UPDATE 2-Mega Brands posts smaller loss, sales decline

(Recasts, changes dateline, previous Toronto. In U.S. dollars unless noted)

OTTAWA, May 8 (Reuters) - Toy-maker Mega Brands Inc MB.TO reported a significantly smaller first-quarter loss on Thursday without last year's big recall charges, but sales slipped as it awaits the launch of a replacement for a key magnetic toy.

Attempting a turnaround after being badly hurt by several recalls of its magnet-based toys and shaky consumer confidence in the toy sector, Mega Brands said it lost $9.6 million, or 26 cents a share, in the period ended March 31.

That compares with a loss of $23.9 million, or 73 cents a share, in the same period last year, when it accounted for product recall and other charges of $35 million, or 69 cents a share.

Sales fell 12 percent to $79.1 million from $90.1 million on smaller shipments of boys’ movie-related products and magnetic construction toys.

“Mega Brands is looking to improve gross margins, particularly in the face of rising raw material, labor and testing costs,” said RBC Capital Markets analyst Sara O’Brien in a note. Gross margin fell to 35 percent from 44 percent.

The company will increase prices in the third and fourth quarters and launch new products, the analyst added.

Meanwhile, it has completed the integration of its North American distribution, which, combined with other efficiency measures it is working on, will generate $12 million in annual savings starting late in the second quarter.

Last week, Mega Brands named Anthony Bazan as its new chief operating officer. Bazan was previously an executive at toy manufacturer Jakks Pacific Inc JAKK.O and several consumer product firms.

The company also said the sale process for its stationery and activities unit is on track, but it won’t comment further until there are material developments. The business had sales of more than $200 million last year.

Mega Brands is still recovering from a recall of its Magnetix toys that began in 2006 and expanded in 2007. One child was killed and 27 others were seriously injured after swallowing small, powerful magnets that came loose.

The magnetic toys were acquired as part of its 2005 takeover of Rose Art.

The U.S. Consumer Product Safety Commission has notified Mega Brands that it is considering civil penalties related to its disclosure of Magnetix recalls. The company also said that a class action was filed in the United States, which it believes is without merit.

In the second half of 2008, Mega Brands will launch a new version of the Magnetix toy, called MagNext. It has embedded magnets and parts the company says cannot be swallowed.

In March, Mega Brands announced two separate recalls after reports of magnets coming loose from several toys manufactured in China. If multiple magnets are swallowed they can attract each other and cause intestinal tears and blockages, which can be fatal.

The company’s shares closed 16 Canadian cents lower at C$3.60 on the Toronto Stock Exchange on Wednesday. In the last 12 months, the stock has lost about 83 percent of its value.

$1=$1.02 Canadian With additional reporting by Leah Schnurr in Toronto; editing by Peter Galloway