the last 5 years -- go ahead.

[David Hargreaves:]

So for the full year, we expect that the kind of overall operating return that we get internationally will be very similar to the U.S., if not be better. Within International, we clearly, have some new markets, Brazil, China, which are major growth markets for us over time, and we are investment-spending. We're investment-spending, putting paper on the ground, putting offices there, advertising our brands. So those markets today don't achieve a breakeven. And I think, we said repeatedly that some of those are on track to deliver profitability in 2013. And obviously, as we go beyond, that will improve. And then similarly, we've just opened an office in Korea this year. We'll open Colombia this year. So as we open these new markets, they're contributing to growth. But those new markets, we have to appreciate will be a little bit of drag on our margins in the short-term.

[Brian Goldner:]

If you look over -- I was saying, and if you look over the last 5 years, 98% -- on average, 98% of the International segment's profitability came in the second half of the year. So the fact that it's already showing some good profitability and growth in profitability bodes very well for the full year.

[Robert Carroll:]

Okay. I guess, just as a quick follow-up, so I mean, if we were look at a more developed international market, say Europe, and compare it against North America and operating margins, I mean, are they adjusting for FX? I mean, are they on par?

[David Hargreaves:]

Yes. So in fact, some of our highest-margin markets in Europe. And if you go back and look at the full year, the last year, very close between International and U.S. and within that, as we said, we've got some emerging markets, which are drag, but we also got some margin markets, mature markets, like France, for example, where margins clearly exceed the U.S. and then Australia had good margin markets as well.

[Operator:]

Our next question is from the line of Gerrick Johnson with BMO Capital Markets.

[Gerrick Johnson:]

I had a question on digital games, 2-part question. First, if you could go over the economics of say a board game sale to Toys"R"Us versus a digital sale to say iTunes? And then secondly, on the digital sale, do you think it's a substitute for a board game? Is it a complement? Is it somewhere in between?

[Brian Goldner:]

Sure. We'll start with the economics first. If you sell a board game, you have an operating profit margin into that board game. And as we know, a lot of board games tend to be very profitable. So call it a high-teens operating profit margin on a board game. On average, if you sell a digital game, the operating profit percentages are different by category

[Gerrick Johnson:]

Okay. And on the economics again, just to be clear. Digital operating margins, I know, they're different between category, but compared to a board game...

[Brian Goldner:]

They're higher.

[Gerrick Johnson:]

Higher, okay. And on your inventory, the closeout activity in the second quarter, can you give us an impact that had on the top line, as well as gross margins?

[David Hargreaves:]

We probably -- we did move a lot of the slow-moving inventory, so we were probably in the region of $40 million to $50 million, as product that was sold at below full cost, or regional price, not certainly below cost.

[Gerrick Johnson:]

Right, so just you might not necessarily hit your gross profit dollars, just your margin?

[David Hargreaves:]

It doesn't hit profitability, but it does hit margin, yes.

[Operator:]

Our final question is coming from the line of Alex Cook of Voyant Advisors.

[Alex Cook:]

I was wondering if you guys could talk about the program production costs, specifically what the balance was as of Q2, and how much was capitalized during the quarter?

[Deborah Thomas:]

Certainly, about -- at the end of the quarter, we had about $60 million on our balance sheet. And during the quarter, we spent about $22 million.

[Alex Cook:]

But when you say spent, is that what was capitalized?

[Deborah Thomas:]

Yes, that's our cash expenditure.

[Operator:]

There are no further questions at this time. I would like to turn the floor back to management for closing comments.

[Debbie Hancock:]

We'd like to thank everyone for joining the call today. The replay will be available on our website at approximately 2 hours. Additionally, management's prepared remarks will be posted on our website following this call. Thank you.

[Operator:]

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.