Business Context and Reporting Period
Mattel, Inc. is a global children’s entertainment company designing, manufacturing, and marketing toys and consumer products, including Barbie, Hot Wheels, Fisher-Price, Thomas & Friends, American Girl, and licensed partner brands. This unaudited Form 10-Q covers the quarter and six months ended June 30, 2018; comparisons are with the corresponding 2017 periods. Results are seasonal, with a significant portion of toy purchases occurring during the holiday season.
Key Financial Metrics
| Metric | Three Months Ended June 30 | Six Months Ended June 30 |
|---|---|---|
| Net sales | $840.7 million, down 14% | $1.549 billion, down 9% |
| Gross profit | $253.2 million; 30.1% margin | $472.1 million; 30.5% margin |
| Prior-year gross margin | 41.0% | 39.7% |
| Operating loss | $189.2 million | $465.8 million |
| Net loss | $240.9 million, or $0.70 diluted loss per share | $552.2 million, or $1.60 diluted loss per share |
| Net cash used in operating activities | Not separately provided | $556.6 million |
| Cash and equivalents at June 30 | $228.6 million | |
| Total debt at June 30 | $2.93 billion, including $80.0 million of short-term borrowings |
Second-quarter gross sales were $954.1 million, down 11%, before $113.4 million of sales adjustments. First-half gross sales were $1.754 billion, down 7%, before $205.0 million of sales adjustments.
Cash used in investing activities was $85.2 million in the first half, including $78.3 million of capital spending. Cash used in financing activities was $198.0 million, compared with $51.5 million of financing cash provided in the prior-year period. Cash declined by $850.6 million from December 31, 2017, primarily because of operating losses and debt repayments.
Material Changes Versus the Prior Comparable Period
- Second-quarter net sales declined 14%; first-half net sales declined 9%. The Toys “R” Us liquidation was a significant factor, particularly in North America.
- Gross margin fell 1,090 basis points in the second quarter and 920 basis points in the first half. Management cited higher product costs, obsolescence, freight and logistics costs, unfavorable foreign exchange, higher sales adjustments, and the effect of Toys “R” Us sales reversals.
- Second-quarter operating loss widened from $49.0 million to $189.2 million; first-half operating loss widened from $174.6 million to $465.8 million.
- Interest expense increased to $43.5 million in the quarter and $84.5 million in the first half, driven by higher debt levels and interest rates.
- First-half other selling and administrative expenses increased 15% to $784.6 million, including approximately $50 million of net bad-debt expense related to Toys “R” Us and $72.7 million of restructuring charges.
- First-half segment losses were $132.7 million in North America, $122.0 million internationally, and $31.1 million for American Girl, compared with prior-year North America income of $23.4 million and smaller losses in the other segments.
- Brand performance was mixed: first-half Barbie and Hot Wheels gross sales increased 17% and 18%, respectively; Fisher-Price and Thomas & Friends declined 12%, American Girl declined 26%, and Toy Box declined 18%.
- Mattel repaid $250.0 million of 2013 Senior Notes and retired $500.0 million of 2014 Senior Notes using proceeds from $500.0 million of 2018 Senior Notes and cash on hand. Total debt decreased from $3.12 billion at December 31, 2017, but debt represented 81.5% of total capitalization at June 30, 2018.
- The quarterly dividend remained suspended. No shares were repurchased under the public repurchase program during the quarter.
Guidance, Outlook, Risks, Contingencies, and Unusual Items
- Mattel is pursuing a Structural Simplification Cost Savings program targeting at least $650 million of net savings by 2020. It realized approximately $42 million of savings in the first half, but expects higher raw-material inflation and foreign-exchange volatility than initially projected. Cumulative restructuring charges were $117.8 million, with approximately $200 million expected in total.
- Mattel stated that it believes liquidity is sufficient to fund business needs through operating cash flows, cash balances, revolving facilities, and other financing sources. The company had access to $1.60 billion of senior secured revolving credit facilities and had $80.0 million outstanding at June 30. The facilities mature June 1, 2021; Mattel was in compliance with covenants, and the fixed-charge coverage covenant was not in effect at quarter-end.
- Approximately $211 million of the $228.6 million cash balance was held by foreign subsidiaries. Continued operating losses, seasonal working-capital needs, debt service, and limited cash generation create liquidity and refinancing risks.
- Toys “R” Us-related items included approximately $30 million of first-quarter net-sales reversals, approximately $50 million of first-half bad-debt expense on outstanding receivables, and an approximately $87 million receivables write-off in the first quarter. Mattel recorded approximately $7 million of net recoveries in the second quarter.
- Mattel expects approximately $4 million of additional pension and postretirement contributions during the remainder of 2018, after approximately $17 million contributed in the first half.
- The company maintains a valuation allowance on U.S. deferred tax assets. The accounting for certain Tax Cuts and Jobs Act effects, including deemed repatriation, remained incomplete at June 30, 2018.
- MGA filed an appeal following Mattel’s successful summary judgment ruling in March 2018. Mattel does not presently believe damages are reasonably possible and has accrued no liability. A Brazilian commercial dispute was settled for 5.0 million Brazilian real, with an approximately $1.5 million reserve recorded.
- A securities class action was dismissed, and the plaintiff indicated it would not amend the complaint; an appeal remained possible. A related derivative action was stayed. Mattel stated that a possible loss could not be reasonably estimated.
- Key ongoing risks include customer concentration and retailer distress, product demand and inventory exposure, foreign currency movements, commodity and transportation costs, competition, licensing, product liability and recalls, financing access, debt covenants, litigation, tariffs and regulatory changes, and execution of cost-saving initiatives.
Investor Verification Priorities
- Verify the pace and sustainability of revenue recovery after the Toys “R” Us liquidation and the effect of retailer inventory policies.
- Reconcile reported net sales with gross sales and sales adjustments, particularly the elevated adjustment rate in 2018.
- Assess whether gross-margin pressure from freight, obsolescence, product costs, foreign exchange, and retailer-related charges is temporary or structural.
- Monitor operating cash burn, seasonal borrowing needs, cash held overseas, debt maturities, interest expense, and compliance with revolving-credit covenants.
- Track delivery of the $650 million cost-savings target against restructuring charges, inflation, and foreign-exchange headwinds.
- Review the final accounting for Tax Cuts and Jobs Act items and the potential utilization of U.S. deferred tax assets.
- Follow the MGA appeal, securities and derivative litigation, the Brazilian settlement approval, and other contingencies for changes in potential exposure.
- Confirm the effect of the 2018 revenue-recognition adoption, including the approximately $29 million reduction to opening retained earnings, on future licensing revenue timing.