Mattel, Inc. 2019 Q3 Form 10-Q Summary
Business context and reporting period
Mattel is a global toy and children’s entertainment company focused on brands including Barbie, Hot Wheels, Fisher-Price, Thomas & Friends, American Girl, MEGA, UNO, and licensed properties. The filing covers the quarter and nine months ended September 30, 2019. Results are seasonal, with a significant portion of sales occurring during the holiday period. The report was filed November 12, 2019.
Operating segments are North America, International, and American Girl. Mattel reorganized its revenue-category and international regional reporting in 2019 and reclassified prior-period amounts for comparability.
Key financial metrics
| Metric | Q3 2019 | Q3 2018 | 9M 2019 | 9M 2018 |
|---|---|---|---|---|
| Net sales | $1.482 billion | $1.437 billion | $3.031 billion | $2.991 billion |
| Gross profit | $686.4 million | $613.1 million | $1.268 billion | $1.089 billion |
| Gross margin | 46.3% | 42.6% | 41.8% | 36.4% |
| Operating income (loss) | $150.1 million | $121.9 million | $(28.3) million | $(339.9) million |
| Operating margin | 10.1% | 8.5% | (0.9)% | (11.4)% |
| Net income (loss) | $70.6 million | $6.3 million | $(213.7) million | $(542.9) million |
| Diluted EPS | $0.20 | $0.02 | $(0.62) | $(1.57) |
- Q3 net sales increased 3%; nine-month net sales increased 1%. Currency movements adversely affected reported growth by approximately 1 percentage point in Q3 and 3 percentage points year to date.
- Q3 gross sales increased 3% to $1.657 billion. Category growth was led by Vehicles, up 13%, and Action Figures, Building Sets, and Games, up 12%; Dolls rose 5%, while Infant, Toddler, and Preschool declined 11%.
- Q3 Power Brand trends included Barbie up 10% and Hot Wheels up 25%, partially offset by Fisher-Price and Thomas & Friends down 3%. American Girl gross sales declined 14%.
- Q3 gross margin increased 370 basis points, primarily from Structural Simplification savings, partly offset by unfavorable mix and input-cost inflation.
- Q3 other selling and administrative expense increased 12% to $366.0 million, principally because of higher incentive compensation associated with improved performance.
- For the first nine months, cost of sales declined 7% despite a 1% increase in net sales, and other selling and administrative expense declined 13% to $971.6 million.
Cash flow, liquidity, debt, and balance sheet
- Operating cash flow was a use of $513.7 million in the first nine months of 2019, compared with a use of $731.5 million in the prior-year period.
- Investing cash flow was a use of $78.4 million, including $75.7 million of purchases of tools, dies, molds, and other property, plant, and equipment.
- Financing cash flow provided $218.3 million, primarily reflecting net short-term borrowings.
- Cash and equivalents were $218.3 million at September 30, 2019, down from $594.5 million at December 31, 2018. Approximately $149 million was held by foreign subsidiaries.
- Accounts receivable were $1.291 billion and inventory was $701.6 million, reflecting seasonal working-capital needs.
- Total debt was approximately $3.087 billion, consisting of $230.0 million of short-term borrowings and $2.857 billion of long-term debt. Stockholders’ equity was $453.7 million, or 13% of debt plus equity capitalization.
- Mattel had $1.60 billion of senior secured revolving credit commitments, approximately $230 million drawn, and approximately $65 million of outstanding letters of credit. The facilities mature June 1, 2021. Mattel reported compliance with all covenants at September 30, 2019.
- A $250 million portion of the 2010 Senior Notes is due October 2020. Management intended to refinance it before maturity, while stating that cash and revolver capacity would be sufficient if refinancing were unavailable.
Material changes versus the prior comparable period
- Profitability improved substantially: Q3 net income rose from $6.3 million to $70.6 million, while the nine-month net loss narrowed by $329.3 million.
- Gross margin expanded 370 basis points in Q3 and 540 basis points year to date, driven primarily by cost savings and, year to date, favorable product mix.
- International segment income increased to $89.2 million in Q3 from $46.5 million and to $61.4 million for nine months from a $71.6 million loss.
- North America segment income increased to $194.4 million in Q3 from $186.7 million and to $202.9 million for nine months from $54.0 million.
- American Girl remained unprofitable, with a Q3 segment loss of $11.1 million and a nine-month loss of $41.4 million; nine-month gross sales declined 23%.
- Prior-year comparisons include approximately $66.8 million of Toys “R” Us-related sales reversal and bad-debt expense in the first nine months of 2018. The 2019 nine-month results include approximately $34 million related to Fisher-Price Rock ’n Play Sleeper recalls.
- Mattel revised previously issued quarterly financial statements for immaterial errors involving advertising-cost capitalization, sales adjustments, employee-related costs, taxes, and cash-flow classification. The revised Q3 2018 nine-month net loss was $(542.9) million.
Guidance, outlook, commentary, risks, and unusual items
- Management reported $826 million of run-rate Structural Simplification savings at September 30, 2019, exceeding the original $650 million two-year target, and expected more than $854 million by year-end 2019. Most savings were expected to be realized in 2020.
- Mattel expects approximately $179 million of total Structural Simplification restructuring charges and approximately $34 million of Capital Light restructuring charges. Capital Light is expected to generate approximately $50 million of run-rate savings exiting 2021.
- The Capital Light initiative is intended to optimize the manufacturing footprint, including possible facility sales or consolidation, improve plant productivity, and reduce supply-chain costs.
- Key risks include seasonal demand and retailer inventory decisions, concentrated customers, competition and licensing, product recalls and liability, tariffs and trade policy, foreign-exchange volatility, commodity and labor costs, access to financing, and execution of cost-saving programs.
- Pending matters include securities litigation, Rock ’n Play Sleeper product-liability and consumer litigation, and the Yellowstone do Brasil matter. Mattel stated that reasonable loss estimates were not available for the securities and Sleeper matters; the Yellowstone reserve was not material. Mattel reported a favorable October 2019 appellate decision in the MGA litigation and no reasonably possible damages.
- Goodwill was not impaired in the third-quarter 2019 annual test. American Girl had approximately 30% excess fair value over carrying value, while International had more than 30%; failure to achieve expected sales and margin improvements could result in future impairment.
- Disclosure controls and procedures were not effective as of September 30, 2019 because of an existing material weakness in internal control over financial reporting. Management was implementing remediation, but additional time and testing were required before the weakness could be considered remediated.
- The filing identifies no material changes to the risk factors in the 2018 Form 10-K/A. Brexit-related currency, tariff, trade, and regulatory uncertainty remained a risk; U.K. operations represented less than 5% of nine-month consolidated sales.
Most important facts for investors to verify
- Whether Q4 holiday execution and 2020 demand convert the improved Q3 margins into sustainable full-year profitability and positive operating cash flow.
- Progress toward the stated $854 million Structural Simplification run-rate savings target and the timing and cost of the Capital Light initiative.
- Liquidity and refinancing plans for the $250 million October 2020 Senior Notes, including revolver availability and covenant headroom.
- Recovery in American Girl and Infant, Toddler, and Preschool, given their continuing sales declines.
- Financial exposure from Rock ’n Play Sleeper litigation, securities litigation, product recalls, and other contingencies.
- Remediation and auditor validation of the material weakness in internal controls, including whether further quarterly revisions are required.
- Foreign-exchange effects, retailer concentration, customer credit quality, and inventory levels during the seasonal holiday build.