Mattel Inc , the world's largest toy company, reported a bigger-than-expected fall in gross margins, hurt by a stronger dollar and higher costs, taking the gloss off a record jump in sales of its iconic Barbie dolls heading into the critical holiday season.

Toymakers are fighting to shield their margins from a rise in the cost of raw materials like plastics and paper, and higher wages demanded by laborers in China, where a lot of U.S. companies make their toys.

Additionally, Mattel -- which gets roughly half its sales from international markets -- said a rise in the U.S. dollar against foreign currencies like the euro in September pulled down gross margins by about 180 basis points.

A stronger dollar, which brings down the value of exported goods by U.S. companies, is also likely to affect Hasbro Inc when it reports results on Monday -- though the company is less dependent on international sales.

The only issue we see with the company's results is the gross margin, which was below expectations and did not see the typical seasonal uplift from Q2 levels, MKM Partners analyst Eric Handler said.

Gross margins in the quarter fell to 47.8 percent from 51.1 percent in the year-ago period.

If the dollar stays at current levels against the euro, it's likely to be a headwind in the fourth quarter as well, Handler said.

While margins fell, the strong sales performance bodes well for Mattel as it heads into the crucial holiday season at a time of growing economic uncertainty.

Mattel's closely awaited toys this holiday season include Angry Birds Knock On Wood, a tabletop version of the highly popular game app for mobile phones, and the Monster High Dead Tired doll line that features offspring of famous monster characters themed on a pajama party.

Wedbush Securities analyst Edward Woo cautioned that the weak economic condition in Europe -- which until now have not really been reflected in toymakers' results -- could hurt sales of toys during the holidays.

Just because the (European) economy hasn't hurt results, does not mean that it won't in the future as well ... right now, we don't know one way or the other, Woo said.

Q3 SALES BEAT

Third-quarter net income was $300.8 million, or 86 cents a share, compared with $283.3 million, or 77 cents a share, a year ago.

Net sales rose 9 percent to $2.0 billion. Barbie sales were up 17 percent in the quarter -- their highest percentage rise in more than a decade. Sales of Other Girls Brands, which include the Monster High and Disney Princess doll lines, were up 32 percent.

Analysts, on average, had expected earnings of 86 cents a share, before special items, on revenue of $1.97 billion, according to Thomson Reuters I/B/E/S.

The company also increased its stock repurchase program by $500 million.

Mattel's shares, which have risen 9 percent this year in contrast to a 27 percent fall in rival Hasbro, were down 1 percent at $27.52 on Friday on Nasdaq.

(Reporting by Mihir Dalal in Bangalore; Editing by Sriraj Kalluvila and Saumyadeb Chakrabarty)

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