Business Context and Reporting Period
Mattel, Inc. designs, manufactures, and markets toys globally, including Mattel Girls & Boys, Fisher-Price, and American Girl brands. This unaudited Form 10-Q covers the three and six months ended June 30, 2013, compared with the corresponding 2012 periods. Results are seasonal and interim results are not necessarily indicative of full-year performance.
Key Financial Metrics
| Metric | Q2 2013 | Q2 2012 | Six Months 2013 | Six Months 2012 |
|---|---|---|---|---|
| Net sales | $1.169 billion | $1.159 billion | $2.165 billion | $2.087 billion |
| Gross profit | $600.0 million | $594.5 million | $1.140 billion | $1.068 billion |
| Gross margin | 51.3% | 51.3% | 52.7% | 51.2% |
| Operating income | $94.8 million | $131.4 million | $160.6 million | $160.2 million |
| Net income | $73.3 million | $96.2 million | $111.9 million | $104.0 million |
| Diluted EPS | $0.21 | $0.28 | $0.32 | $0.30 |
| Operating cash flow | Not separately provided | Not separately provided | $(285.9) million | $(61.9) million |
- Q2 operating margin declined to 8.1% from 11.3%; first-half operating margin was 7.4% versus 7.7%.
- Cash and equivalents were $823.0 million at June 30, 2013, down from $1.336 billion at December 31, 2012; approximately $777 million was held by foreign subsidiaries.
- Inventory was $793.6 million, up from $465.1 million at year-end 2012, while accounts receivable declined to $945.7 million from $1.227 billion.
- Total long-term debt was $1.650 billion, including $50.0 million current debt. The company issued $500 million of 2013 Senior Notes and repaid $350 million of maturing 2008 Senior Notes.
- Mattel had $1.60 billion of available capacity under its committed revolving credit facility and was compliant with its covenants. Debt-to-EBITDA was 1.37x versus a 3.00x maximum; interest coverage was 14.53x versus a 3.50x minimum.
- Six-month investing cash outflow was $132.5 million, compared with $814.7 million in 2012, primarily because the 2012 period included the HIT Entertainment acquisition.
- Six-month financing cash outflow was $84.3 million, including $249.1 million of dividends and $150.8 million of share repurchases.
Material Changes Versus the Prior Comparable Period
- Q2 net sales increased 1%, while first-half net sales increased 4%; reported sales were not affected by currency changes in either comparison.
- Q2 operating income fell 28% because other selling and administrative expenses increased 12%, including higher strategic and employee-related costs and a $14 million asset impairment charge.
- First-half net income increased 8% despite essentially flat operating income, helped by lower interest expense and lower income taxes, including $15.2 million of discrete tax benefits.
- First-half gross margin expanded 150 basis points, reflecting product mix, price increases, and Operational Excellence 3.0 savings, partly offset by input costs and currency effects.
- Worldwide Q2 gross sales growth was led by Other Girls brands, up 23%, American Girl, up 14%, and Fisher-Price Friends, up 10%. Barbie declined 12%, and Wheels declined 6%.
- By segment, Q2 gross sales declined 3% in North America, increased 4% internationally, and increased 13% in American Girl. First-half segment income declined 10% in North America, increased 13% internationally, and improved from a $5.4 million loss to $7.2 million in American Girl.
- Operating cash flow deteriorated substantially because of seasonal working-capital use, particularly inventory and payments of accounts payable and accrued liabilities.
Guidance, Outlook, Risks, Contingencies, and Unusual Items
- Management’s objectives include sustaining gross margins in the low-to-mid 50% range near term and above 50% long term, improving operating margins, and generating significant cash flow.
- Operational Excellence 3.0 targets approximately $50 million of gross cost savings in 2013 and approximately $150 million cumulatively by the end of 2014. The company recorded approximately $9 million of gross savings in Q2 and $14 million in the first half.
- Management expects cash, credit facilities, commercial paper, and foreign credit lines to meet 2013 seasonal financing needs. The company’s capital framework targets $800 million to $1 billion of year-end cash, a year-end debt-to-capital ratio of approximately 35%, and annual capital expenditures of $180 million to $200 million.
- Mattel recorded a $14 million impairment charge on the Polly Pocket trade name after changing its brand strategy; the remaining asset was reclassified as amortizable.
- Foreign currency remains a material risk. Mattel estimates that, assuming other factors remain constant, a 1% change in the U.S. dollar Trade-Weighted Index could affect net sales by approximately 0.5% and full-year EPS by approximately $0.01 to $0.02.
- Mattel’s IRS appeals process remains unresolved. The company believes unrecognized tax benefits could decrease by approximately $185 million to $205 million over the next twelve months, plus approximately $9 million from state and foreign matters; ultimate outcomes could materially affect the financial statements.
- The MGA/Bratz litigation remains a contingency. Mattel accrued $137.8 million for affirmed copyright-related fees and costs. MGA’s separate trade-secret claim was vacated without prejudice and may be reasserted.
- In the Yellowstone do Brasil matter, Mattel believes a loss could range from $0 to approximately $20 million, but considers a loss not probable and has not accrued a liability.
- On July 17, 2013, the board authorized an additional $500 million for share repurchases and declared a third-quarter dividend of $0.36 per share.
Important Facts for Investors to Verify
- Whether seasonal inventory buildup converts into operating cash flow and whether year-end cash reaches management’s $800 million to $1 billion target.
- The sustainability of gross-margin gains and the execution and realization of Operational Excellence 3.0 savings.
- Whether higher strategic, employee-related, and other selling and administrative expenses moderate operating-margin recovery.
- Performance of Barbie, Wheels, Core Fisher-Price, and other mature brands relative to growth from Monster High, Thomas & Friends, and American Girl.
- Outcomes of IRS, state, and foreign tax audits and the potential effect of changes in unrecognized tax benefits.
- Developments in MGA/Bratz litigation and the Yellowstone do Brasil appeal.
- Foreign exchange exposure, including the company’s derivative positions and the effect of currency movements on international results and accumulated other comprehensive loss.
- The company’s ability to fund dividends and share repurchases while maintaining covenant compliance and targeted leverage.