Mattel, Inc. Form 10-Q Summary
Business Context and Reporting Period
Mattel designs, manufactures, and markets toys worldwide through North America, International, and American Girl segments. This quarterly report covers the three and nine months ended September 30, 2014. Results are seasonal, with a significant portion of toy purchases occurring during the holiday period.
Mattel acquired MEGA Brands on April 30, 2014, adding Construction and Arts & Crafts brands, including MEGA BLOKS, RoseArt, and Board Dudes.
Key Financial Metrics
| Metric | Q3 2014 | Q3 2013 | Change |
|---|---|---|---|
| Net sales | $2.021 billion | $2.207 billion | Down 8% |
| Gross profit | $1.021 billion | $1.188 billion | Down 14% |
| Gross margin | 50.5% | 53.8% | Down 330 bps |
| Operating income | $409.5 million | $528.2 million | Down 22% |
| Operating margin | 20.3% | 23.9% | Down 360 bps |
| Net income | $331.8 million | $422.8 million | Down 22% |
| Diluted EPS | $0.97 | $1.21 | Down $0.24 |
| Dividend per share | $0.38 | $0.36 | Up 6% |
| Metric | Nine Months 2014 | Nine Months 2013 | Change |
|---|---|---|---|
| Net sales | $4.030 billion | $4.372 billion | Down 8% |
| Gross profit | $1.995 billion | $2.328 billion | Down 14% |
| Gross margin | 49.5% | 53.3% | Down 380 bps |
| Operating income | $416.7 million | $688.8 million | Down 40% |
| Operating margin | 10.3% | 15.8% | Down 550 bps |
| Net income | $348.9 million | $534.7 million | Down 35% |
| Diluted EPS | $1.02 | $1.52 | Down $0.50 |
For the first nine months, cash flow used in operating activities was $144.3 million, versus $321.3 million used in the prior-year period. Investing cash flow used was $604.4 million, including $423.3 million for the MEGA Brands acquisition. Financing cash flow used was $20.1 million, including $386.4 million of dividends and $128.2 million of share repurchases.
Cash and equivalents were $262.2 million at September 30, 2014, down from $1.039 billion at December 31, 2013. Accounts receivable were $1.690 billion and inventories were $826.8 million. Long-term debt was $2.100 billion, compared with $1.600 billion at December 31, 2013. Mattel issued $500 million of 2.35% senior notes due May 2019. Debt-to-total capital was 41.2%, above the company’s approximately 35% year-end objective.
Mattel had $1.60 billion of available capacity under its committed revolving credit facility and was in compliance with its covenants. The reported debt-to-EBITDA ratio was 1.89 to 1, versus a maximum of 3.00 to 1; the interest coverage ratio was 14.68 to 1, versus a minimum of 3.50 to 1.
Material Changes Versus the Prior Comparable Period
- Gross sales declined 7% in both the quarter and nine-month period; currency reduced reported growth by approximately one percentage point in the quarter and two percentage points for the International segment year to date.
- Q3 gross sales declined in Mattel Girls & Boys Brands by 11% and Fisher-Price Brands by 16%; American Girl declined 8%. Construction and Arts & Crafts generated $123.4 million of Q3 gross sales following the MEGA Brands acquisition.
- Significant Q3 brand declines included Barbie, down 21%, and Entertainment, down 23%. Wheels increased 4%.
- Lower sales volume, unfavorable product mix, efforts to improve consumer takeaway, fixed-cost deleveraging, and MEGA Brands inventory fair-value adjustments reduced gross margin.
- Advertising and promotion expense declined 12% in Q3 as spending was shifted toward the fourth quarter. Other selling and administrative expense declined 4%, although it included approximately $15 million of MEGA integration and amortization costs.
- Mattel recognized $51.4 million of net discrete tax benefits in the first nine months of 2014, compared with $32.2 million in the prior-year period, contributing to the lower effective tax burden.
- Accumulated other comprehensive loss increased to $492.7 million, primarily from currency translation losses.
Guidance, Outlook, Risks, and Unusual Items
Management stated that third-quarter results were below expectations. Mattel expects to maintain near-term gross margins in the low-to-mid 50% range and long-term gross margins above 50%. It remained on track for approximately $175 million of cumulative gross cost savings from Operational Excellence 3.0 by year-end 2014; cumulative gross savings were approximately $142 million through September 30.
- MEGA Brands produced new revenue but also caused integration, amortization, transaction, and inventory fair-value costs. Purchase accounting remained subject to final valuation adjustments.
- Mattel faces seasonal working-capital needs and relies on cash, commercial paper, short-term borrowings, and its revolving credit facility. Lower demand, retailer inventory controls, customer liquidity, input costs, currency movements, and credit-market conditions could pressure liquidity.
- Currency exposure is material. Foreign currency forward contracts had approximately $1.11 billion of notional value at September 30, 2014. A 1% change in the U.S. dollar Trade-Weighted Index was estimated to affect net sales by approximately 0.5% and full-year EPS by approximately $0.01 to $0.02, assuming other factors remain constant.
- Mattel reported a new MGA trade-secrets lawsuit seeking damages exceeding $1 billion but assessed the loss risk as remote and recorded no liability. A Brazil litigation matter had a reasonably possible loss range of $0 to approximately $21 million, with no accrual recorded.
- Venezuelan operations were less than 0.1% of consolidated sales but had approximately $22 million of bolivar-denominated net monetary assets. Use of alternative exchange rates could have produced pre-tax charges of approximately $10 million or $19 million; ceasing operations could result in a charge of up to $95 million.
- The filing states that there were no material changes to previously disclosed risk factors. Disclosure controls were deemed effective, excluding MEGA Brands from the assessment as permitted for a recently acquired business.
Important Facts for Investors to Verify
- Whether holiday-quarter advertising and promotional shifts improve Barbie, Entertainment, and Fisher-Price sales and consumer takeaway.
- Whether gross margins recover toward management’s low-to-mid 50% near-term objective after MEGA-related purchase-accounting effects and mix pressure.
- MEGA Brands’ ongoing revenue contribution, integration costs, amortization, and final purchase-price allocation.
- Cash generation and seasonal liquidity, including the decline in cash, elevated receivables and inventories, and reliance on the revolving credit facility.
- Progress toward the $175 million Operational Excellence 3.0 savings target and the effect of severance and restructuring costs.
- Debt reduction prospects relative to the company’s approximately 35% year-end debt-to-capital objective.
- Developments in the MGA and Yellowstone litigation matters, tax audits, and Venezuelan currency restrictions.