Mattel, Inc. 2014 Second-Quarter Form 10-Q Summary
Business context and reporting period
Mattel designs, manufactures, and markets toys globally through North America, International, and American Girl segments. This quarterly report covers the three and six months ended June 30, 2014. Results are seasonal and are not necessarily indicative of full-year performance.
On April 30, 2014, Mattel acquired MEGA Brands for total cash consideration of approximately $454.9 million, including cash acquired. The acquisition added the Construction and Arts & Crafts category, including MEGA BLOKS, RoseArt, and Board Dudes.
Key financial metrics
| Metric | Three months ended June 30, 2014 | Three months ended June 30, 2013 | Six months ended June 30, 2014 | Six months ended June 30, 2013 |
|---|---|---|---|---|
| Net sales | $1,062.3 million | $1,169.1 million | $2,008.4 million | $2,164.7 million |
| Gross profit | $492.6 million | $600.0 million | $974.1 million | $1,140.1 million |
| Gross margin | 46.4% | 51.3% | 48.5% | 52.7% |
| Operating income | $1.0 million | $94.8 million | $7.2 million | $160.6 million |
| Net income | $28.3 million | $73.3 million | $17.1 million | $111.9 million |
| Diluted EPS | $0.08 | $0.21 | $0.05 | $0.32 |
| Operating cash flow | Not separately provided | Not separately provided | $(79.2) million | $(285.9) million |
Second-quarter cost of sales was $569.7 million, or 53.6% of net sales. Advertising and promotion expense was $99.9 million, while other selling and administrative expense was $391.7 million. The second-quarter income tax benefit was $42.7 million, including approximately $40.1 million of discrete tax benefits. The first-half tax benefit was $40.9 million, including approximately $36.4 million of discrete benefits.
At June 30, 2014, cash and equivalents were $518.2 million, accounts receivable were $878.9 million, and inventories were $885.4 million. Total assets were $6.48 billion and stockholders’ equity was $2.95 billion.
Long-term debt was $2.10 billion, compared with $1.60 billion at December 31, 2013. Mattel issued $500 million of 2.35% senior unsecured notes due May 2019. Short-term borrowings were $20.5 million. The company had a $1.60 billion revolving credit facility available and was in compliance with its financial covenants. Reported debt-to-EBITDA was 1.71 to 1 versus a maximum of 3.00 to 1, and interest coverage was 16.30 to 1 versus a minimum of 3.50 to 1.
Cash used in investing activities was $524.7 million in the first half, including $423.3 million for the MEGA Brands acquisition and $108.4 million for capital expenditures. Financing activities provided $83.1 million, including proceeds from long-term borrowings, while dividends paid were $257.7 million and share repurchases were $128.2 million.
Material changes versus the prior comparable period
- Second-quarter net sales declined 9%; first-half net sales declined 7%. Currency reduced second-quarter sales growth by approximately 1 percentage point and first-half sales by approximately 1 percentage point.
- Second-quarter gross margin fell 490 basis points to 46.4%; first-half gross margin fell 420 basis points to 48.5%. Management attributed the decline primarily to the MEGA Brands acquisition, inventory fair-value markup, close-out sales to reduce inventory, lower volume, unfavorable product mix, and higher input costs.
- Second-quarter operating income fell 99% to $1.0 million; first-half operating income fell 96% to $7.2 million. Other selling and administrative expense was essentially flat in the quarter but increased 2% for the first half due partly to approximately $21 million of incremental severance and termination costs and approximately $16 million of MEGA-related transaction, integration, and amortization costs.
- Worldwide gross sales declined 8% in the second quarter. Mattel Girls & Boys Brands declined 13%, Fisher-Price declined 17%, American Girl increased 6%, and Construction and Arts & Crafts contributed $61.6 million of sales. First-half gross sales declined 7%.
- North America segment income declined 53% in the quarter and 42% for the first half. International segment income declined 60% in the quarter and 55% for the first half. American Girl sales increased 5% in the quarter and first half, and first-half segment income increased 11%.
- Cash declined $521.0 million from December 31, 2013, primarily due to the MEGA acquisition, dividends, repurchases, and capital expenditures, partially offset by debt issuance. Inventory increased $316.6 million from year-end, while accounts receivable decreased $381.2 million.
- Mattel repurchased approximately 2.6 million shares during the second quarter at a cost of approximately $100 million. The quarterly dividend increased to $0.38 per share from $0.36.
Guidance, outlook, management commentary, risks, and unusual items
Management stated that second-quarter results did not meet expectations but emphasized progress on completing the MEGA acquisition, reducing inventory, strengthening management, shifting marketing spending toward the second half, and managing selling and administrative costs. Management expected to focus on new products, additional advertising investment, and improved marketing effectiveness during the second half and holiday season.
Mattel’s near-term objective is to sustain gross margins in the low-to-mid-50% range and exceed 50% over the long term. Its Operational Excellence 3.0 program targets approximately $175 million of cumulative gross savings by the end of 2014. Through June 30, 2014, cumulative gross savings were approximately $101 million; management stated it remained on track for the target.
The filing does not provide specific full-year revenue or earnings guidance. Mattel’s capital framework targets year-end cash of approximately $800 million to $1.0 billion, a year-end debt-to-capital ratio of approximately 35%, annual capital expenditures of approximately $180 million to $200 million, strategic acquisitions, and continued dividends and repurchases.
- Liquidity depends on seasonal cash generation, commercial paper, the revolving credit facility, foreign credit lines, and access to debt markets. Approximately $449 million of reported cash was held by foreign subsidiaries.
- Mattel is exposed to foreign currency, interest-rate, customer credit, inventory, pension, and counterparty risks. Foreign currency forward contracts had notional amounts of approximately $1.43 billion at June 30, 2014.
- For Venezuela, use of alternative exchange rates could have produced an estimated pre-tax charge of approximately $9 million under SICAD 1 or $19 million under SICAD 2. Mattel stated that ceasing Venezuelan operations could result in a pre-tax charge of up to $95 million.
- MGA filed a new trade-secrets claim seeking damages exceeding $1 billion. Mattel considered the risk of loss remote and recorded no liability.
- In the Yellowstone do Brasil matter, Mattel estimated a reasonably possible loss range of $0 to approximately $22 million, potentially offset by Mattel’s counterclaim. No liability was accrued because management did not believe a loss was probable.
- The IRS completed its audit of Mattel’s 2010 and 2011 federal returns. Mattel estimated that unrecognized tax benefits could decrease by approximately $38 million during the following twelve months, although ultimate settlements could materially affect the financial statements.
- MEGA Brands was excluded from the scope of the company’s disclosure-controls assessment as permitted for a recently acquired business. Management concluded that Mattel’s disclosure controls were effective as of June 30, 2014.
Most important facts for an investor to verify
- Whether MEGA Brands integration, purchase-accounting effects, and inventory normalization improve gross margins and earnings in subsequent quarters.
- Whether sales trends recover across Barbie, Fisher-Price, Entertainment, and other declining brands, particularly during the holiday season.
- Progress toward the $175 million Operational Excellence 3.0 savings target and the extent to which savings offset severance and other restructuring costs.
- Cash generation, inventory levels, debt repayment capacity, dividend sustainability, and compliance with revolving-credit covenants.
- Potential exposure from MGA litigation, Yellowstone do Brasil, tax audits, and Venezuelan currency restrictions.
- The effect of the $500 million senior-notes issuance and the resulting increase in debt-to-capital from 36.7% at June 30, 2013 to 41.8% at June 30, 2014.