Mattel, Inc. 2018 Q3 Form 10-Q Summary
Business context and reporting period
Mattel is a global toy and children’s entertainment company with North America, International, and American Girl operating segments. This unaudited Form 10-Q covers the quarter and nine months ended September 30, 2018. Results are seasonal, with a significant portion of sales occurring during the holiday period.
Mattel reorganized its brand and regional reporting in 2018. Its principal brands include Barbie, Hot Wheels, Fisher-Price and Thomas & Friends, American Girl, and Toy Box owned and partner brands.
Key financial metrics
| Metric | Q3 2018 | Q3 2017 | 9M 2018 | 9M 2017 |
|---|---|---|---|---|
| Net sales | $1.44 billion | $1.56 billion | $2.99 billion | $3.27 billion |
| Gross profit | $613.1 million | $647.2 million | $1.09 billion | $1.33 billion |
| Gross margin | 42.6% | 41.5% | 36.3% | 40.5% |
| Operating income (loss) | $121.9 million | $86.2 million | $(343.9) million | $(88.4) million |
| Net income (loss) | $6.3 million | $(603.2) million | $(545.9) million | $(772.6) million |
| Diluted EPS | $0.02 | $(1.75) | $(1.58) | $(2.25) |
| Operating cash flow | Not separately provided for the quarter | $(731.5) million | $(740.1) million |
- Q3 gross sales declined 6% to $1.61 billion; reported net sales declined 8%, partly because sales adjustments increased to $169.2 million from $149.2 million.
- Q3 operating margin improved to 8.5% from 5.5%, and gross margin expanded by 110 basis points. Management attributed the improvement primarily to approximately $63 million of Structural Simplification savings, price increases, lower freight and distribution costs, and the absence of the 2017 Toys “R” Us sales reversal.
- Nine-month gross margin fell 420 basis points to 36.3%, reflecting raw-material and plant-labor inflation, unfavorable product mix, and Toys “R” Us-related sales reversals and costs.
- Q3 interest expense increased 95% to $48.2 million; nine-month interest expense increased 94% to $132.7 million, driven by higher debt levels and interest rates.
Material changes versus the prior comparable period
- Q3 net sales declined 8%. North America gross sales rose 6%, while International and American Girl gross sales declined 16% and 32%, respectively.
- Brand performance was mixed: Q3 Barbie gross sales increased 14%, while Fisher-Price and Thomas & Friends declined 12%, American Girl declined 31%, and Toy Box declined 9%.
- For the first nine months, gross sales declined 6%. Barbie increased 15% and Hot Wheels increased 6%, but American Girl declined 28%, Fisher-Price and Thomas & Friends declined 12%, and Toy Box declined 14%.
- International segment income declined to $46.5 million in Q3 from $81.3 million and turned to a nine-month loss of $75.5 million versus income of $48.1 million. North America Q3 segment income increased to $186.7 million, but nine-month segment income declined to $54.0 million from $109.6 million.
- Mattel recorded approximately $66.8 million of nine-month charges related to the Toys “R” Us liquidation, comprising approximately $30 million of reversed 2018 sales and $37 million of bad debt expense, net. Q3 included approximately $13 million of bad debt recoveries.
- Q3 2017 included a $561.9 million discrete, non-cash tax expense related primarily to a valuation allowance on U.S. deferred tax assets. This charge largely explains the significant year-over-year improvement in Q3 net income and does not represent a comparable operating improvement.
- Mattel suspended its quarterly dividend beginning in Q4 2017. No dividends were declared in the first nine months of 2018, compared with $0.91 per common share in the comparable 2017 period.
Liquidity, debt, and capital resources
- Cash and equivalents were $209.2 million at September 30, 2018, down from $1.08 billion at December 31, 2017; approximately $190 million was held by foreign subsidiaries.
- Mattel used $731.5 million of operating cash flow and $114.6 million for investing activities during the first nine months. Capital spending included $58.2 million for tools, dies, and molds and $52.9 million for other property, plant, and equipment.
- Total debt was approximately $3.12 billion, and debt represented 82.4% of total capitalization, compared with 66.6% at September 30, 2017. Stockholders’ equity declined to $666.4 million from $1.44 billion.
- Mattel had $275 million outstanding under its $1.60 billion senior secured revolving credit facilities at September 30, 2018. The facilities mature June 1, 2021; the fixed-charge coverage covenant was not in effect based on excess availability, and Mattel reported compliance with all covenants.
- Mattel issued $500 million of 6.75% senior unsecured notes due December 2025 in May 2018, repaid $250 million of 2013 Senior Notes in March, and redeemed $500 million of 2014 Senior Notes in June.
Outlook, management commentary, risks, and unusual items
- Mattel’s Structural Simplification program targets at least $650 million of cost savings by 2020. The company reported approximately $162 million of savings in the first nine months of 2018, before severance, investments, and cost inflation.
- Mattel recorded $103.9 million of restructuring charges in the first nine months and $149.1 million cumulatively; it expects total program charges of approximately $200 million.
- Management stated that raw-material inflation and foreign-exchange volatility were higher than initially projected and continued to assess manufacturing footprint and supply-chain savings.
- International goodwill was not impaired, but the International reporting unit was identified as at risk; its estimated fair value was approximately 1.24 times carrying value. Lower-than-expected demand, sales growth, or gross-margin improvement could result in future impairment.
- Mattel’s principal risks include the continuing effects of the Toys “R” Us liquidation, concentrated retail customers, seasonal working-capital needs, negative operating cash flow, substantial leverage, foreign-exchange volatility, product and license competition, tariffs and trade-policy changes involving China, and execution risk associated with restructuring.
- Mattel manufactures or sources a substantial portion of finished goods from China. Tariffs had not materially affected its product categories as of the filing date, but future tariffs could reduce sales or margins.
- The company expects the new lease accounting standard, effective January 1, 2019, to have a material impact on its financial position, although the effect on operating results was not yet clear.
- Mattel reported an appeal related to the MGA securities and trade-secret litigation, a pending securities-law appeal, and continuing Brazilian litigation. The filing states that the potential loss in the securities litigation cannot reasonably be estimated and that no liability was accrued for the MGA matter.
- Goodwill testing found no impairment, and disclosure controls and procedures were assessed as effective as of September 30, 2018.
Important facts for investors to verify
- Whether holiday-season sales, particularly Barbie and Hot Wheels, offset continued weakness in International, American Girl, Fisher-Price, and partner brands.
- Whether Structural Simplification savings continue to exceed restructuring charges, inflation, freight costs, and foreign-exchange headwinds.
- Mattel’s ability to generate positive operating cash flow and reduce reliance on seasonal borrowings.
- Debt maturities, interest costs, borrowing-base availability, and compliance with the senior secured revolving credit facilities.
- The ultimate impact of Toys “R” Us receivable recoveries, customer concentration, and retailer inventory policies.
- Potential goodwill impairment in the International reporting unit and the effect of tariffs or other China-U.S. trade measures.
- Final tax accounting under the Tax Cuts and Jobs Act and any changes to U.S. deferred-tax-asset valuation allowances.
- Material developments in the MGA, securities litigation, and Yellowstone litigation, including any settlement or appeal outcomes.