Mattel, Inc. 2012 Third-Quarter Form 10-Q Summary
Business Context and Reporting Period
Mattel designs, manufactures, markets, and sells toys and entertainment products worldwide, including Mattel Girls & Boys Brands, Fisher-Price Brands, and American Girl Brands. This unaudited Form 10-Q covers the three and nine months ended September 30, 2012. The business is seasonal, so interim results are not necessarily indicative of full-year results.
Effective January 1, 2012, Mattel reorganized its operating segments into North America, International, and American Girl. Prior-period amounts were reclassified to conform to the new presentation.
Key Financial Metrics
| Metric | Q3 2012 | Q3 2011 | 9M 2012 | 9M 2011 |
|---|---|---|---|---|
| Net sales | $2.078 billion | $1.999 billion | $4.165 billion | $4.112 billion |
| Gross profit | $1.115 billion | $956.1 million | $2.183 billion | $1.985 billion |
| Gross margin | 53.7% | 47.8% | 52.4% | 48.3% |
| Operating income | $487.4 million | $397.6 million | $647.5 million | $543.6 million |
| Operating margin | 23.5% | 19.9% | 15.5% | 13.2% |
| Net income | $365.9 million | $300.8 million | $470.0 million | $397.9 million |
| Diluted EPS | $1.04 | $0.86 | $1.35 | $1.12 |
Q3 net sales increased 4%, while nine-month sales increased 1%. Q3 gross profit increased 17%, operating income increased 23%, and net income increased 22%. Nine-month gross profit increased 10%, operating income increased 19%, and net income increased 18%.
Management attributed margin improvement primarily to favorable currency movements, product mix, manufacturing efficiencies, Operational Excellence 2.0 savings, price increases, and the HIT Entertainment acquisition. These benefits were partly offset by higher input costs and higher selling and administrative expenses.
Cash Flow, Liquidity, Debt, and Capital
- Net cash used in operating activities was $101.2 million for the first nine months of 2012, compared with $322.1 million used in the prior-year period. Working-capital usage remained significant, including $541.7 million of cash used for accounts receivable and $288.9 million for inventories.
- Net cash used in investing activities was $833.3 million, including $684.5 million for the HIT Entertainment acquisition and $156.6 million for tools, dies, molds, and other property, plant, and equipment.
- Net cash used in financing activities was $153.8 million, including $317.0 million of dividends, $38.9 million of share repurchases, and $50.0 million of long-term debt repayments.
- Cash and equivalents declined to $282.1 million at September 30, 2012 from $1.369 billion at December 31, 2011, primarily because of seasonal working-capital needs, the acquisition, dividends, and capital expenditures.
- Total long-term debt was $1.50 billion, including $350.0 million classified as current. Short-term borrowings were $154.5 million. The debt-to-total-capital ratio was 36.3%, compared with 33.0% at September 30, 2011.
- Mattel reported $1.34 billion of available borrowing capacity under its $1.40 billion revolving credit facility. It was in compliance with its debt covenants; debt-to-EBITDA was 1.3-to-1 versus a maximum of 3.0-to-1, and interest coverage was 14.8-to-1 versus a minimum of 3.50-to-1.
- Management’s capital framework targets approximately $800 million to $1.0 billion of year-end cash, a year-end debt-to-capital ratio of about 35%, annual capital expenditures of $180 million to $200 million, strategic acquisitions, and shareholder returns through dividends and repurchases.
Material Changes Versus the Prior Comparable Period
- HIT Entertainment was acquired on February 1, 2012 for total cash consideration of $713.5 million. The acquisition added $243.4 million of goodwill and $510.7 million of identifiable intangible assets. Mattel incurred approximately $14 million of integration costs and $6 million of transaction costs through September 30, 2012.
- Q3 segment gross sales increased 5% in North America, 2% internationally, and 12% for American Girl. Segment income increased 15% in North America and 24% internationally; American Girl segment income increased 59% in Q3 but declined 25% for the first nine months because of retail-expansion costs.
- Key growth drivers included Monster High, Fisher-Price, American Girl, Hot Wheels, Disney Princess, and licensing revenue associated with HIT. CARS 2-related sales declined because of the timing of the prior-year movie release.
- International gross sales growth was substantially affected by unfavorable currency movements, including an estimated nine-percentage-point headwind in Q3 and an eight-percentage-point headwind for the first nine months.
- Operational Excellence 2.0 generated approximately $20 million of gross savings in Q3 and $79 million in the first nine months, or approximately $17 million and $67 million net of severance and investments. Cumulative gross savings reached approximately $173 million through September 30, 2012, and management expected to slightly exceed its $175 million year-end target.
- Interest expense increased to $22.7 million in Q3 and $65.4 million for the first nine months, primarily because of the $600 million of senior notes issued in November 2011.
Guidance, Outlook, Commentary, and Risks
- Management’s stated objectives include sustaining gross margins of approximately 50%, lowering selling and administrative costs, generating significant cash flow, and deploying capital through investment, acquisitions, dividends, and repurchases. The filing does not provide specific full-year revenue or earnings guidance.
- Management expected total 2012 HIT transaction and integration costs of approximately $25 million to $30 million.
- Mattel identified risks from seasonal demand, economic conditions, consumer preferences, manufacturing and distribution costs, raw-material availability, foreign exchange, customer liquidity and credit, interest rates, pension obligations, debt covenants, and access to commercial paper and other financing.
- Mattel hedges portions of its foreign-currency exposure with forward contracts. As of September 30, 2012, notional amounts were approximately $1.33 billion. Management estimated that, holding other factors 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.
- Goodwill and indefinite-lived intangible assets were not impaired in the third-quarter tests. However, one indefinite-lived intangible asset with a carrying value of approximately $113 million had little excess fair value; lower-than-expected future cash flows could result in a future impairment charge.
- Mattel continued to contest the MGA litigation. A judgment totaling approximately $310 million had been entered in favor of MGA, including damages, punitive damages, and legal fees. Mattel appealed and had not accrued a liability because management did not believe it was probable that the damages would be sustained. An unfavorable outcome could materially affect financial condition and results.
- Tax authorities continued to examine prior-year returns. Mattel believed significant changes to unrecognized tax benefits were unlikely in the next 12 months, but stated that a settlement of a particular issue could materially affect the financial statements. Potential tax benefits of up to approximately $8 million could arise from certain state and foreign audits or expiring statutes of limitation.
- Disclosure controls were deemed effective as of September 30, 2012, although HIT Entertainment was excluded from the initial assessment while integration of its controls continued.
Important Facts for Investors to Verify
- Whether the substantial Q3 gross-margin expansion is sustainable after currency benefits, favorable mix, cost savings, and HIT-related effects normalize.
- The conversion of strong reported earnings into cash, particularly given negative nine-month operating cash flow and large receivables and inventory balances.
- The timing and funding of the $350 million current debt maturity and the company’s ability to rebuild seasonal cash balances.
- The final purchase accounting for HIT Entertainment, future integration costs, and the performance of acquired brands and intellectual property.
- The status and potential financial impact of the MGA appeal and related litigation.
- Exposure to foreign-currency movements, customer credit risk, input-cost inflation, and seasonal demand volatility.
- Whether Operational Excellence 2.0 savings exceed the stated $175 million target without impairing advertising, innovation, or brand investment.