Mattel, Inc. 2017 First-Quarter Form 10-Q Summary
Business context and reporting period
Mattel designs, manufactures, and markets toys worldwide, including Barbie, Hot Wheels, Fisher-Price, American Girl, MEGA BLOKS, and licensed entertainment products. This unaudited Form 10-Q covers the three months ended March 31, 2017, compared with the three months ended March 31, 2016. Mattel notes that its business is seasonal, with a significant portion of purchases occurring during the holiday season.
Financial performance and condition
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Net sales | $735.6 million | $869.4 million | Down 15% |
| Gross profit | $278.8 million | $388.7 million | Down 28% |
| Gross margin | 37.9% | 44.7% | Down 680 basis points |
| Operating loss | $127.0 million | $49.1 million | Loss increased |
| Net loss | $113.2 million | $73.0 million | Loss increased |
| Diluted loss per share | $0.33 | $0.21 | Higher loss |
| Operating cash flow | $(310.0) million | $(89.3) million | Greater cash use |
- Gross sales were $814.6 million, down 15% from $962.1 million. Net sales reflected $79.0 million of sales adjustments.
- Cost of sales declined 5% to $456.8 million, but decreased sales volume, higher obsolescence, unfavorable product mix, lower licensing income, freight costs, foreign exchange, and product-related costs reduced gross margin.
- Advertising and promotion expense declined 15% to $73.6 million, while other selling and administrative expense declined 5% to $332.2 million. Selling and administrative expense nevertheless increased to 45.2% of sales from 40.4%.
- Cash and equivalents were $381.9 million at March 31, 2017, down from $869.5 million at December 31, 2016 and $599.7 million at March 31, 2016.
- Inventory was $769.8 million, up from $613.8 million at year-end 2016 and $698.3 million a year earlier. Management attributed the year-end increase primarily to lower-than-expected first-quarter sales and inventory for anticipated CARS 3-related demand.
- Cash used in investing activities was $44.7 million, including $70.3 million of capital spending. Cash used in financing activities was $142.6 million, including $130.1 million of dividends.
- Total debt, including short-term borrowings and the current portion of long-term debt, was approximately $2.315 billion. Debt-to-total capital was 51.1%, compared with 45.7% at March 31, 2016.
- Mattel declared a $0.38 per-share second-quarter dividend payable June 9, 2017.
Material changes versus the prior comparable period
- North America gross sales fell 26% to $362.3 million, and the segment moved from $41.1 million of income to a $19.3 million loss.
- International gross sales declined 2% to $366.3 million; Asia Pacific increased 17%, while Europe declined 10%. International segment loss increased to $24.8 million from $17.4 million.
- American Girl gross sales declined 11% to $86.0 million, and the segment moved from $3.4 million of income to a $5.8 million loss.
- Worldwide brand performance was mixed: Wheels increased 4%, while Construction and Arts & Crafts declined 38%, Other Girls declined 34%, Entertainment declined 27%, Barbie declined 13%, Fisher-Price declined 9%, and American Girl declined 11%.
- Management cited a larger-than-expected retail inventory overhang following the holiday season, slower retail reorders, a lighter entertainment release schedule, and unfavorable Easter timing.
- Other non-operating income was $0.9 million in Q1 2017 versus $24.2 million of expense in Q1 2016. The prior-year expense included an approximately $26 million Venezuelan currency remeasurement loss.
- Operating cash use increased substantially because of higher working-capital usage and the larger net loss. Accounts receivable declined seasonally, but inventories increased and accounts payable and accrued liabilities declined.
Liquidity, outlook, commentary, and risks
- Management stated that first-quarter performance was below expectations but said core brands, including Barbie, Fisher-Price, and Hot Wheels, continued to show strength in consumer takeaway data. Management also highlighted long-term potential in Asia Pacific and Latin America.
- No specific full-year revenue or earnings guidance is provided in the filing. Mattel is focused on brand building, commercial execution, cost improvement, emerging-market growth, and returning to growth and improved profitability.
- Mattel had approximately $1.42 billion of incremental borrowing capacity under its $1.60 billion revolving credit facility at March 31, 2017. The company stated that cash, the facility, and foreign credit lines should be adequate for 2017 seasonal financing needs.
- Mattel was in compliance with its credit covenants. The consolidated debt-to-Consolidated EBITDA ratio was 3.04 to 1 versus a 3.50 maximum; the interest coverage ratio was 8.11 to 1 versus a 3.50 minimum.
- Management’s capital framework targets year-end cash of approximately $800 million to $1 billion, a year-end debt-to-capital ratio of approximately 35%, annual capital expenditures of $180 million to $200 million, strategic acquisitions, and shareholder returns. These are objectives rather than guaranteed results.
- Foreign currency exposure remains significant. Mattel held approximately $1.48 billion of foreign-currency forward contracts and estimates that a 1% change in the U.S. dollar Trade-Weighted Index could affect annual earnings per share by approximately $0.00 to $0.01, assuming other factors remain constant.
- Mattel’s Venezuelan operations were less than 0.01% of consolidated sales. A significant bolivar devaluation or deterioration in conditions could result in a pre-tax charge of up to $71 million.
- Pending litigation includes the MGA trade-secrets matter, for which Mattel believes a reasonably possible loss could range from zero to approximately $12.5 million plus up to approximately $12.0 million of prejudgment interest, and the Yellowstone do Brasil matter, for which a reasonably possible loss could range from zero to approximately $18.0 million before a potential offset of approximately $7.5 million.
- The filing states that there were no material changes to previously disclosed risk factors and that disclosure controls and procedures were effective as of March 31, 2017.
Important facts for investors to verify
- Whether retail inventory levels normalize and retail reorders improve after the first-quarter overhang.
- Whether gross margin recovers from 37.9%, particularly through lower obsolescence, improved product mix, licensing performance, freight efficiency, and cost savings.
- Progress in North America and American Girl, which both shifted to segment losses, and sustainability of growth in Asia Pacific and Latin America.
- Inventory levels, operating cash flow, dividend funding, and the company’s ability to maintain covenant compliance while debt-to-capital remains elevated.
- Potential outcomes and offsets related to the MGA and Yellowstone litigation contingencies.
- Impact of foreign exchange, Brexit-related uncertainty, Venezuela, and future accounting-standard adoption, including the new revenue and lease standards.