UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
________________________________________________________
FORM 10-K
(Mark One)
ý | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended December 31, 2018. | |
or
¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to | |
Commission File Number 001-05647
______________________________________________________
MATTEL, INC.
(Exact name of registrant as specified in its charter)
Delaware | 95-1567322 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |
333 Continental Blvd.
El Segundo, CA 90245-5012
(Address of principal executive offices)
Registrant’s telephone number, including area code (310) 252-2000
Securities registered pursuant to Section 12(b) of the Act:
Title of each class | Name of each exchange on which registered | |
Common Stock, $1.00 par value | The Nasdaq Global Select Market | |
________________________________________________________
Securities registered pursuant to Section 12(g) of the Act:
NONE
_________________________________________________
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ý No ¨
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No ý
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No ¨
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T(§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ý No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer | ý | Accelerated filer | ¨ | |||
Non-accelerated filer | ¨ | Smaller reporting company | ¨ | |||
Emerging growth company | ¨ | |||||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Ex-change Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No ý
The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant was $5,650,844 based upon the closing market price as of the close of business June 30, 2018, the last business day of the registrant’s most recently completed second fiscal quarter.
Number of shares outstanding of registrant’s common stock, $1.00 par value, as of February 8, 2019:
345,396,232 shares
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Mattel, Inc. 2019 Proxy Statement, to be filed with the Securities and Exchange Commission (“SEC”) within 120 days after the close of the registrant’s fiscal year (incorporated into Part III to the extent stated herein).
MATTEL, INC. AND SUBSIDIARIES
Page | ||
PART I | ||
Item 1. | ||
Item 1A. | ||
Item 1B. | ||
Item 2. | ||
Item 3. | ||
Item 4. | ||
PART II | ||
Item 5. | ||
Item 6. | ||
Item 7. | ||
Item 7A. | ||
Item 8. | ||
Item 9. | ||
Item 9A. | ||
Item 9B. | ||
PART III | ||
Item 10. | ||
Item 11. | ||
Item 12. | ||
Item 13. | ||
Item 14. | ||
PART IV | ||
Item 15. | ||
Item 16. | ||
2
(Cautionary Statement Under the Private Securities Litigation Reform Act of 1995)
Mattel is including this Cautionary Statement to caution investors and qualify for the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 (the "Act") for forward-looking statements. This Annual Report on Form 10-K includes forward-looking statements within the meaning of the Act. Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts. The use of words such as "anticipates," "expects," "intends," "plans," "confident that" and "believes," among others, generally identify forward-looking statements. These forward-looking statements are based on currently available operating, financial, economic and other information, and are subject to a number of significant risks and uncertainties. A variety of factors, many of which are beyond our control, could cause actual future results to differ materially from those projected in the forward-looking statements. Specific factors that might cause such a difference include, but are not limited to: (i) Mattel’s ability to design, develop, produce, manufacture, source and ship products on a timely and cost-effective basis, as well as interest in and purchase of those products by retail customers and consumers in quantities and at prices that will be sufficient to profitably recover Mattel’s costs; (ii) downturns in economic conditions affecting Mattel’s markets which can negatively impact retail customers and consumers, and which can result in lower employment levels, lower consumer disposable income and spending, including lower spending on purchases of Mattel’s products; (iii) other factors which can lower discretionary consumer spending, such as higher costs for fuel and food, drops in the value of homes or other consumer assets, and high levels of consumer debt; (iv) potential difficulties or delays Mattel may experience in implementing cost savings and efficiency enhancing initiatives; (v) other economic and public health conditions or regulatory changes in the markets in which Mattel and its customers and suppliers operate, which could create delays or increase Mattel’s costs, such as higher commodity prices, labor costs or transportation costs, or outbreaks of disease; (vi) currency fluctuations, including movements in foreign exchange rates, which can lower Mattel’s net revenues and earnings, and significantly impact Mattel’s costs; (vii) the concentration of Mattel’s customers, potentially increasing the negative impact to Mattel of difficulties experienced by any of Mattel’s customers, including the bankruptcy and liquidation of Toys "R" Us, Inc., or changes in their purchasing or selling patterns; (viii) the future willingness of licensors of entertainment properties for which Mattel currently has licenses or would seek to have licenses in the future to license those products to Mattel; (ix) the inventory policies of Mattel’s retail customers, including retailers’ potential decisions to lower their inventories, even if it results in lost sales, as well as the concentration of Mattel’s revenues in the second half of the year, which coupled with reliance by retailers on quick response inventory management techniques increases the risk of underproduction of popular items, overproduction of less popular items and failure to achieve compressed shipping schedules; (x) the increased costs of developing more sophisticated digital and smart technology products, and the corresponding supply chain and design challenges associated with such products; (xi) work disruptions, which may impact Mattel’s ability to manufacture or deliver product in a timely and cost-effective manner; (xii) the bankruptcy and liquidation of Toys "R" Us, Inc. or other of Mattel’s significant retailers, or the general lack of success of one of Mattel’s significant retailers which could negatively impact Mattel’s revenues or bad debt exposure; (xiii) the impact of competition on revenues, margins and other aspects of Mattel’s business, including the ability to offer products which consumers choose to buy instead of competitive products, the ability to secure, maintain and renew popular licenses and the ability to attract and retain talented employees; (xiv) the risk of product recalls or product liability suits and costs associated with product safety regulations; (xv) changes in laws or regulations in the United States and/or in other major markets, such as China, in which Mattel operates, including, without limitation, with respect to taxes, tariffs, trade policies, or product safety, which may increase Mattel’s product costs and other costs of doing business, and reduce Mattel’s earnings, (xvi) failure to realize the planned benefits from any investments or acquisitions made by Mattel, (xvii) the impact of other market conditions, third party actions or approvals and competition which could reduce demand for Mattel’s products or delay or increase the cost of implementation of Mattel’s programs or alter Mattel’s actions and reduce actual results; (xviii) changes in financing markets or the inability of Mattel to obtain financing on attractive terms (xix) the impact of litigation or arbitration decisions or settlement actions; and (xx) other risks and uncertainties detailed in Part 1, Item 1A "Risk Factors. Mattel does not update forward-looking statements and expressly disclaims any obligation to do so, except as required by law.
3
PART I
Item 1. | Business. |
Throughout this report "Mattel" refers to Mattel, Inc. and/or one or more of its family of companies. Mattel is a leading global children’s entertainment company that specializes in the design and production of quality toys and consumer products. Mattel's products are among the most widely recognized toy products in the world. Mattel's mission is to "create innovative products and experiences that inspire, entertain, and develop children through play." In order to deliver on this mission, Mattel is focused on the following two-part strategy to transform Mattel from a toy manufacturing company into an intellectual property ("IP")-driven, high-performing toy company:
• | In the short- to mid-term, restore profitability by reshaping operations and regain topline growth by growing Mattel's Power Brands (Barbie, Hot Wheels, Fisher-Price and Thomas & Friends, and American Girl) and expanding Mattel's brand portfolio. |
• | In the mid- to long-term, capture the full value of Mattel's IP through franchise management and the development of Mattel's online retail and e-commerce capabilities. |
Mattel is the owner of a portfolio of global brands with vast intellectual property potential. Mattel's portfolio of brands and products are classified as Power Brands and Toy Box:
Power Brands include:
Barbie—Empowering girls since 1959, Barbie has inspired the limitless potential of every girl by showing them that they can be anything. With an extensive portfolio of dolls and accessories, content, gaming, and lifestyle products, Barbie is the premier fashion doll for children around the world.
