MATTEL INC quarterly report, Q2 FY2016

Mattel, Inc. 2016 Second-Quarter Form 10-Q Summary

Business Context and Reporting Period

Mattel designs, manufactures, markets, and sells toys and related products globally, including Mattel Girls & Boys, Fisher-Price, American Girl, and Construction and Arts & Crafts brands. The filing covers the quarter and six months ended June 30, 2016. Results are seasonal, with a significant portion of toy purchases occurring during the holiday season.

Mattel continued its turnaround program, emphasizing brand franchises, commercial execution, cost reduction, emerging markets, and technology-enabled products. In January 2016, Mattel acquired Sproutling and substantially all assets of Fuhu for aggregate consideration of approximately $33.0 million.

Financial Performance and Key Metrics

Metric	Three Months Ended June 30, 2016	Three Months Ended June 30, 2015	Six Months Ended June 30, 2016	Six Months Ended June 30, 2015
Net sales	$957.3 million	$988.2 million	$1,826.7 million	$1,910.9 million
Gross profit	$433.6 million	$472.9 million	$822.2 million	$923.3 million
Gross margin	45.3%	47.9%	45.0%	48.3%
Operating income (loss)	$(11.7) million	$0.6 million	$(60.8) million	$(53.9) million
Net income (loss)	$(19.1) million	$(11.4) million	$(92.1) million	$(69.5) million
Diluted loss per share	$(0.06)	$(0.03)	$(0.27)	$(0.21)

Gross sales, excluding sales adjustments, were $1.05 billion in the second quarter, down 4%, and $2.01 billion for the first half, down 5%. Currency movements reduced reported second-quarter net sales growth by approximately 2 percentage points and first-half net sales growth by approximately 3 percentage points.

Second-quarter advertising and promotion expense declined 10% to $94.8 million, while other selling and administrative expense declined 5% to $350.5 million. First-half expenses declined 12% and 9%, respectively. Mattel reported approximately $31 million of gross Funding Our Future savings in the quarter and $77 million in the first half, or approximately $24 million and $64 million of net savings after severance and investment costs.

Segment performance was mixed. Second-quarter gross sales increased 4% in North America to $515.6 million and decreased 9% internationally to $465.2 million and 18% in American Girl to $72.0 million. North America segment income rose to $64.4 million, International segment income was $23.1 million, and American Girl reported a $9.6 million segment loss.

Brand trends included second-quarter gross sales increases of 23% for Barbie, 19% for Entertainment, 5% for Core Fisher-Price, and 12% for Construction and Arts & Crafts. These gains were more than offset by declines of 60% in Other Girls and 19% in American Girl. Management attributed much of the Other Girls decline to lower Disney Princess and Monster High sales.

Cash Flow, Liquidity, Debt, and Capital Structure

Cash and equivalents were $317.8 million at June 30, 2016, compared with $892.8 million at December 31, 2015 and $300.5 million at June 30, 2015.
Operating cash flow was negative $240.6 million for the first half, essentially unchanged from negative $240.8 million in the prior-year period.
Investing cash flow was negative $123.9 million, including $111.3 million of capital expenditures and $33.0 million for acquisitions. This compared with negative $161.2 million in the prior-year period.
Financing cash flow was negative $194.0 million, including $258.6 million of dividends and $67.0 million of net short-term borrowings.
Inventories increased to $891.8 million from $587.5 million at December 31, 2015, primarily to support expected demand for new products and higher American Girl production.
Total debt consisted of $67.0 million of short-term borrowings, $300.0 million of current long-term debt, and $1.786 billion of noncurrent long-term debt. Estimated fair value of total long-term debt, including the current portion, was approximately $2.19 billion.
Mattel maintained a $1.60 billion unsecured revolving credit facility, with an accordion feature allowing availability to increase to $1.85 billion under specified conditions. Incremental borrowing resources were approximately $1.53 billion at June 30, 2016.
Mattel was in compliance with its debt covenants. Debt-to-Consolidated EBITDA was 2.57 to 1 versus a maximum of 3.50 to 1, and interest coverage was 9.46 to 1 versus a minimum of 3.50 to 1.
Mattel’s debt-to-total-capital ratio increased to 48.2% at June 30, 2016 from 44.8% at June 30, 2015, primarily because of lower stockholders’ equity.

