MATTEL INC annual report, FY2011

Business Context and Reporting Period

Mattel, Inc. designs, manufactures, and markets toys worldwide, including Barbie, Hot Wheels, Fisher-Price, American Girl, Monster High, and entertainment-licensed products. This Form 10-K covers the fiscal year ended December 31, 2011; the filing metadata references 2011 Q4, for which quarterly results are also provided. International gross sales represented 48% of worldwide gross sales, and the business remained highly seasonal, with significant sales concentrated in the third and fourth quarters.

Financial Performance and Position

Metric	2011	2010	Change
Net sales	$6.266 billion	$5.856 billion	Up 7%
Gross profit	$3.146 billion	$2.955 billion	Up 6%
Gross margin	50.2%	50.5%	Down 30 bps
Operating income	$1.041 billion	$901.9 million	Up 15%
Operating margin	16.6%	15.4%	Up 120 bps
Net income	$768.5 million	$684.9 million	Up 12%
Diluted EPS	$2.18	$1.86	Up 17%
Operating cash flow	$664.7 million	$528.0 million	Up $136.7 million

Fourth-quarter 2011 net sales were $2.154 billion, operating income was $497.5 million, and net income was $370.6 million, compared with fourth-quarter 2010 net sales of $2.125 billion, operating income of $428.6 million, and net income of $325.2 million.

2011 gross sales increased 7% to $6.841 billion before $575.1 million of sales adjustments.
Mattel Girls & Boys Brands gross sales rose 13% to $4.15 billion, supported by Barbie, Monster High, Disney Princess, Hot Wheels, and CARS 2.
Fisher-Price gross sales declined 3% to $2.16 billion, primarily because of the discontinuation of the Sesame Street license.
American Girl gross sales increased 5% to $510.9 million.
International gross sales increased 12% to $3.26 billion; segment income increased 17% to $619.3 million.
Advertising and promotion expense increased 8% to $699.2 million, or 11.2% of net sales.
Accounts receivable increased to $1.247 billion and inventories increased to $487.0 million at year-end.

Cash Flow, Debt, Liquidity, and Capital Allocation

Cash and equivalents were $1.369 billion at December 31, 2011, up $88.0 million from 2010.
Cash used in investing activities was $174.5 million, including $190.9 million of purchases of tools, dies, molds, and other property, plant, and equipment.
Cash used in financing activities was $397.3 million, including $524.0 million of share repurchases and $316.5 million of dividend payments.
Mattel issued $600.0 million of senior notes in November 2011 and repaid $250.0 million of scheduled long-term debt maturities. Noncurrent long-term debt increased to $1.50 billion from $950.0 million.
Total debt-to-capital increased to 37.4% from 31.3%, above management’s target of approximately 35%.
The company had an undrawn $1.40 billion revolving credit facility maturing in 2015 and stated that liquidity was adequate for 2012 seasonal financing needs. It was in compliance with its debt covenants at year-end.
Mattel repurchased 20.4 million shares for $536.3 million and had $427.3 million of remaining repurchase authorization. Dividends paid per share increased to $0.92 from $0.83.

Material Changes Versus the Prior Comparable Period

Revenue growth and higher operating income reflected stronger Girls & Boys Brands performance, international growth, lower incentive and share-based compensation, lower legal expenses, and cost savings.
Gross margin contracted modestly because of higher product costs, higher royalties on licensed products, and unfavorable foreign currency effects; price increases and cost savings partly offset these pressures.
Fisher-Price performance weakened following the loss of the Sesame Street license, while Mattel Girls & Boys Brands and International produced significant growth.
Operating Excellence 2.0 generated approximately $94 million of gross savings, or approximately $71 million net of severance charges and investments. Management targeted cumulative sustainable savings of approximately $175 million by the end of 2012.
Share repurchases, dividends, foreign currency translation losses, and increased debt reduced stockholders’ equity slightly to $2.611 billion from $2.629 billion.

Guidance, Outlook, Risks, Contingencies, and Unusual Items

Management’s long-term objectives were gross margins of approximately 50% and operating margins of 15% to 20%. It expected 2012 and 2013 effective tax rates of approximately 22% to 23%.
The 2012 plan emphasized Fisher-Price international growth, integration of HIT Entertainment, entertainment partnerships, Monster High, new franchises, category expansion, international growth, and continued cost savings.
Mattel completed the $680.0 million acquisition of HIT Entertainment on February 1, 2012, after year-end.
Key risks include unpredictable consumer preferences, intense competition, dependence on entertainment licenses, holiday seasonality, retailer and customer concentration, commodity and freight costs, supply-chain disruption, foreign currency exposure, regulatory and product-safety requirements, and access to seasonal financing.
Wal-Mart, Toys “R” Us, and Target accounted for approximately 38% of 2011 net sales and approximately 46% of year-end net accounts receivable; the ten largest customers represented approximately 48% of sales.
Mattel disclosed approximately $4.234 billion of contractual obligations, including $1.550 billion of long-term debt, $472.8 million of operating leases, $314.0 million of licensing minimums, and $405.7 million of purchase commitments.
The company faced an approximately $310 million judgment in favor of MGA related to Bratz litigation, including damages, punitive damages, and legal fees. Mattel appealed and accrued no liability because management did not believe the damages were probable of being sustained.
The IRS was auditing Mattel’s 2008 and 2009 federal tax returns. Unrecognized tax benefits totaled $262.6 million at year-end; the filing states that the ultimate resolution of tax audits could materially affect the financial statements.
Goodwill and nonamortizable intangible assets passed the 2011 impairment tests, although one nonamortizable intangible asset with a carrying value of approximately $113 million had limited excess fair value cushion.
Management and the independent auditor concluded that internal control over financial reporting was effective as of December 31, 2011.

Important Facts for Investors to Verify

Whether the $680 million HIT Entertainment acquisition delivers expected growth and synergies without materially increasing leverage.
Progress toward the $175 million Operational Excellence 2.0 savings target and the sustainability of reported cost reductions.
Fisher-Price recovery following the Sesame Street license discontinuation and the durability of growth in Barbie, Monster High, Hot Wheels, and International markets.
Exposure to retailer concentration, receivables collectibility, inventory obsolescence, and holiday-season demand volatility.
Future effects of higher product, royalty, freight, labor, and commodity costs on the approximately 50% gross-margin objective.
Resolution of the MGA litigation appeal, IRS and other tax audits, and potential changes in unrecognized tax benefits.
Debt maturities, covenant compliance, seasonal borrowing needs, and whether the 37.4% debt-to-capital ratio returns toward the approximately 35% target.