Hot Wheels—In production for over 50 years, Hot Wheels continues to push the limits of performance and design and ignites the challenger spirit of kids, adults, and collectors. From diecast cars, to tracks, playsets, and advanced play products, the Hot Wheels portfolio has broad appeal that engages and excites kids.
Fisher-Price and Thomas & Friends—An institution in learning and child development for over 85 years, Fisher-Price is driven to enrich children's lives from birth to school readiness, helping families provide their children with the best possible start. Thomas & Friends, a key property in the Fisher-Price portfolio, is an award-winning preschool train brand franchise that brings meaningful life lessons of friendship and teamwork to kids through content, toy, live events, and other lifestyle categories.
American Girl—A beloved brand since the first catalog debuted in 1986, American Girl is best known for imparting valuable life lessons through its inspiring dolls and books, featuring diverse characters from past and present. Its products are sold directly to consumers via its catalog, website, and proprietary retail stores.
Toy Box includes new and innovative products, as well as time-tested classics, from Mattel-owned and licensed entertainment properties:
Owned Brands—Mattel has an engaging portfolio of owned brands such as MEGA, Polly Pocket, Uno, Enchantimals, Fireman Sam, and Matchbox.
Partner Brands—Mattel brings top entertainment properties to life through innovative toy design, in partnership with Disney (CARS, Mickey Mouse Clubhouse), WWE Wrestling, Nickelodeon (Shimmer and Shine, Blaze and the Monster Machines), Warner Bros. Consumer Products (DC Comics—Batman, DC Comics Superhero Girls), NBCUniversal (Jurassic World, Fast and Furious), and Mojang (Minecraft).
Mattel, Inc. was incorporated in California in 1948 and reincorporated in Delaware in 1968. Its executive offices are located at 333 Continental Blvd., El Segundo, California 90245-5012, telephone number (310) 252-2000.
Business Segments
Mattel’s operating segments are separately managed business units, consisting of: (i) North America, which consists of the U.S. and Canada, (ii) International, and (iii) American Girl. The North America and International segments sell products in both the Power Brands, excluding American Girl, and Toy Box categories, although some are developed and adapted for particular international markets.
For additional information on Mattel’s worldwide revenues by brand category, see Part II, Item 7 "Management’s Discussion and Analysis of Financial Condition and Results of Operations—Results of Operations" and Part II, Item 8 "Financial Statements and Supplementary Data—Note 13 to the Consolidated Financial Statements—Segment Information."
4
North America Segment
The North America segment markets and sells toys in the U.S. and Canada from the Power Brands, excluding American Girl, and Toy Box categories.
In the Power Brands category, 2019 will be a milestone year for Barbie, as the brand celebrates its 60th anniversary by honoring global role models and celebrating firsts for girls and women. In 2019, new product lines will include travel and exploration, and the Fashionistas line will continue to celebrate diversity with even more additions to the line. Barbie products will also continue to be supported by new animated content, including new episodes of Barbie: Dreamhouse Adventures.
Hot Wheels will launch several core product and marketing initiatives in 2019, including an expansion of the Hot Wheels Legends Tour and the launch of the kid-favorite dinosaur theme for Hot Wheels City. The brand will also launch Hot Wheels Monster Trucks globally, backed by the full-year touring live event Hot Wheels Monster Trucks Live in the U.S., and in the fall will launch an exciting partnership with Nintendo’s Mario Kart.
In 2019, Fisher-Price will return its focus to being a partner to parents with infants and children up to five years old through a combination of new product launches and a new brand platform with renewed relevance. Building off of its 89-year heritage of delivering early childhood development through play, Fisher-Price will launch three new categories that provide growth opportunities by leveraging classic play patterns with mixed materials. Thomas & Friends will continue its journey around the world with the fall 2019 release of the twenty-third season of Thomas & Friends: Big World! Big Adventures!, featuring new animated content in which Thomas and the Steam Team will meet new friends and learn about new cultures while traveling farther than ever before, visiting Italy, Brazil, China, Australia, India, and of course—Sodor.
In the Toy Box category, which consists of Owned Brands and Partner Brands, Mattel will continue to focus on developing its owned brands and being a partner of choice for leading entertainment properties by bringing products to the global marketplace with speed and innovation.
Toy Box Owned Brands includes brands such as MEGA, Polly Pocket, and Enchantimals, as well as games and other growth properties. MEGA will be launching a Detective Pikachu product line in spring 2019, based on the May 2019 theatrical release of Warner Bros. Entertainment Inc.'s Pokemon Detective Pikachu. Building off of its content distribution, Mattel will continue to revitalize its brands Polly Pocket and Enchantimals by streaming animated content on Netflix. Additionally, Polly Pocket animated content will continue streaming on Hulu, allowing for further exposure and connection points to the brand. In the games category, Mattel has a strong slate of new kids and preschool games that will launch in the spring of 2019.
Toy Box Partner Brands will continue to partner with Disney, Warner Bros. Consumer Products, Nickelodeon and NBCUniversal, bringing innovative products to the global marketplace. Key 2019 product lines based on entertainment franchises include Disney’s Toy Story 4 with a theatrical release in June 2019, continued franchise support of NBCUniversal’s Jurassic World, and the highly anticipated global launch of BTS products, modeled after the world's leading South Korean boy band, which has become a cultural sensation with global appeal.
International Segment
Products marketed by the International segment are generally the same as those developed and marketed by the North America segment, although some are developed or adapted for particular international markets. Mattel’s products are sold directly to retailers and wholesalers in most European, Latin American, and Asian countries, and in Australia and New Zealand, and through agents and distributors in those countries where Mattel has no direct presence. No individual country within the International segment exceeded 7% of worldwide consolidated gross sales during 2018.
American Girl Segment
The American Girl segment is a direct marketer, children’s publisher, and retailer dedicated to its mission to help build girls of strong character. American Girl is best known for its line of historical and contemporary characters that feature books, dolls, and accessories that inspire girls with important lessons from America’s past to today. For girls who are ready to tell their own stories, Bitty Baby introduces girls to nurturing play until they are ready for WellieWishers, a sweet group of girls who teach about empathy and being a good friend. Truly Me allows girls to express what’s on their minds and in their hearts by choosing a doll—or creating their own—from more than 1.3 million possibilities. American Girl also publishes best-selling fiction and non-fiction titles that help girls navigate the changes and challenges of growing up. The American Girl segment sells products directly to consumers via its catalog, website, in its proprietary retail stores in the U.S., at select retailers nationwide, and at specialty boutiques and franchise stores in Canada, Dubai, and Bahrain.
5
In January 2019, American Girl introduced its newest Girl of the Year character, Blaire Wilson, a young chef-in-training who is growing up on her family’s sustainable farm and finds that cultivating sustainable relationships is the key to true happiness. Throughout 2019, American Girl will continue to increase visibility of its exclusive content by continuing the Character Matters brand campaign, which focuses on creating girls of strong character through stories and experiences.