Management stated that cash on hand, the revolving credit facility, commercial paper access, and foreign credit lines should be adequate to meet 2016 seasonal financing requirements. Approximately $273 million of cash was held by foreign subsidiaries.

Material Changes Versus the Prior Comparable Period

Second-quarter net sales declined 3%, while first-half net sales declined 4%.
Gross margin contracted by 260 basis points in the quarter and 330 basis points in the first half, principally due to unfavorable foreign exchange and product mix, partly offset by pricing and cost savings.
The company moved from slight operating income in the second quarter of 2015 to an operating loss of $11.7 million in the second quarter of 2016.
First-half net loss increased to $92.1 million from $69.5 million, despite lower advertising and administrative expenses.
International first-half segment income declined 68% to $5.7 million, while North America first-half segment income increased 99% to $105.5 million.
Other non-operating expense increased materially, primarily because of a $26 million unrealized foreign-currency loss related to the change in Venezuela’s remeasurement rate.
Currency translation losses were $4.4 million in the first half of 2016 versus $89.3 million in the prior-year period, but transaction losses were $65.1 million versus gains of $21.0 million.

Guidance, Outlook, Commentary, Risks, and Unusual Items

Management did not provide formal full-year revenue or earnings guidance in the filing. Management described second-quarter results as progress in its turnaround, citing improving consumer takeaway, strength in Barbie, Fisher-Price, Hot Wheels, Entertainment, and MEGA Brands, and continued cost-reduction execution.

Mattel targeted cumulative gross Funding Our Future savings of approximately $250 million to $300 million by the end of 2016.
Management’s capital framework targeted year-end cash of approximately $800 million to $1.0 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 through dividends and repurchases.
Mattel declared a third-quarter dividend of $0.38 per share, payable September 16, 2016.
Venezuelan operations accounted for less than 0.01% of first-half consolidated sales. Further deterioration could result in a pre-tax charge of up to $71 million if Mattel ceased operations there.
Brexit caused a sharp decline in the British pound. United Kingdom operations represented approximately 5% of first-half consolidated sales, and future effects could include tariff, trade, regulatory, and currency risks.
Mattel’s foreign-exchange forward contracts had approximately $1.21 billion of notional value at June 30, 2016. Management estimated that, holding other factors constant, a 1% change in the U.S. dollar Trade-Weighted Index would affect net sales by approximately 0.5% and full-year earnings per share by approximately $0.01 to $0.02.
Mattel disclosed reasonably possible, but not probable, losses in litigation involving MGA and Yellowstone do Brasil; no liability was accrued for these matters. The potential exposure and offsets depend on litigation outcomes and appeals.
Mattel adopted accounting updates affecting debt issuance costs and deferred tax classification retrospectively. The company was evaluating the future effects of new revenue recognition, inventory, lease, and share-based payment standards.
Disclosure controls and procedures were considered effective as of June 30, 2016. The assessment excluded the recently acquired Fuhu and Sproutling businesses.

Most Important Facts for Investors to Verify

Whether the turnaround produces sustained sales growth after the loss of Disney Princess and continued weakness in Other Girls and American Girl.
Whether gross-margin pressure from foreign exchange and product mix reverses as pricing and Funding Our Future savings accumulate.
Inventory levels, seasonal sell-through, working-capital requirements, and the company’s ability to rebuild cash toward its $800 million to $1.0 billion year-end target.
Debt maturities, covenant compliance, refinancing needs, and the effect of the higher debt-to-capital ratio.
The durability of North American gains and whether International performance improves despite currency and emerging-market pressures.
Potential exposure from Venezuela, Brexit, foreign-exchange volatility, tax audits, and the disclosed litigation matters.
The extent to which cost savings are recurring gross efficiencies versus offsets from severance, restructuring, and implementation costs.