Mattel, Inc. 10-Q Summary
Business context and reporting period
Mattel designs, manufactures, and markets toys globally, including Barbie, Hot Wheels, Fisher-Price, American Girl, MEGA BLOKS, and licensed entertainment products. This unaudited Form 10-Q covers the three and nine months ended September 30, 2017. Results are highly seasonal, with a substantial portion of annual toy purchases occurring during the holiday season.
Key financial metrics
| Metric | Q3 2017 | Q3 2016 | 9M 2017 | 9M 2016 |
|---|---|---|---|---|
| Net sales | $1.561 billion | $1.796 billion | $3.271 billion | $3.622 billion |
| Gross profit | $647.2 million | $870.8 million | $1.326 billion | $1.693 billion |
| Gross margin | 41.5% | 48.5% | 40.5% | 46.7% |
| Operating income (loss) | $85.7 million | $317.4 million | $(90.0) million | $256.6 million |
| Net income (loss) | $(603.2) million | $236.3 million | $(772.6) million | $144.2 million |
| Diluted EPS | $(1.75) | $0.68 | $(2.25) | $0.42 |
| Operating cash flow | Not separately presented for the quarter | $(740.1) million | $(331.3) million |
Q3 gross sales were $1.710 billion, down 13%; nine-month gross sales were $3.593 billion, down 10%. Q3 operating margin was 5.5%, compared with 17.7% in the prior year. The nine-month operating margin was negative 2.8%, compared with 7.1%.
- Q3 sales declines were concentrated in North America, where gross sales fell 22%; International gross sales were approximately flat; American Girl gross sales fell 28%.
- Q3 brand gross sales declined 40% for Other Girls, 30% for American Girl, 29% for Construction and Arts & Crafts, and 15% for Fisher-Price. Entertainment gross sales increased 1%.
- Cash and equivalents were $181.3 million at September 30, 2017, down from $869.5 million at December 31, 2016 and $297.1 million at September 30, 2016.
- Inventories were $990.0 million, up from $613.8 million at December 31, 2016 and $910.5 million at September 30, 2016, reflecting lower-than-expected sales and seasonal working-capital requirements.
- Accounts receivable were $1.506 billion, versus $1.115 billion at December 31, 2016 and $1.529 billion at September 30, 2016.
Material changes versus the prior comparable period
- Net sales declined 13% in Q3 and 10% year to date. Mattel reversed approximately $43 million of net sales and $47 million of gross sales and receivables following Toys “R” Us’ September 2017 bankruptcy. Reduced shipments to Toys “R” Us also lowered Q3 revenue.
- Gross margin declined 700 basis points in Q3 and 620 basis points year to date, driven by unfavorable product mix, higher freight and logistics costs, lower licensing income, and the Toys “R” Us sales reversal. Q3 freight and logistics expense increased 16% to $103.0 million.
- Other selling and administrative expense increased 9% in Q3 to $381.8 million and 1% year to date to $1.067 billion. Q3 included approximately $15 million of asset impairments, $7 million of higher employee-related costs, and $6 million of higher severance and restructuring expense.
- Mattel recorded a $561.9 million non-cash charge to establish a valuation allowance against U.S. federal and state deferred tax assets. This drove Q3 income tax expense to $664.5 million and materially increased the reported net loss.
- Operating cash use increased to $740.1 million for the first nine months, primarily because of the larger loss and higher working-capital usage. Investing cash use was $174.9 million, including $235.3 million of capital spending on tools, dies, molds, and other property and equipment. Financing cash flow was positive $213.7 million, principally from net short-term borrowings.
- Debt-to-total capital increased to 66.6% from 50.2% at September 30, 2016, reflecting higher short-term borrowings and lower equity. Short-term borrowings were $732.6 million, current long-term debt was $250.0 million, and long-term debt was $1.886 billion at September 30, 2017.
Outlook, management commentary, risks, and unusual items
- Management described its strategy as strengthening core brands, accelerating emerging-market and digital growth, improving innovation, reshaping operations, and rebuilding its culture and team. The filing does not provide a clear quantitative earnings or revenue forecast.
- Mattel amended its $1.60 billion revolving credit facility. The debt-to-consolidated-EBITDA covenant was removed for Q3 2017; during the covenant modification period, the limit is 4.50-to-1 for Q4 2017 and 4.25-to-1 thereafter until specified conditions are met. Mattel was in compliance with its interest coverage covenant, reporting a 6.19-to-1 ratio versus a 3.50-to-1 minimum.
- Commercial paper borrowings were $732.6 million, while the revolving credit facility had no borrowings outstanding at September 30, 2017. Management stated that available cash, foreign credit lines, the credit facility, and alternative financing should be adequate for 2017 seasonal needs, but noted risks from weaker demand, covenant compliance, credit ratings, and financing-market access.
- Mattel’s credit ratings were reduced or placed under pressure during 2017: one agency reported BBB- long-term and A-3 short-term ratings with a negative outlook; another reported BBB long-term debt.
- On October 26, 2017, after the reporting date, the Board suspended the quarterly dividend beginning in Q4 2017, previously $0.15 per share, to improve financial flexibility and strengthen the balance sheet.
- Goodwill was not impaired, but the International reporting unit was identified as at risk; its estimated fair value was approximately 1.39 times carrying value. Continued weak sales, margins, or market conditions could result in future impairment.
- Mattel disclosed securities class actions alleging misleading statements concerning retailer inventory, point-of-sale data, and financial condition. A potential loss could not be reasonably estimated.
- Other reasonably possible but unaccrued litigation exposures included the MGA matter, with potential damages and interest estimated by Mattel at up to approximately $24.5 million before any offset, and the Yellowstone matter, with potential loss up to approximately $18.5 million before an estimated $7.5 million counterclaim offset.
- Foreign exchange remains material. Mattel held foreign currency forward contracts with $2.46 billion of notional amounts at September 30, 2017. Venezuela represented less than 0.01% of nine-month sales but could generate a pre-tax charge of up to $71 million if operations were ceased.
Most important facts for investors to verify
- Whether holiday-season demand and new products reverse the 2017 sales declines, particularly in North America, American Girl, Fisher-Price, and Other Girls.
- Inventory levels, retailer ordering patterns, customer concentration, and additional credit exposure related to Toys “R” Us and other retailers.
- Liquidity, commercial paper access, short-term borrowing needs, credit ratings, and compliance with amended debt covenants.
- The sustainability of operating cash flow and the effect of working-capital requirements on cash balances.
- Whether the $561.9 million deferred-tax valuation allowance remains appropriate and whether future earnings can utilize the related tax assets.
- Progress in restoring gross margins, controlling freight and logistics costs, and executing restructuring and operational initiatives.
- Potential future goodwill or intangible impairments, especially for the International reporting unit.
- The effect of the dividend suspension, pending litigation, securities claims, foreign exchange exposure, and other contingencies on shareholder returns and capital allocation.