Manufacturing and Materials
Mattel manufactures toy products for all segments in both company-owned facilities and through third-party manufacturers. Products are also purchased from unrelated entities that design, develop, and manufacture those products. To provide greater flexibility in the manufacture and delivery of its products, and as part of a continuing effort to reduce manufacturing costs, Mattel has concentrated production of most of its core products in company-owned facilities and generally uses third-party manufacturers for the production of non-core products.
Mattel’s principal manufacturing facilities are located in Canada, China, Indonesia, Malaysia, Mexico, and Thailand. To help avoid disruption of its product supply due to political instability, civil unrest, economic instability, changes in government policies or regulations, and other risks, Mattel produces its products in multiple facilities across multiple countries. Mattel believes that the existing production capacity at its own and its third-party manufacturers’ facilities is sufficient to handle expected volume in the foreseeable future. Mattel continues to evaluate its manufacturing footprint in connection with its Structural Simplification cost savings program.
Mattel bases its production schedules for toy products on customer orders and forecasts, taking into account historical trends, results of market research, and current market information. Actual shipments of products ordered and order cancellation rates are affected by consumer acceptance of product lines, strength of competing products, marketing strategies of retailers, changes in buying patterns of both retailers and consumers, and overall economic conditions. Unexpected changes in these factors could result in a lack of product availability or excess inventory in a particular product line.
The majority of Mattel’s raw materials are available from numerous suppliers but may be subject to fluctuations in price. See Part I, Item 1A "Risk Factors."
Competition and Industry Background
Mattel is a worldwide leader in the manufacture, marketing, and sale of toys, games, and other products related to play, learning, and development. Competition in the toy industry is based primarily on quality, play value, brands, and price. Mattel offers a diverse range of products for children of all ages and families that include, among others, toys for infants and preschoolers, dolls, vehicles, action figures, construction toys, youth electronics, hand-held and other games, puzzles, educational toys, technology-related products, media-driven products, and fashion-related toys. The North America segment competes with several large toy companies, including Hasbro, JAKKS Pacific, Just Play Products, LEGO, MGA Entertainment, Moose Toys, Spin Master, and VTech, many smaller toy companies, and manufacturers of video games and consumer electronics. The International segment competes with global toy companies including Famosa, Giochi Preziosi, Hasbro, LEGO, MGA Entertainment, Playmobil, Ravensburger, Simba, Spin Master, and VTech, other national and regional toy companies, and manufacturers of video games and consumer electronics. Foreign regions may include competitors that are strong in a particular toy line or geographical area but do not compete with Mattel or other international toy companies worldwide. The American Girl segment competes with companies that manufacture dolls and accessories and with children’s book publishers and retailers.
Competition among the above companies is intensifying due to trends towards shorter life cycles for individual toy products and an increasing use of high technology among consumers. As a result of children outgrowing toys at younger ages, Mattel competes with companies that sell non-toy products, such as electronic consumer products, video games, as well as content and other entertainment companies. Competition continues to be heavily influenced by the fact that a small number of retailers account for a large portion of all toy sales, allocate the shelf space from which toys are viewed, and have direct contact with parents and children through in-store and online purchases. Such retailers can and do promote their own private-label toys, facilitate the sale of competitors’ toys, showcase toys online based on proprietary algorithms, and allocate shelf space to one type of toy over another. Online distributors are able to promote a wide variety of toys and represent a wide variety of toy manufacturers, and, with limited overhead, do so at a lower cost.
6
Seasonality
Mattel’s business is highly seasonal, with consumers making a large percentage of all toy purchases during the traditional holiday season. A significant portion of Mattel’s customers’ purchasing occurs in the third and fourth quarters of Mattel’s fiscal year in anticipation of holiday buying. These seasonal purchasing patterns and requisite production lead times create risk to Mattel’s business associated with the underproduction of popular toys and the overproduction of less popular toys that do not match consumer demand. Retailers have also been attempting to manage their inventories more tightly in recent years, requiring Mattel to ship products closer to the time the retailers expect to sell the products to consumers. These factors increase the risk that Mattel may not be able to meet demand for certain products at peak demand times or that Mattel’s own inventory levels may be adversely impacted by the need to pre-build products before orders are placed. Additionally, as retailers manage their inventories, Mattel experiences cyclical ordering patterns for products and product lines that may cause its sales to vary significantly from period to period.
In anticipation of retail sales in the traditional holiday season, Mattel significantly increases its production in advance of the peak selling period, resulting in a corresponding build-up of inventory levels in the first three quarters of its fiscal year. Seasonal shipping patterns result in significant peaks in the third and fourth quarters in the respective levels of inventories and accounts receivable, which result in seasonal working capital financing requirements. See Part II, Item 8 "Financial Statements and Supplementary Data—Note 5 to the Consolidated Financial Statements—Seasonal Financing and Debt."
Advertising and Marketing
Mattel supports its product lines with extensive advertising and consumer promotions. Advertising takes place at varying levels throughout the year and peaks during the traditional holiday season. Advertising includes television and radio commercials, social media, and magazine, newspaper, and internet advertisements. Promotions include in-store displays, sweepstakes, merchandising materials, major events focusing on products, and tie-ins with various consumer products companies.
During 2018, 2017, and 2016, Mattel incurred expenses of $526.4 million (11.7% of net sales), $642.3 million (13.2% of net sales), and $634.9 million (11.6% of net sales), respectively, for advertising and promotion.
Sales
Mattel’s products are sold throughout the world. Products within the North America segment are sold directly to retailers, including discount and free-standing toy stores, chain stores, department stores, other retail outlets, and, to a limited extent, wholesalers. Mattel also operates two small retail outlets at certain corporate offices as a service to its employees and as an outlet for its products. Products within the International segment are sold directly to retailers and wholesalers in most European, Latin American, and Asian countries, and in Australia and New Zealand, and through agents and distributors in those countries where Mattel has no direct presence. Mattel also has retail outlets in Latin America and Europe that serve as outlets for its products. American Girl products and its children's publications are sold directly to consumers and select retailers nationwide. Mattel has 20 American Girl retail stores: American Girl Place in Chicago, Illinois, Los Angeles, California, and New York, New York, and American Girl stores in Alpharetta, Georgia, Bloomington, Minnesota, Charlotte, North Carolina, Columbus, Ohio, Dallas, Texas, Houston, Texas, Lone Tree, Colorado, Lynnwood, Washington, McLean, Virginia, Miami, Florida, Nashville, Tennessee, Natick, Massachusetts, Orlando, Florida, Overland Park, Kansas, Palo Alto, California, Hershey, Pennsylvania, and Scottsdale, Arizona, each of which features children’s products from the American Girl segment. Additionally, Mattel sells certain of its products online through websites of one or more of its subsidiaries.
