Mattel, Inc. 2017 Form 10-K Summary
Business context and reporting period
Mattel designs, manufactures, and markets toys worldwide, including Barbie, Hot Wheels, Fisher-Price, Thomas & Friends, American Girl, MEGA, and licensed entertainment products. The filing covers the fiscal year ended December 31, 2017, with quarterly information provided for the fourth quarter. Operating segments are North America, International, and American Girl.
Mattel’s strategy centers on strengthening core brands, expanding emerging markets and digital offerings, improving innovation, simplifying operations, and restructuring its organization. The business is highly seasonal, with a significant portion of sales generated during the third and fourth quarters.
Key financial metrics
| Metric | 2017 | 2016 | Change |
|---|---|---|---|
| Net sales | $4.882 billion | $5.457 billion | Down 11% |
| Gross profit | $1.821 billion | $2.554 billion | Down 29% |
| Gross margin | 37.3% | 46.8% | Down 950 basis points |
| Operating income/(loss) | $(342.8) million | $519.2 million | Turned to loss |
| Net income/(loss) | $(1.054) billion | $318.0 million | Turned to loss |
| Diluted EPS | $(3.07) | $0.92 | Declined |
| Cash flow from operations | $(27.6) million | $594.5 million | Declined $622.1 million |
| Cash and equivalents | $1.079 billion | $869.5 million | Increased $209.7 million |
| Total debt | $3.123 billion | $2.327 billion | Increased approximately $797 million |
| Debt-to-total capitalization | 71.3% | 49.1% | Increased |
2017 investing cash outflows were $235.7 million, primarily reflecting capital spending. Financing cash inflows were $458.5 million, principally due to the December 2017 issuance of $1.0 billion of senior notes. Capital expenditures included $128.9 million for tools, dies, and molds and $168.2 million for other property, plant, and equipment.
At December 31, 2017, accounts receivable were $1.129 billion, inventory was $600.7 million, and stockholders’ equity was $1.257 billion. The inventory obsolescence reserve increased to $118.4 million, or 16.8% of total inventory, from $36.8 million, or 5.5%, in 2016.
Material changes versus the prior comparable period
- Gross sales declined 9% to $5.514 billion; net sales declined 11% after sales adjustments. North America gross sales fell 16%, International gross sales increased 2%, and American Girl gross sales fell 20%.
- Brand performance was mixed: Entertainment gross sales increased 12%, while Other Girls declined 36%, American Girl declined 21%, Construction and Arts & Crafts declined 29%, and Fisher-Price Brands declined 11%.
- Gross margin contracted sharply due to higher inventory obsolescence, unfavorable product mix, increased freight and logistics costs, asset impairments, and the effect of the Toys “R” Us bankruptcy.
- Toys “R” Us filed for Chapter 11 in September 2017. Mattel reversed approximately $47 million of gross sales and $43 million of net sales and reduced shipments during the second half of the year. Toys “R” Us represented 8% of 2017 net sales versus 11% in 2016.
- Advertising and promotion expense increased to $642.3 million, or 13.2% of net sales, from $634.9 million, or 11.6%. Other selling and administrative expense increased to $1.521 billion, or 31.2% of net sales.
- Mattel recorded a $59.0 million loss related to the discontinuation of its Venezuelan operations and approximately $56.3 million of asset impairment charges.
- The income tax provision increased to $548.8 million. This included approximately $454.4 million of net tax expense, primarily from a valuation allowance on U.S. deferred tax assets and a provisional estimate of U.S. Tax Reform effects.
- The quarterly dividend was suspended beginning in the fourth quarter of 2017. Dividends paid declined to $312.0 million from $518.5 million in 2016; no share repurchases were made.
Guidance, outlook, management commentary, risks, and unusual items
Mattel announced a Structural Simplification Cost Savings program targeting at least $650 million of net savings by 2020, with approximately 40% expected in 2018 and the remainder in 2019. The program includes manufacturing and SKU simplification, organizational restructuring, headcount reductions, and advertising optimization. Mattel recorded $45.1 million of related severance and termination charges in 2017 and expects approximately $160 million of such charges during 2018 and 2019. The filing cautions that expected savings may not be achieved or may be offset by lower sales or higher expenses.
Mattel issued $1.0 billion of 6.75% senior unsecured notes due December 31, 2025. It also entered into new senior secured revolving credit facilities totaling $1.60 billion, subject to borrowing-base capacity, maturing December 20, 2020. No amounts were outstanding under these facilities at year-end, and Mattel stated that cash, available facilities, and foreign credit lines should be adequate for 2018 seasonal financing needs.
Liquidity remains a key risk because operating cash flow was negative, debt increased materially, credit ratings were downgraded, and $250 million of long-term debt is scheduled to mature in 2018. Contractual obligations totaled approximately $6.21 billion, including $3.15 billion of long-term debt principal, $1.40 billion of interest, $580.6 million of operating leases, $321.5 million of licensing minimums, and $358.8 million of purchase obligations.
Additional material risks include customer concentration, retailer bankruptcies, rapidly changing consumer preferences, intense competition, licensing dependence, foreign currency volatility, product safety and recalls, supply-chain disruption, commodity and freight costs, cybersecurity and privacy regulation, litigation, tax uncertainty, and potential goodwill or intangible-asset impairment. The International goodwill reporting unit was identified as relatively close to its impairment threshold, with estimated fair value approximately 1.08 times carrying value after the fourth-quarter reassessment.
Pending matters include a securities class action and related derivative action for which a loss estimate could not be made, and litigation in Brazil for which a reasonably possible loss was estimated at up to approximately $18.0 million before a potential counterclaim offset. In February 2018, a court granted Mattel summary judgment in the MGA matter; Mattel expected a final judgment in its favor, subject to possible appeal, and had accrued no liability.
The company expects a cumulative-effect reduction of approximately $29 million to opening retained earnings upon adoption of the new revenue standard on January 1, 2018. Adoption of the new lease standard in 2019 is preliminarily expected to have a material effect on the balance sheet.
Most important facts for an investor to verify
- Whether the Structural Simplification program delivers the targeted $650 million of savings and the level of associated restructuring cash costs.
- Whether revenue and margins stabilize after the Toys “R” Us disruption and the deterioration in American Girl, Other Girls, Fisher-Price, and MEGA-related products.
- Mattel’s ability to generate positive operating cash flow and refinance or repay upcoming debt maturities while maintaining seasonal liquidity.
- The impact of the dividend suspension, credit-rating downgrades, and elevated 71.3% debt-to-total-capitalization ratio.
- Changes in customer credit exposure, particularly Toys “R” Us, which represented approximately 5% of total accounts receivable as of February 23, 2018.
- Future tax expense and cash-tax effects as Mattel finalizes its accounting for U.S. Tax Reform and evaluates the realizability of deferred tax assets.
- Potential impairment of International goodwill and other intangible assets if sales or gross-margin forecasts are not achieved.
- Outcomes of the securities litigation, Brazilian litigation, tax audits, licensing commitments, and other contingencies.