Hasbro Inc.’s (HAS) third quarter earnings of 99 cents per share were well ahead of the Zacks Consensus Estimate of 91 cents, reflecting a drop in costs and demand for its movie-based toys. The company had earned 89 cents per share in the year-ago period.

Net revenues for the quarter decreased 1.7% to $1.28 billion from the prior-year quarter. Excluding the adverse impact from a stronger dollar, revenues were up 1% in the quarter. Results reflected challenging economic environment, though the Transformers and G.I. Joe experienced strong demand.

However, gross margin increased 110 basis points from a year ago to 57.0%. Third quarter results include a 3 cents per share dilutive impact from the company’s investment in its joint venture with Discovery Communications and initial investments in Hasbro’s virtual studio.

Operating profit was $230.7 million, up 6.8% year-over-year. Operating margin increased 140 basis points over the year-ago quarter to 18.0%. Total EBITDA increased 9.6% to $286.9 million.

The U.S. and Canada segment’s net revenues were down 3.5% year-over-year to $791.9 million. While the boys category posted decent performance in the quarter, it was offset by declines in girls, preschool and the games and puzzles category. Operating profit in the segment decreased 2.2% year-over-year to $129.1 million. Operating margin for the segment increased 20 basis points to 16.3%.

The International segment reported net revenues of $444.1 million. The segment was down 3.6% year-over-year in U.S. dollars but up 4% excluding the impact of foreign exchange. Results reflect growth in boys and preschool categories offset by declines in the girls and the games and puzzles category. Operating profit in the segment was down 2.5% year-over-year to $64.1 million. Operating margin increased 10 basis points year-over-year to 14.4%.

Entertainment and Licensing segment net revenues were $41.6 million, compared to $18.3 million in the year-ago quarter, driven by demand for Transformers and G.I. Joe. The segment reported operating profit of $19.8 million compared to operating profit of $6.3 million a year earlier.

Regarding expenses, we note that royalty expenses increased 19.1% over the prior-year quarter to $99.7 million, as entertainment driven brands − which include its own core brands − continue to play a major role in its growth. Research and product development expenses totaled $43.8 million, down 12.2% year-over-year. Advertising expenses declined 10.8% year-over-year to $135.0 million. The decline is primarily due to a change in product mix as the company has shifted more entertainment base business this quarter compared to a year ago.

Regarding the impact from its joint venture investment with Discovery Communications, the company now expects that the dilution to the fourth quarter earnings will be in the range of 4 to 5 cents per share. For 2010, the company expects dilution of 25 to 30 cents per share.

The economic slowdown has severely impacted discretionary consumer spending, which has deteriorated sharply in the U.S. and in many other countries around the world. As a result, the balance sheets of toy manufacturers such as Hasbro, Mattel Inc. (MAT) and JAKKS Pacific Inc. (JAKK) have been impacted significantly.

We note, however, that Hasbro’s financial results are back-end loaded, with nearly two-thirds of annual revenue generated in the second half of the year. Hence, with some early signs of economic recovery, we think that the company should be able to enjoy growth in sales during the holiday season, though such growth would be limited.

Given its extremely strong financial position, we believe that Hasbro is poised to grow in future. The company has an impressive array of products and is generating strong performance out of popular items such as the Marvel and Transformers toy lines.

Nevertheless, given the high-level of uncertainty regarding consumer spending in the near term, we remain cautious. Hence, we have a Neutral recommendation on the shares of Hasbro.
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