During 2018, Mattel’s two largest customers (Walmart at $1.07 billion and Target at $0.45 billion) accounted for approximately 34% of worldwide consolidated net sales. During 2017 and 2016, Toys "R" Us accounted for $0.40 billion and $0.64 billion, respectively, of worldwide consolidated net sales. Substantially all of Mattel's sales to its two largest customers were in North America. Within countries in the International segment, there is also a concentration of sales to certain large customers that do not operate in the U.S., none of which exceeded 10% of worldwide consolidated net sales. The customers and the degree of concentration vary depending upon the region or nation. See Part I, Item 1A "Risk Factors" and Part II, Item 8 "Financial Statements and Supplementary Data—Note 13 to the Consolidated Financial Statements—Segment Information."
Licenses and Distribution Agreements
Mattel has license agreements with third parties that permit Mattel to utilize the trademark, characters, or inventions of the licensor in products that Mattel sells. A number of these licenses relate to product lines that are significant to Mattel’s business and operations.
7
Mattel has entered into agreements to license entertainment properties from, among others, Disney Enterprises, Inc. (including Star Wars, Mickey Mouse, Jake and the Never Land Pirates, CARS 3 and Toy Story from Pixar, and certain Disney films and television properties), NBCUniversal (including Fast and Furious and Jurassic World), Viacom International, Inc. relating to its Nickelodeon properties (including Dora the Explorer, Blaze and the Monster Machines, SpongeBob SquarePants, and Sunny Day), Warner Bros. Consumer Products (including Batman, Superman, Wonder Woman, Justice League, and DC Comics Superhero Girls), Microsoft (including Halo), Mojang (including Minecraft), and WWE Wrestling.
Mattel's license with Warner Bros. Consumer Products for the global rights to produce and sell action figures based on DC Comics characters expires in March 2020 and will not be renewed.
Royalty expense for 2018, 2017, and 2016 was $224.0 million, $244.5 million, and $228.9 million, respectively. See "Commitments" and Part II, Item 8 "Financial Statements and Supplementary Data—Note 12 to the Consolidated Financial Statements—Commitments and Contingencies."
Mattel also licenses a number of its trademarks and other property rights to others for use in connection with the sale of their products. Mattel distributes some third-party finished products that are independently designed and manufactured.
Trademarks, Copyrights, and Patents
Most of Mattel’s products are sold under trademarks, trade names, and copyrights, and some of these products incorporate devices or designs for which patent protection has been, or is being pursued. Trademarks, copyrights, and patents are significant assets of Mattel in that they provide product recognition and acceptance worldwide.
Mattel customarily seeks trademark, copyright, and/or patent protection covering its products, and it owns or has applications pending or registrations for U.S. and foreign trademarks, copyrights, and patents covering many of its products. Although a number of these trademarks, copyrights, and patents relate to product lines that are significant to Mattel’s business and operations, Mattel does not believe it is dependent on a single trademark, copyright, or patent. Mattel believes its rights to these properties are adequately protected, but there can be no assurance that its rights can be successfully asserted in the future or will not be invalidated, circumvented, or challenged.
Commitments
In the normal course of business, Mattel enters into contractual arrangements for future purchases of goods and services to ensure availability and timely delivery and to obtain and protect Mattel’s right to create and market certain products. Certain of these commitments routinely contain provisions for guarantees or minimum expenditures during the term of the contracts. Current and future commitments for guaranteed payments reflect Mattel’s focus on expanding its product lines through alliances with businesses in other industries. Additionally, Mattel routinely enters into noncancelable lease agreements for premises and equipment used in the normal course of business.
Agreements to purchase inventory, services, and other items with terms extending through 2023 contain future minimum payments totaling approximately $448 million. Licensing and similar agreements with terms extending through 2023 and beyond contain provisions for future guaranteed minimum payments totaling approximately $282 million. Operating lease commitments with terms extending through 2023 and beyond contain future minimum obligations totaling approximately $516 million. See Part II, Item 7 "Management’s Discussion and Analysis of Financial Condition and Results of Operations—Commitments" and Part II, Item 8 "Financial Statements and Supplementary Data—Note 12 to the Consolidated Financial Statements—Commitments and Contingencies."
Backlog
Mattel ships products in accordance with delivery schedules specified by its customers, which usually request delivery within three months. In the toy industry, orders are subject to cancellation or change at any time prior to shipment. In recent years, a trend toward just-in-time inventory practices in the toy industry has resulted in fewer advance orders and therefore less backlog of orders. Mattel believes that the amount of backlog orders at any given time may not accurately indicate future sales.
8
Financial Instruments
Currency exchange rate fluctuations may impact Mattel’s results of operations and cash flows. Mattel seeks to mitigate its exposure to foreign exchange risk by monitoring its foreign currency transaction exposure for the year and partially hedging such exposure using foreign currency forward exchange contracts primarily to hedge its purchase and sale of inventory and other intercompany transactions denominated in foreign currencies. These contracts generally have maturity dates of up to 18 months. In addition, Mattel manages its exposure to currency exchange rate fluctuations through the selection of currencies used for international borrowings. Mattel does not trade in financial instruments for speculative purposes.
For additional information regarding foreign currency contracts, see "International Segment" above, Part II, Item 7A "Quantitative and Qualitative Disclosures About Market Risk," and Part II, Item 8 "Financial Statements and Supplementary Data—Note 10 to the Consolidated Financial Statements—Derivative Instruments."
Seasonal Financing
See Part II, Item 8 "Financial Statements and Supplementary Data—Note 5 to the Consolidated Financial Statements—Seasonal Financing and Debt."
Government Regulations and Environmental Quality
Mattel’s products sold in the U.S. are subject to the provisions of the Consumer Product Safety Act, as amended by the Consumer Product Safety Improvement Act of 2008, the Federal Hazardous Substances Act, and the Consumer Product Safety Improvement Act of 2008, and may also be subject to the requirements of the Flammable Fabrics Act or the Food, Drug, and Cosmetics Act and the regulations promulgated pursuant to such statutes. These statutes and the related regulations ban from the market consumer products that fail to comply with applicable product safety laws, regulations, and standards. The Consumer Product Safety Commission may require the recall, repurchase, replacement, or repair of any such banned products or products that otherwise create a substantial risk of injury and may seek penalties for regulatory noncompliance under certain circumstances. Similar laws exist in some U.S. states. Mattel believes that it is in substantial compliance with these federal and state laws and regulations.
Mattel’s products sold worldwide are subject to the provisions of similar laws and regulations in many jurisdictions, including the European Union and Canada. Mattel believes that it is in substantial compliance with these laws and regulations.
Mattel maintains a quality control program to help ensure compliance with applicable product safety requirements. Nonetheless, Mattel has experienced, and may in the future experience, issues in products that result in recalls, withdrawals, or replacements of products. A product recall could have a material adverse effect on Mattel’s results of operations and financial condition, depending on the product affected by the recall and the extent of the recall efforts required. A product recall could also negatively affect Mattel’s reputation and the sales of other Mattel products. See Part I, Item 1A "Risk Factors."
Mattel’s advertising is subject to the Federal Trade Commission Act, The Children’s Television Act of 1990, the rules and regulations promulgated by the Federal Trade Commission, and the Federal Communications Commission, as well as laws of certain countries that regulate advertising and advertising to children. In addition, Mattel’s web-based products and services and other online and digital communications activity are or may be subject to U.S. and foreign privacy-related regulations, including the U.S. Children’s Online Privacy Protection Act of 1998 and the EU General Data Protection Regulation and related national regulations. Privacy-related laws also exist in some U.S. states. Mattel believes that it is in substantial compliance with these laws and regulations.
