Mattel, Inc. 2014 First-Quarter Form 10-Q Summary
Business context and reporting period
Mattel designs, manufactures, and markets toys worldwide, including Mattel Girls & Boys, Fisher-Price, and American Girl brands. This unaudited quarterly report covers the three months ended March 31, 2014, with comparison to March 31, 2013. Results are seasonal and are not necessarily indicative of full-year performance.
Key financial metrics
| Metric | Q1 2014 | Q1 2013 | Change |
|---|---|---|---|
| Net sales | $946.2 million | $995.6 million | Down 5% |
| Gross profit | $481.5 million | $540.1 million | Down 11% |
| Gross margin | 50.9% | 54.2% | Down 330 bps |
| Operating income | $6.2 million | $65.8 million | Down 91% |
| Operating margin | 0.7% | 6.6% | Down 590 bps |
| Net income | $(11.2) million | $38.5 million | Turned to loss |
| Diluted EPS | $(0.03) | $0.11 | Down $0.14 |
| Operating cash flow | $60.6 million | $(62.4) million | Improved $123.0 million |
| Capital expenditures | $43.8 million | $53.1 million | Down $9.3 million |
| Dividends per share | $0.38 | $0.36 | Up 6% |
Cost of sales increased 2% despite the sales decline, reducing gross margin. Advertising and promotion expense declined 13% to $90.8 million, while other selling and administrative expense increased 4% to $384.5 million, including approximately $16 million of incremental severance and termination-related costs. The filing also identifies approximately $22 million of severance and termination-related costs associated with workforce reductions.
Cash and equivalents were $897.3 million at March 31, 2014, down from $1.04 billion at December 31, 2013 and $1.26 billion at March 31, 2013. Approximately $788 million of the March 31, 2014 cash balance was held by foreign subsidiaries. Accounts receivable were $762.6 million and inventories were $650.8 million.
Total long-term debt was $1.60 billion, unchanged from December 31, 2013. Mattel had no short-term borrowings or current portion of long-term debt at March 31, 2014. The estimated fair value of long-term debt was $1.66 billion. The debt-to-total-capital ratio was 34.1%, compared with 35.2% a year earlier.
Material changes versus the prior comparable period
- Gross sales declined 4% to $1.04 billion; currency movements had an unfavorable one-percentage-point effect on both gross and net sales.
- Barbie gross sales declined 14%, primarily because of weaker consumer takeaway and elevated retail inventories.
- Fisher-Price Friends sales declined 12%, including lower sales of Disney Jake and the Never Land Pirates and Nickelodeon products.
- American Girl gross sales increased 5%, supported partly by the 2014 Girl of the Year, Isabelle.
- North America segment income declined 28% to $48.7 million; International segment income declined 49% to $31.5 million; American Girl segment income declined 23% to $9.2 million.
- Gross margin was pressured by close-out sales, inventory obsolescence, unfavorable product mix, and higher input costs, partly offset by price increases and cost savings.
- Operating cash flow improved primarily because of lower working-capital usage, although net income was lower.
- Financing cash flow changed from a $57.3 million inflow in Q1 2013 to a $168.9 million outflow in Q1 2014, primarily reflecting the absence of 2013 long-term borrowing proceeds and lower stock-option exercise proceeds.
Guidance, outlook, commentary, risks, and unusual items
Management stated that it was addressing higher carryover inventory, softer consumer takeaway, and the timing of trade spending and advertising. Management expects investments in Ever After High, BOOMco., and the planned MEGA Brands acquisition to support growth in 2014 and beyond. The filing does not provide specific full-year revenue or earnings guidance.
Mattel reported approximately $76 million of cumulative gross savings through March 31, 2014 under Operational Excellence 3.0 and remained on track for approximately $175 million of cumulative gross savings by year-end 2014. First-quarter gross savings were approximately $16 million, or approximately $8 million net of severance charges and investments.
Mattel had $1.60 billion of unused availability under its domestic revolving credit facility, maturing in March 2018, and was in compliance with its covenants. The debt-to-EBITDA ratio was 1.20 to 1 versus a maximum of 3.00 to 1, and the interest coverage ratio was 17.74 to 1 versus a minimum of 3.50 to 1.
Mattel agreed to acquire MEGA Brands for approximately $460 million, including net debt assumed or repaid, subject to customary closing conditions. The transaction was expected to close in the second quarter of 2014.
Material contingencies include a new MGA trade-secrets lawsuit seeking damages in excess of $1 billion. Mattel believes the claim should be barred and has not accrued a liability because it does not consider a loss probable. In the Yellowstone do Brasil matter, the company estimated a reasonably possible loss range of $0 to approximately $20 million, potentially offset by an approximately $8 million counterclaim; no liability was accrued.
Foreign-exchange and geopolitical risks remain significant. Mattel estimated that using the Venezuelan SICAD 1 rate at March 31, 2014 would have produced an approximately $9 million pretax charge, while using the SICAD 2 rate would have produced an approximately $19 million charge. If Venezuelan conditions materially worsen, the company indicated a potential pretax charge of up to $95 million.
The IRS was auditing Mattel's 2010 and 2011 federal tax returns. Mattel believed unrecognized tax benefits could decrease by approximately $40 million to $60 million over the following twelve months, although settlements could materially affect the financial statements.
Important facts for investors to verify
- Whether inventory reductions and related close-out sales and obsolescence charges normalize, and whether gross margin returns toward management's low-to-mid-50% near-term objective.
- The sustainability of sales trends in Barbie, Fisher-Price Friends, International markets, and the performance of new brands.
- Execution and realized savings from Operational Excellence 3.0, including the cost and timing of workforce reductions.
- Funding, integration, and financial impact of the approximately $460 million MEGA Brands acquisition.
- Cash accessibility, given that most cash was held by foreign subsidiaries, and continued availability under the $1.60 billion revolving credit facility.
- Developments in the MGA and Yellowstone litigation and any resulting accruals or cash payments.
- Venezuelan exchange-rate restrictions and potential impairment or exit costs.
- Dividend and share-repurchase capacity amid lower earnings and the planned acquisition.