Mattel, Inc. 2019 First-Quarter Form 10-Q Summary
Business Context and Reporting Period
Mattel, Inc. designs, manufactures, and markets toys and children’s entertainment products globally, including Barbie, Hot Wheels, Fisher-Price, Thomas & Friends, American Girl, MEGA, and UNO. The filing covers the three months ended March 31, 2019. The business is seasonal, with a substantial portion of annual sales generally occurring during the holiday season; first-quarter results are therefore not necessarily indicative of full-year performance.
Mattel reports North America, International, and American Girl segments. Beginning in the first quarter, the company revised its revenue category and international regional reporting structures and reclassified prior-period amounts for comparability.
Key Financial Metrics
| Metric | Q1 2019 | Q1 2018 | Change |
|---|---|---|---|
| Net sales | $689.2 million | $708.4 million | Down 3%; unfavorable currency impact of 4 percentage points |
| Gross profit | $239.8 million | $218.9 million | Up 10% |
| Gross margin | 34.8% | 30.9% | Up 390 basis points |
| Operating loss | $131.0 million | $276.6 million | Improved by $145.6 million |
| Loss before income taxes | $177.5 million | $313.9 million | Improved by $136.4 million |
| Net loss | $183.7 million | $311.3 million | Improved by $127.5 million |
| Diluted loss per share | $0.53 | $0.90 | Improved by $0.37 |
| Cash flow used in operations | $192.8 million | $273.7 million | Outflow reduced by $80.9 million |
Cost of sales declined 8% to $449.5 million, and gross margin benefited from Structural Simplification savings, favorable product mix, and the absence of the prior-year Toys “R” Us sales reversal. These benefits were partly offset by approximately $27.3 million of Fisher-Price Rock ’n Play recall costs and input-cost inflation.
Advertising and promotion expense was $69.5 million, or 10.1% of net sales, compared with 10.0% in the prior-year quarter. Other selling and administrative expense fell 29% to $301.3 million, primarily reflecting the absence of approximately $57 million of Toys “R” Us bad-debt expense and ongoing cost savings. Interest expense increased 14% to $47.0 million, primarily because of higher interest rates on refinanced debt.
Liquidity, Debt, and Balance Sheet
- Cash and equivalents were $380.1 million at March 31, 2019, down from $594.5 million at December 31, 2018 and $526.7 million at March 31, 2018. Approximately $373 million was held by foreign subsidiaries.
- Total debt was $2.85 billion, compared with $2.86 billion at December 31, 2018. Debt represented approximately 85% of total capitalization; stockholders’ equity was $518.5 million.
- Mattel had no short-term borrowings and no borrowings under its $1.60 billion senior secured revolving credit facilities. Outstanding letters of credit were approximately $70 million.
- The revolving facilities mature June 1, 2021 and include customary covenants. Mattel reported compliance with all covenants at March 31, 2019; the fixed-charge coverage covenant was not in effect because excess availability exceeded the applicable threshold.
- Operating cash outflows were partly driven by seasonal working-capital requirements, including a $94.7 million inventory increase and a $327.8 million reduction in accounts payable, accrued liabilities, and income taxes payable.
- Capital expenditures were approximately $24.1 million, and investing cash outflows totaled $19.2 million.
- Mattel adopted the new lease standard on January 1, 2019. At March 31, 2019, operating lease right-of-use assets were $327.4 million and lease liabilities were $371.9 million. The adoption did not materially affect operating results or cash flows.
Material Changes Versus the Prior Comparable Period
- Net sales declined modestly, but reported results benefited materially from lower operating expenses and the absence of the prior-year Toys “R” Us liquidation effects, which included approximately $30 million of sales reversals and $57 million of bad-debt expense.
- Gross sales declined 2% to $780.1 million. Action Figures/Building Sets/Games increased 18%, partly due to initial Toy Story 4 shipments, while Infant/Toddler/Preschool declined 15%.
- Barbie gross sales increased 7% and Hot Wheels increased 4%; Fisher-Price and Thomas & Friends declined 8%.
- North America gross sales increased 6% and segment loss improved to $21.6 million from $106.8 million. International gross sales declined 5%, with a 9-percentage-point unfavorable currency impact, while segment loss improved to $24.3 million from $72.3 million.
- American Girl gross sales declined 32% to $45.6 million, primarily due to lower proprietary retail and direct-channel sales. Segment loss was $14.3 million versus $14.8 million.
- Mattel realized approximately $68 million of Structural Simplification savings during the quarter and recorded $8.7 million of related restructuring charges, compared with $24.9 million in the prior-year quarter. Cumulative charges were $163.7 million, with approximately $200 million expected in total.
- Cash flow used in operations improved, and financing outflows declined substantially because the company repaid $250 million of long-term debt in the first quarter of 2018 but made no long-term debt repayments in the current quarter.
Guidance, Outlook, Commentary, and Risks
Management remained on track to exceed $650 million of Structural Simplification run-rate savings exiting 2019. Mattel also commenced a Capital Light initiative to optimize its manufacturing footprint, potentially including facility sales or consolidation, and expects additional savings, costs, and non-cash charges from the initiative.
The filing does not provide explicit consolidated revenue or earnings guidance. Management stated that it believes liquidity is sufficient to operate the business and expects to use revolving facilities or alternative financing, subject to market conditions, for short-term liquidity needs.
- The Rock ’n Play Sleeper recall announced April 12, 2019 resulted in a $27.3 million first-quarter charge, including $5.4 million of estimated retailer returns and $21.9 million of cost-of-sales charges. Subsequent class-action lawsuits were filed, and potential losses were not reasonably estimable.
- Other litigation includes an appeal in the MGA-related matter, the Yellowstone do Brasil dispute with the amount payable not yet determined, 2017 and 2019 securities litigation, and other product-related claims. The filing states that reasonable loss estimates cannot currently be made for several matters.
- Key operating risks include consumer demand and discretionary spending, retailer concentration and inventory practices, foreign exchange, commodity, labor and transportation costs, product recalls and safety claims, licensing, competition, tariffs and trade policies, financing-market access, debt covenants, and execution of cost-reduction initiatives.
- Mattel’s U.K. operations represented approximately 4% of consolidated net sales. Brexit-related tariff, regulatory, cost, and currency uncertainty remained a risk.
- Mattel’s disclosure controls and procedures were deemed effective as of March 31, 2019, and no material change in internal control over financial reporting was reported.
Important Facts for Investors to Verify
- Whether the Rock ’n Play recall produces additional returns, remediation costs, litigation exposure, or reputational effects beyond the $27.3 million accrued in the quarter.
- Progress toward the targeted $650 million-plus Structural Simplification run-rate savings and the additional costs or non-cash charges associated with the Capital Light initiative.
- Cash generation and seasonal liquidity needs given the $2.85 billion debt balance, $380.1 million of cash, and recurring first-half operating cash outflows.
- Whether International and American Girl sales stabilize, particularly in Infant/Toddler/Preschool products and American Girl’s direct and proprietary retail channels.
- The effect of foreign exchange, input-cost inflation, tariffs, retailer concentration, and customer inventory decisions on margins and demand.
- Developments in the disclosed litigation and whether any matter becomes estimable or requires an accrual.
- The company’s ability to sustain improved gross margins and lower selling and administrative expenses after excluding prior-year unusual Toys “R” Us charges.