Mattel’s worldwide operations are subject to the requirements of various environmental laws and regulations in the jurisdictions where those operations are located. Mattel believes that it is in substantial compliance with those laws and regulations. Mattel’s operations are from time to time the subject of investigations, conferences, discussions, and negotiations with various federal, state, and local environmental agencies within and outside the U.S. with respect to the discharge or cleanup of hazardous waste. Mattel is not aware of any material cleanup liabilities.
Mattel is subject to various other federal, state, local, and international laws and regulations applicable to its business. Mattel believes that it is in substantial compliance with these laws and regulations.
Employees
The total number of persons employed by Mattel and its subsidiaries at any one time varies because of the seasonal nature of its manufacturing operations. As of December 31, 2018, Mattel’s total number of employees was approximately 27,000.
9
Available Information
Mattel files its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, Proxy Statements, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (the "Exchange Act") with the SEC. The SEC maintains an Internet website that contains reports, proxy, and other information regarding issuers that file electronically with the SEC at http://www.sec.gov.
Mattel’s internet website address is http://corporate.mattel.com. Mattel makes available on its internet website, free of charge, its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, Proxy Statements, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after such materials are electronically filed with, or furnished to, the SEC.
Item 1A. | Risk Factors. |
If any of the risks and uncertainties described in the cautionary risk factors listed below actually occurs, Mattel’s business, financial condition and results of operations could be significantly and adversely affected. The risk factors listed below are not exhaustive. Other sections of this Annual Report on Form 10-K include additional factors that could materially and adversely impact Mattel’s business, financial condition and results of operations. Moreover, Mattel operates in a very competitive and rapidly changing environment. New factors emerge from time to time, and it is not possible for management to predict the impact of all of these factors on Mattel’s business, financial condition, or results of operations, or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements. Given these risks and uncertainties, investors should not rely on forward-looking statements as a prediction of actual results. Any or all of the forward-looking statements contained in this Annual Report on Form 10-K and any other public statement made by Mattel or its representatives may turn out to be wrong. Mattel expressly disclaims any obligation to update or revise any forward-looking statements, whether as a result of new developments or otherwise.
If Mattel does not successfully identify or satisfy consumer preferences, its results of operations may be adversely affected.
Mattel’s business and operating results depend largely upon the appeal of its products, driven by both innovation and marketing. Consumer preferences, particularly with children as the end users of Mattel’s products, are continuously changing. Significant, sudden shifts in demand are caused by "hit" toys and trends, which are often unpredictable. Mattel offers a diverse range of products for children of all ages and families that includes, among others, toys for infants and preschoolers, girls’ toys, boys’ toys, youth electronics, digital media, hand-held and other games, puzzles, educational toys, media-driven products, and fashion-related toys. Mattel competes domestically and internationally with a wide range of large and small manufacturers, marketers and sellers of toys, video games, consumer electronics such as tablets and mobile devices, and other play products, as well as retailers, which means that Mattel’s market position is always at risk. Mattel’s ability to maintain its current product sales, and increase its product sales or establish product sales with new, innovative toys, will depend on Mattel’s ability to satisfy play preferences, enhance existing products, develop and introduce new products, and achieve market acceptance of these products. These challenges are intensifying due to trends towards shorter life cycles for individual toy products, the phenomenon of children outgrowing traditional toys at younger ages, an increasing use of more sophisticated technology in toys, and an evolving path to purchase. If Mattel does not successfully meet the challenges outlined above in a timely and cost-effective manner, demand for its products could decrease, and Mattel’s revenues, profitability, and results of operations may be adversely affected.
High levels of competition and low barriers to entry make it difficult to achieve, maintain, or build upon the success of Mattel’s brands, products, and product lines.
Mattel faces competitors who are also constantly monitoring and attempting to anticipate consumer tastes, seeking ideas which will appeal to consumers, and introducing new products that compete with Mattel’s products. In addition, competition for access to entertainment properties could lessen Mattel’s ability to secure, maintain, and renew popular licenses to entertainment products developed by other parties and licensed to Mattel or require Mattel to pay licensors higher royalties and higher minimum guaranteed payments in order to obtain or retain these licenses. As a licensee of entertainment properties, Mattel has no guarantee that a particular property or brand will translate into a successful toy, game, or other product. In addition, the barriers to entry for new participants in the toy products industry are low. In a very short period of time, new market participants with a popular product idea or entertainment property can become a significant source of competition for Mattel and its products. If demand for Mattel’s brands, products and product lines is reduced as a result of these factors, Mattel’s results of operations may be adversely affected.
10
Inaccurately anticipating changes and trends in popular culture, media and movies, fashion, or technology can negatively affect Mattel’s sales.
Successful movies and characters in children’s literature affect play preferences, and many products depend on media-based intellectual property licenses. Media-based licenses can cause a line of toys or other products to gain immediate success among children, parents, or families. Trends in media, movies, and children’s characters change swiftly and contribute to the transience and uncertainty of play preferences. In addition, certain developments in the entertainment industry, including labor strikes, could cause delay or interruption in the release of new movies and television programs and could adversely affect the sales of Mattel’s products based on such movies and television programs. Mattel responds to such trends and developments by modifying, refreshing, extending, and expanding its product offerings on an annual basis. If Mattel does not accurately anticipate trends in popular culture, movies, media, fashion, or technology, its products may not be accepted by children, parents, or families and Mattel’s revenues, profitability, and results of operations may be adversely affected.
Mattel’s failure to successfully market or advertise its products could have an adverse effect on Mattel’s business, financial condition, and results of operations.
Mattel’s products are marketed worldwide through a diverse spectrum of advertising and promotional programs. Mattel’s ability to sell products is dependent in part upon the success of these programs. If Mattel does not successfully market its products or if media or other advertising or promotional costs increase, these factors could have an adverse effect on Mattel’s business, financial condition, and results of operations.
Mattel’s business is highly seasonal and its operating results depend, in large part, on sales during the relatively brief traditional holiday season. Any events that disrupt Mattel’s business during its peak demand times could significantly, adversely, and disproportionately affect Mattel’s business.
Mattel’s business is subject to risks associated with the underproduction of popular toys and the overproduction of toys that are less popular with consumers. Sales of toy products at retail are highly seasonal, with a majority of retail sales occurring during the period from September through December. In recent years, many consumers have delayed their purchases until just before the holidays. As a result, Mattel’s operating results depend, in large part, on sales during the relatively brief traditional holiday season. Retailers attempt to manage their inventories tightly, which requires Mattel to ship products closer to the time the retailers expect to sell the products to consumers. This in turn results in shorter lead times for production. Management believes that the recent increase in "last minute" shopping during the holiday season and the popularity of gift cards (which often shift purchases to after the holiday season) may negatively impact customer re-orders during the holiday season. These factors may decrease sales or increase the risks that Mattel may not be able to meet demand for certain products at peak demand times or that Mattel’s own inventory levels may be adversely impacted by the need to pre-build products before orders are placed.
