Mattel Inc. (MAT) posted a worse-than-expected 46% drop on slumping sales, refuting the idea that toy makers are relatively immune to economic downturns.

Executives with the largest U.S. toy maker said challenges will continue in 2009, citing economic and employment conditions, weak opportunities for new movie-themed toys and the credit squeeze some of its vendors and retail customers are still facing.

"We have some anxiety on both sides of our supply chain," Chairman and Chief Executive Robert Eckert said during a conference call.

Shares of Mattel fell 15.4% and pushed other toy makers lower. Hasbro Inc. (HAS) shares were recently down 8%; Leapfrog Enterprises (LF) fell 6.5%; Rc2 Corp. (RCRC) dropped 4.6% and JAKKS Pacific Inc. (JAKK) was off 3.8%.

Mattel's "terrible" results are a bad sign for Hasbro and the rest of the toy industry, JPMorgan analysts said.

"While we think Hasbro is much better positioned from a market share standpoint in Q4 and 2009 given a strong movie pipeline, such a large miss from the industry's top toy manufacturer clearly highlights weak toy industry trends at retail," the brokerage firm said in a note to clients.

Still, the toy industry seems to have outperformed other categories in 2008, and Mattel gained market share, Eckert said, citing NPD Group data through November, the most recent month Mattel had available.

"Consumers in this kind of environment are focusing on core products and brands with which they're familiar," Eckert said.

Mattel's report coincided with new government data showing U.S. consumers are saving more by cutting their spending despite falling prices. The Commerce Department said personal consumption expenditures fell 1.0% in December from the month before, while personal saving as a percentage of disposable income rose to 3.6% from 2.8% in November and reached its highest level since 4.8% in May 2008.

In response to the difficult consumer spending environment and the continued hit to sales expected from unfavorable foreign currency translation, Mattel is cutting capital spending and taking new steps to cut costs. They include outsourcing information technology, reducing the number of items in its product lineup and boosting direct procurement. Mattel in November cut 1,000 jobs worldwide, or about 3% of its work force, generating about $60 million in annual cost savings.

Chief Financial Officer Kevin Farr said Mattel is on track for goals of $90 million to $100 million of net cost savings in 2009 and $180 million to $200 million in savings by the end of 2010. Mattel also implemented mid-single-digit percentage price increases Jan. 1.

Capital spending will decline to below $150 million, from about $199 million in 2008 and Mattel expects to reduce its debt.

"Our priority is to protect the dividend, so you won't see a lot of activity from us in either repurchasing shares" or mergers and acquisitions, Eckert said. "This is a year really to hunker down and run the cash machine for cash."

Eckert noted significant toy retailers, such as KBToys in the U.S. and Woolworth's in the U.K., closed or filed for bankruptcy in 2008, while published reports said some 1,000 toy exporters in China closed last year.

Mattel's fourth-quarter net income fell $176.4 million, or 49 cents a share, down from $328.5 million, or 89 cents a share, a year earlier, which included a net 13-cent tax benefit.

Revenue decreased 11% to $1.94 billion, with nearly half the drop due to the stronger dollar. International sales dropped 20%, while sales in the slumping North American market fell 6%.

Analysts polled by Thomson Reuters expected earnings of 76 cents on revenue of $2.21 billion.

Gross margins fell to 46% from 48%. Many toy retailers had been cutting prices before Christmas in an effort to boost sales amid a challenging holiday season.

Fisher-Price sales fell 10% while Barbie, Mattel's flagship franchise, slumped 21% after a 1% drop in the third quarter. Mattel is working on revamping Barbie for her 50th anniversary this year to try to make the doll fashionable again with older girls, who are dropping her for other, edgier playthings like video games. Sales of Barbie products account for about one-fifth of the company's overall sales.

Sales for the Wheels category - which includes the Hot Wheels, Matchbox and Tyco R/C brands - declined 19%, while the entertainment business, which includes games and puzzles, fell 17%.

American Girl Brands, Mattel's expanding high-end doll unit, saw sales rise 5%.

One potential threat to its doll franchises could be eased through its court victory over MGA Entertainment related to the Bratz dolls that MGA sells but were created by a former Mattel employee while still on the payroll there. Mattel lost one round in the legal fight last month when a federal judge ruled MGA could sell Bratz dolls through 2009 before turning the franchise over to Mattel. The ruling stayed a previous decision that would have forced MGA to give up control as soon as this month.

By Mattel's estimates, retail inventories of the company's goods ended 2008 up mid- to high-single digit percentages, and Eckert expects retailers to continue managing inventories conservatively. Mattel ended the year with inventory up 13%, but about half of the increase was tied to higher costs and Eckert said he was generally pleased with Mattel's ability to pull back on production.

"Across the board, I'm pretty comfortable with our inventories right now," he said. "If you look at the sales decline in the fourth quarter, it was sizable and quick, and given our lead time, either retailers or Mattel could have been hung with significant inventory and neither of us were."

-By Mary Ellen Lloyd, Dow Jones Newswires; 704-948-9145; maryellen.lloyd@dowjones.com

(Kerry E. Grace contributed to this report.)

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