Mattel, Inc. 2016 Q3 Form 10-Q Summary
Business context and reporting period
Mattel designs, manufactures, and markets toys globally, including Barbie, Fisher-Price, Hot Wheels, American Girl, MEGA, and entertainment-related products. This unaudited filing covers the three and nine months ended September 30, 2016. The business is seasonal, with a significant portion of toy purchases occurring during the holiday season; interim results are therefore not necessarily indicative of full-year performance.
Key financial metrics
| Metric | Q3 2016 | Q3 2015 | 9M 2016 | 9M 2015 |
|---|---|---|---|---|
| Net sales | $1.796 billion | $1.792 billion | $3.622 billion | $3.703 billion |
| Gross profit | $870.8 million | $879.6 million | $1.693 billion | $1.803 billion |
| Gross margin | 48.5% | 49.1% | 46.7% | 48.7% |
| Operating income | $317.4 million | $300.8 million | $256.6 million | $246.9 million |
| Net income | $236.3 million | $223.8 million | $144.2 million | $154.3 million |
| Diluted EPS | $0.68 | $0.66 | $0.42 | $0.45 |
| Operating cash flow | Not separately provided | Not separately provided | $(331.3) million | $(222.3) million |
Q3 net sales and gross sales were essentially flat year over year despite approximately two percentage points of unfavorable currency impact. Q3 operating margin improved to 17.7% from 16.8%, while net margin was approximately 13.2% versus 12.5%. For the first nine months, operating margin increased to 7.1% from 6.7%, but net margin declined to approximately 4.0% from 4.2%.
- Q3 gross sales were $1.975 billion, compared with $1.983 billion in the prior-year quarter.
- Q3 advertising and promotion expense declined 5% to $202.9 million, and other selling and administrative expense declined 4% to $350.5 million.
- Q3 interest expense increased to $25.0 million from $21.4 million.
- Nine-month cash flow used in investing was $204.7 million, including $179.1 million of purchases of tools, dies, molds, and other property, plant, and equipment, plus $33.2 million for acquisitions.
- Cash and equivalents were $297.1 million at September 30, 2016, down from $892.8 million at December 31, 2015. Approximately $259 million was held by foreign subsidiaries.
- Accounts receivable were $1.529 billion and inventories were $910.5 million at September 30, 2016.
- Total debt, including the current portion, was approximately $2.433 billion, compared with $2.101 billion at September 30, 2015. Debt-to-total capital increased to 50.2% from 46.6%.
- Mattel declared quarterly dividends of $0.38 per share; $388.5 million was paid during the first nine months.
Material changes versus the prior comparable period
- Q3 net income increased 6% and diluted EPS increased from $0.66 to $0.68, primarily due to lower advertising and selling and administrative expenses and higher licensing income.
- Q3 gross margin declined 60 basis points because of unfavorable foreign exchange, product mix, and higher input costs, partly offset by pricing and cost savings.
- First-nine-month net sales declined 2%, gross profit declined 6%, and net income declined 7% despite a 4% increase in operating income. Higher interest expense, foreign-exchange-related costs, and other non-operating expense more than offset operating improvement.
- First-nine-month gross sales declined 3%, primarily because of a 56% decline in Other Girls products, with approximately half of that decline attributed to lower Disney Princess sales. Barbie, Entertainment, Fisher-Price, and Construction and Arts & Crafts products grew.
- North America gross sales were flat in Q3 and increased 1% for the first nine months; International gross sales declined 3% in Q3 and 7% for the first nine months; American Girl gross sales increased 13% in Q3 but declined 5% for the first nine months.
- Segment income improved substantially in Q3 for North America, International, and American Girl. American Girl segment income increased 293% in Q3 and 289% for the first nine months, primarily because of higher licensing income.
- Mattel issued $350 million of 2.35% senior unsecured notes due 2021. Proceeds were intended primarily to repay $300 million of 2011 Senior Notes due in November 2016 and for general corporate purposes.
Guidance, outlook, commentary, risks, and unusual items
Management did not provide a specific quantitative full-year sales or earnings forecast in the filing. Management stated that Q3 performance reflected continuing progress on turnaround efforts, improving consumer takeaway trends, core-brand strength, and progress toward cost-reduction objectives. The company’s stated strategic priorities include strengthening brand franchises, improving commercial execution, reducing costs, and expanding emerging-market leadership.
- The Funding Our Future program targets cumulative gross cost savings of approximately $250 million to $300 million by the end of 2016. Mattel reported approximately $31 million of gross savings in Q3 and $108 million for the first nine months, or approximately $28 million and $92 million of net savings, respectively.
- Mattel expects its cash, $1.60 billion revolving credit facility, and foreign credit lines to meet 2016 seasonal financing needs. The credit facility matures in 2020 and permits an accordion increase to $1.85 billion under specified conditions.
- At September 30, 2016, Mattel complied with debt covenants. Its debt-to-Consolidated EBITDA ratio was 2.87-to-1 versus a 3.50-to-1 maximum, and its interest coverage ratio was 9.19-to-1 versus a 3.50-to-1 minimum.
- First-nine-month operating cash flow was negative because of working-capital usage, including increases in accounts receivable and inventory. The company’s capital framework targets approximately $800 million to $1 billion of year-end cash and annual capital expenditures of $180 million to $200 million.
- Mattel recognized an approximately $26 million unrealized foreign-exchange loss in Q1 from changing the Venezuelan remeasurement rate. Venezuela contributed less than 0.01% of nine-month consolidated sales, but a future deterioration could result in a pre-tax charge of up to $71 million.
- Foreign currency transaction losses were $114.5 million for the first nine months, compared with net gains of $1.7 million in the prior-year period. The company estimates that a 1% change in the U.S. dollar Trade-Weighted Index could affect annual sales by approximately 0.5% and full-year EPS by approximately $0.01 to $0.02, assuming other factors remain constant.
- Brexit-related currency volatility could affect the company’s United Kingdom operations, which represented approximately 5% of nine-month consolidated sales.
- Mattel completed acquisitions of Sproutling and substantially all assets of Fuhu for aggregate consideration of approximately $33.2 million. Final purchase accounting remained subject to adjustment.
- Potential contingencies include the MGA trade-secret litigation, for which management assessed a reasonably possible loss range of $0 to approximately $12.5 million plus up to approximately $10 million of prejudgment interest, with no accrual because loss was not considered probable. A Brazilian litigation matter had a reasonably possible loss range of up to approximately $14 million, subject to an offset of approximately $6.1 million; no liability was accrued.
- Management reported effective disclosure controls and no material changes to internal control over financial reporting. The risk factors were unchanged from the 2015 Form 10-K.
Important facts for investors to verify
- Whether Q4 holiday demand and new products offset continued weakness in Other Girls products and the loss of Disney Princess.
- Whether gross-margin pressure from currency, product mix, and input costs persists or reverses.
- Cash conversion and working-capital performance, particularly the elevated accounts receivable and inventory balances.
- Repayment or refinancing of the $300 million of 2011 Senior Notes due in November 2016 and the resulting interest burden.
- Progress toward the $250 million to $300 million Funding Our Future savings target and whether savings are sustainable.
- International demand, foreign-exchange exposure, Brexit effects, and Venezuela-related downside risk.
- Final purchase accounting and operating contribution from Fuhu and Sproutling.
- Developments in the MGA and Yellowstone litigation matters and any related accruals or cash requirements.
- The impact of pending revenue recognition, inventory, lease, share-based payment, and cash-flow accounting standards.