In addition, as a result of the seasonal nature of Mattel’s business, Mattel may be significantly and adversely affected, in a manner disproportionate to the impact on a company with sales spread more evenly throughout the year, by unforeseen events, such as terrorist attacks, economic shocks, severe weather, earthquakes or other catastrophic events, that harm the retail environment or consumer buying patterns during its key selling season, or by events, such as strikes, disruptions in transportation, or port delays, that interfere with the manufacture or shipment of goods during the critical months leading up to the holiday purchasing season.
11
Mattel has significant customer concentration, so that economic difficulties or changes in the purchasing policies or patterns of its key customers could have a significant impact on Mattel’s business and operating results.
A small number of customers account for a large share of Mattel’s net sales. In 2018, Mattel’s two largest customers, Walmart and Target, in the aggregate, accounted for approximately 34% of net sales, and its ten largest customers, in the aggregate, accounted for approximately 49% of net sales. During 2017 and 2016, Toys "R" Us accounted for $0.40 billion and $0.64 billion, respectively, of worldwide consolidated net sales. While the concentration of Mattel’s business with a relatively small number of customers may provide certain benefits to Mattel, such as potentially more efficient product distribution and decreased costs of sales and distribution, this concentration may expose Mattel to a material adverse effect if one or more of Mattel’s large customers were to significantly reduce purchases for any reason, favor competitors or new entrants, or increase their direct competition with Mattel by expanding their private-label business. Customers make no binding long-term commitments to Mattel regarding purchase volumes and make all purchases by delivering one-time purchase orders. Any customer could reduce its overall purchases of Mattel’s products, reduce the number and variety of Mattel’s products that it carries and the shelf space allotted for Mattel’s products, or otherwise seek to materially change the terms of the business relationship at any time. Any such change could significantly harm Mattel’s business and operating results. Furthermore, the bankruptcy or other lack of success of one or more of Mattel's significant retail customers has, and in the future could negatively impact Mattel's revenues and profitability.
Liquidity problems or bankruptcy of Mattel’s key customers, including the bankruptcy filing by Toys "R" Us, could have a significant adverse effect on Mattel’s business, financial condition and results of operations.
Mattel’s sales to customers are typically made on credit without collateral. There is a risk that key customers will not pay, or that payment may be delayed, because of bankruptcy, contraction of credit availability to such customers, weak retail sales, or other factors beyond the control of Mattel, which could increase Mattel’s exposure to losses from bad debts. In addition, if key customers were to cease doing business as a result of bankruptcy, or significantly reduce the number of stores operated, it could have a significant adverse effect on Mattel’s business, financial condition, and results of operations.
On September 18, 2017, Toys "R" Us and certain of its affiliates filed voluntary petitions for relief under Chapter 11 of the United States Bankruptcy Code with the United States Bankruptcy Court for the Eastern District of Virginia, Richmond Division. This Chapter 11 proceeding and subsequent liquidation has negatively impacted Mattel’s recurring revenue from Toys "R" Us.
Mattel may be unable to realize the anticipated cost savings from its previously announced cost savings plan or may incur additional and/or unexpected costs in order to realize them.
Mattel is implementing a series of cost savings initiatives as described in Part II, Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations—Cost Savings Programs." Mattel incurred costs of $109.8 million and $45.1 million in 2018 and 2017, respectively, to achieve such cost savings, and expects to incur additional costs during 2019. There can be no assurance that Mattel will be able to realize the anticipated cost savings from its previously announced cost savings plan in the amounts or within the anticipated timeframes or at all. In addition, any cost savings that Mattel realizes may be offset, in whole or in part, by reductions in net sales or through increases in other expenses. Failure to realize the expected cost savings from its proposed cost savings plan could have an adverse effect on Mattel’s financial results and prospects.
The amounts of anticipated cost savings and anticipated expenses related thereto are based on Mattel’s current estimates, but they involve risks, uncertainties, assumptions, and other factors that may cause actual results, performance, or achievements to be materially different from those described herein. Assumptions relating to the plans and amounts related thereto involve subjective decisions and judgments with respect to, among other things, the estimated impact of certain operational adjustments, including marketing efficiency, labor management, material input cost fluctuations, plant transition costs, and other cost and savings adjustments, as well as future economic, competitive, industry and market conditions and future business decisions, all of which are inherently uncertain and may be beyond the control of Mattel’s management. Although Mattel’s management believes these estimates and assumptions to be reasonable, any of the assumptions could be inaccurate, and there can be no assurance that the estimates described herein will prove to be accurate or that the objectives and plans expressed will be achieved. Neither Mattel’s independent registered public accounting firm nor any other independent registered public accounting firm, has examined, compiled, or performed any procedures with respect to these amounts, nor have they expressed any opinion, or any other form of assurance, on such information or their achievability.
12
Accordingly, there can be no assurance that the anticipated cost savings will be realized or that the impact of the efforts to achieve such cost savings will not be significantly different than currently anticipated. Mattel undertakes no obligation to update or otherwise revise or reconcile its expectations regarding its cost savings efforts whether as a result of new information, future events or otherwise.
Failure to successfully implement new initiatives or meet product introduction schedules could have a significant adverse effect on Mattel’s business, financial condition, and results of operations.
Mattel has announced, and in the future may announce, initiatives to reduce its costs, optimize its manufacturing footprint, increase its efficiency, improve the execution of its core business, globalize and extend Mattel’s brands, catch new trends, create new brands, offer new innovative products and improve existing products, enhance product safety, develop people, improve productivity, simplify processes, maintain customer service levels, as well as initiatives designed to drive sales growth, capitalize on Mattel’s scale advantage, and improve its supply chain. These initiatives involve investment of capital and complex decision-making as well as extensive and intensive execution, and the success of these initiatives is not assured. In addition, Mattel may anticipate introducing a particular product, product line or brand at a certain time in the future. There is no guarantee that Mattel will be able to manufacture, source and ship new or continuing products in a timely manner and on a cost-effective basis. Unforeseen delays or difficulties in the development process or significant increases in the planned cost of development for new Mattel products may cause the introduction date for products to be later than anticipated or, in some situations, may cause a product or new product introduction to be discontinued. Failure to successfully implement any of these initiatives or launches, or the failure of any of these initiatives or launches to produce the results anticipated by management, could have a significant adverse effect on Mattel’s business, financial condition, and results of operations.
Significant increases in the price of commodities, transportation, or labor, if not offset by declines in other input costs, or a reduction or interruption in the delivery of raw materials, components, and finished products from Mattel’s vendors could negatively impact Mattel’s financial results.
Cost increases, whether resulting from rising costs of materials, transportation, services, labor, or compliance with existing or future regulatory requirements, could impact the profit margins realized by Mattel on the sale of its products. Because of market conditions, timing of pricing decisions, and other factors, there can be no assurance that Mattel will be able to offset any of these increased costs by adjusting the prices of its products. Increases in prices of Mattel’s products may not be sustainable and could result in lower sales. Mattel’s ability to meet customer demand depends, in part, on its ability to obtain timely and adequate delivery of materials, parts, and components from its suppliers and internal manufacturing capacity. Mattel has experienced shortages in the past, including shortages of raw materials and components. Additionally, as Mattel cannot guarantee the stability of its major suppliers, major suppliers may stop manufacturing components at any time with little or no notice. If Mattel is required to use alternative sources, it may be required to redesign some aspects of the affected products, which may involve delays and additional expense. Although Mattel works closely with suppliers to avoid these types of shortages, there can be no assurance that Mattel will not encounter these problems in the future. A reduction or interruption in supplies or in the delivery of finished products, whether resulting from more stringent regulatory requirements, disruptions in transportation, port delays, labor strikes, lockouts, an outbreak of a severe public health pandemic, severe weather, the occurrence or threat of wars or other conflicts, or a significant increase in the price of one or more supplies, such as fuel or resin (which is an oil-based product used in plastics), or otherwise, could negatively impact Mattel’s financial results.
Mattel’s substantial indebtedness could adversely affect its ability to raise additional capital to fund its operations, limit its ability to react to changes in the economy or its industry, and expose it to interest rate risk to the extent of its variable rate debt.
At December 31, 2018, Mattel had $2.85 billion of indebtedness on a consolidated basis, consisting primarily of 6.75% Senior Notes due 2025, as well as Senior Notes issued in the prior years. In addition, Mattel has $1.60 billion of unused commitments under its senior secured revolving credit facilities, subject to borrowing base capacity. For more information, see Part II, Item 8 "Financial Statements and Supplementary Data—Note 5 to the Consolidated Financial Statements—Seasonal Financing and Debt."
13
Subject to the limits contained in the credit agreement that governs Mattel’s senior secured revolving credit facilities, the indenture that governs the notes and Mattel’s other debt instruments, Mattel may incur substantial additional debt from time to time to finance working capital, capital expenditures, investments or acquisitions, or for other purposes. If Mattel does so, the risks related to Mattel’s high level of debt would increase. Specifically, Mattel’s substantial indebtedness could have important consequences. For example, it could:
• | Require Mattel to dedicate a substantial portion of its cash flow from operations to payments on Mattel’s indebtedness, thereby reducing the availability of Mattel’s cash flow to fund acquisitions, working capital, capital expenditures, research and development efforts, and other general corporate purposes; |
• | Increase Mattel’s vulnerability to and limit Mattel’s flexibility in planning for, or reacting to, changes in its business and the industries in which it operates; |
• | Restrict Mattel from making strategic acquisitions or cause Mattel to make non-strategic divestitures; |
• | Expose Mattel to the risk of increased interest rates as borrowings under its senior secured revolving credit facilities will be subject to variable rates of interest; |
• | Expose Mattel to additional risks related to currency exchange rates and repatriation of funds; |
• | Place Mattel at a competitive disadvantage compared to its competitors that have less debt; and |
• | Limit Mattel’s ability to obtain additional debt or equity financing for working capital, capital expenditures, business development, debt service requirements, acquisitions, and general corporate or other purposes. |
Mattel’s credit ratings have declined in recent years and as a result, Mattel’s cost of issuing new debt has increased. Any further reduction in Mattel’s credit ratings could further increase the cost of issuing any such debt. Mattel may be hindered from obtaining, or incur incremental costs to obtain, additional credit in tight credit markets. Further, Mattel’s ability to issue additional debt could be adversely affected by other factors, such as market conditions.
In addition, the indenture governing the notes and the agreements governing Mattel’s senior secured revolving credit facilities contain affirmative and negative covenants that limit Mattel’s ability to engage in activities that may be in its long-term best interests. Mattel’s failure to comply with those covenants could result in an event of default which, if not cured or waived, could result in the acceleration of all of Mattel’s debts.
To service Mattel’s indebtedness, Mattel will require a significant amount of cash and Mattel’s ability to generate cash depends on many factors beyond Mattel’s control.
Mattel’s ability to make cash payments on and to refinance its indebtedness, and to fund planned capital expenditures, will depend on Mattel’s ability to generate significant operating cash flow in the future. This, to a significant extent, is subject to general economic, financial, competitive, legislative, regulatory, and other factors that are beyond Mattel’s control.
Mattel’s business may not generate sufficient cash flow from operations and future borrowings may not be available under Mattel’s senior secured revolving credit facilities in an amount sufficient to enable Mattel to pay its indebtedness or to fund its other liquidity needs. In such circumstances, Mattel may need to refinance all or a portion of its indebtedness upon or before maturity. Mattel may not be able to refinance any of Mattel’s indebtedness, including its senior secured revolving credit facilities and the notes, on commercially reasonable terms or at all. If Mattel cannot service its indebtedness, Mattel may need to take actions such as selling assets, seeking additional equity or reducing or delaying capital expenditures, strategic acquisitions, investments and alliances. Such actions, if necessary, may not be effected on commercially reasonable terms or at all. The credit agreement governing Mattel’s senior secured revolving credit facilities and the indenture governing the notes will restrict Mattel’s ability to sell assets and use the proceeds from such sales.
14
If Mattel is unable to generate sufficient cash flow or is otherwise unable to obtain funds necessary to meet required payments of principal, premium, if any, and interest on its indebtedness, or if Mattel otherwise fails to comply with the various covenants in the instruments governing its indebtedness, Mattel could be in default under the terms of the agreements governing such indebtedness. In the event of such default, the holders of such indebtedness could elect to declare all the funds borrowed thereunder to be due and payable, together with accrued and unpaid interest, the lenders under Mattel’s senior secured revolving credit facilities could elect to terminate their commitments thereunder, cease making further loans and institute foreclosure proceedings against Mattel’s assets, and Mattel could be forced into bankruptcy or liquidation. If Mattel’s operating performance declines, it may need to obtain waivers in the future from the required lenders under its senior secured revolving credit facilities to avoid being in default. If Mattel breaches its covenants under its senior secured revolving credit facilities and seeks a waiver, Mattel may not be able to obtain a waiver from the required lenders. If this occurs, Mattel would be in default under its senior secured revolving credit facilities, the lenders could exercise their rights, as described above, and Mattel could be forced into bankruptcy or liquidation.
Mattel’s variable rate indebtedness subjects Mattel to interest rate risk, which could cause Mattel’s debt service obligations to increase significantly.
Borrowings under Mattel’s senior secured revolving credit facilities will be at variable rates of interest and will expose Mattel to interest rate risk. Interest rates are currently at historically low levels. If interest rates increase, Mattel’s debt service obligations on the variable rate indebtedness will increase even though the amount borrowed remains the same, and Mattel’s net income and cash flows, including cash available for servicing its indebtedness, will correspondingly decrease. Assuming all revolving loans under Mattel’s senior secured revolving credit facilities are fully drawn and the interest rates are above the interest rate floor set forth in the credit agreement governing Mattel’s senior secured revolving credit facilities, each one-eighth point change in interest rates would result in a $2.0 million change in annual interest expense on Mattel’s indebtedness under its senior secured revolving credit facilities. However, Mattel may maintain interest rate swaps with respect to any of its variable rate indebtedness, and any swaps Mattel enters into may not fully mitigate Mattel’s interest rate risk.
Mattel is dependent upon its lenders for financing to execute its business strategy and meet its liquidity needs. If Mattel’s lenders are unable to fund borrowings under their credit commitments or Mattel is unable to borrow, it could negatively impact Mattel’s business.
In the current volatile credit market, there is risk that any lenders, even those with strong balance sheets and sound lending practices, could fail or refuse to honor their legal commitments and obligations under existing credit commitments, including but not limited to extending credit up to the maximum amount permitted by a credit facility and otherwise accessing capital and/or honoring loan commitments. If Mattel’s lenders are unable to fund borrowings under their credit commitments or Mattel is unable to borrow, it could be difficult in this environment to replace Mattel’s senior secured revolving credit facilities on similar terms.
Significant changes in currency exchange rates or the ability to transfer capital across borders could have a significant adverse effect on Mattel’s business and results of operations.
Mattel operates facilities and sells products in numerous countries outside the U.S. During 2018, Mattel’s International segment net sales were 42% of Mattel’s total consolidated net sales. Furthermore, Mattel’s net investment in its foreign subsidiaries and its results of operations and cash flows are subject to changes in currency exchange rates and regulations. Highly inflationary economies of certain foreign countries can result in foreign currency devaluation, which negatively impacts Mattel’s profitability. Mattel seeks to mitigate the exposure of its results of operations to fluctuations in currency exchange rates by aligning its prices with the local currency cost of acquiring inventory, distributing earnings in U.S. dollars, and partially hedging this exposure using foreign currency forward exchange contracts. These contracts are primarily used to hedge Mattel’s purchase and sale of inventory, and other intercompany transactions denominated in foreign currencies. Government action may restrict Mattel’s ability to transfer capital across borders and may also impact the fluctuation of currencies in the countries where Mattel conducts business or has invested capital. Significant changes in currency exchange rates, reductions in Mattel’s ability to transfer its capital across borders, and changes in government-fixed currency exchange rates, including the Chinese yuan, could have a significant adverse effect on Mattel’s business and results of operations.
15
If global economic conditions deteriorate, Mattel’s business and financial results could be adversely affected.
Mattel designs, manufactures, and markets a wide variety of toy products worldwide through sales to retailer customers and directly to consumers. Mattel’s performance is impacted by the level of discretionary consumer spending, which remains relatively weak in many countries around the world in which Mattel does business. Consumers’ discretionary purchases of toy products may be impacted by job losses, foreclosures, bankruptcies, reduced access to credit, significantly falling home prices, lower consumer confidence, and other macroeconomic factors that affect consumer spending behavior. Any of these factors can reduce the amount that consumers spend on the purchase of Mattel’s products. Deterioration of global economic conditions or disruptions in credit markets in the markets in which Mattel operates could potentially have a material adverse effect on Mattel’s liquidity and capital resources, including increasing Mattel’s cost of capital or its ability to raise additional capital if needed, or otherwise adversely affect Mattel’s business and financial results. For instance, our financial condition and results could be negatively affected by the economic impact of changes in trade relations among the United States and other countries, including a new United States-Mexico-Canada Agreement, China, or changes in the European Union, such as Brexit. For further discussion of these risks, see below risk factor "Political developments, including trade relations, and the threat or occurrence of war or terrorist activities could adversely impact Mattel, its personnel and facilities, its customers and suppliers, retail and financial markets, and general economic conditions."
In addition to experiencing potentially lower revenues during times of economic difficulty, in an effort to maintain sales during such times, Mattel may need to increase promotional spending or take other steps to encourage retailer and consumer purchase of its products. Those steps may increase costs and/or decrease operating margins.
An increasing portion of Mattel's business may come from new and emerging markets, and growing business in new and emerging markets presents additional challenges.
Mattel expects an increasing portion of its net revenues to come from new and emerging markets, including China, India, and Russia. Operating in new and emerging markets, each with its own unique consumer preferences and business climates, presents additional challenges that Mattel must meet. In addition, sales and operations in new and emerging markets are subject to other risks associated with international operations. Such risks include complications in complying with different laws in varying jurisdictions; dealing with changes in governmental policies and the evolution of laws and regulations that impact Mattel's product offerings and related enforcement; difficulties understanding the retail climate, consumer trends, local customs and competitive conditions in foreign markets, which may be quite different from the U.S.; difficulties in moving materials and products from one country to another, including port congestion, strikes and other transportation delays and interruptions; potential challenges to Mattel's transfer pricing determinations and other aspects of its cross border transactions; and the impact of tariffs, quotas, or other protectionist measures.
Because of the importance of Mattel's new and emerging market net revenues, Mattel's business, financial condition, and results of operations could be harmed if any of the risks described above are not properly managed, or if Mattel is otherwise unsuccessful in managing its new and emerging market business.
An increasing portion of Mattel's business may come from technologically advanced or sophisticated digital and smart technology products, which present additional challenges compared to more traditional toys and games.
Mattel expects that children will continue to be interested in product offerings incorporating sophisticated technology, such as video games, consumer electronics, and social and digital media, at younger and younger ages. Mattel also expects that parents will seek to enhance child development and learning through digital technologies and analog and technology-based play.
16
In addition to the risks associated with Mattel’s more traditional products, sophisticated digital and smart technology products face certain additional risks. Costs associated with designing, developing, and producing technologically advanced or sophisticated products tend to be higher than for many of Mattel’s more traditional products. Heavy competition in consumer electronics and entertainment products and difficult economic conditions may increase the risk of Mattel not achieving sales sufficient to recover the increased costs associated with these products. Designing, developing, and producing sophisticated digital and smart technology products requires different competencies and may follow longer timelines than traditional toys and games, and any delays in the design, development, or production of these products could have a significant impact on Mattel's ability to successfully offer such products. In addition, the pace of change in product offerings and consumer tastes in the video games, consumer electronics, and social and digital media areas is potentially even greater than for Mattel’s more traditional products. This pace of change means that the window in which a technologically advanced or sophisticated product can achieve and maintain consumer interest may be shorter than traditional toys and games. These products may also present data security and data privacy risks and be subject to certain laws, government policies or regulations not applicable to more traditional products, such as the U.S. Children’s Online Privacy Protection Act of 1998, the EU General Data Protection Regulation, which took effect in May 2018, and related national regulations. For further discussion of these risks, see below risk factor "Mattel relies extensively on information technology in its operations, and any material failure, inadequacy, interruption, or security breach of that technology could have a material adverse impact on its business."
Mattel relies extensively on information technology in its operations, and any material failure, inadequacy, interruption, or security breach of that technology could have a material adverse impact on its business.
Mattel relies extensively on information technology systems across its operations, including for management of its supply chain, sale and delivery of its products and services, reporting its results of operations, collection and storage of consumer data, personal data of customers, employees and other stakeholders, and various other processes and transactions. Many of these systems are managed by third-party service providers. Mattel uses third-party technology and systems for a variety of reasons, including, without limitation, encryption and authentication technology, employee email, content delivery to customers, back-office support, and other functions. A small and growing volume of Mattel’s consumer products and services are web-based, and some are offered in conjunction with business partners or such third-party service providers. Mattel and its business partners and third-party service providers collect, process, store, and transmit consumer data, including personal information, in connection with those products and services. Failure to follow applicable regulations related to those activities, or to prevent or mitigate data loss or other security breaches, including breaches of Mattel’s business partners’ technology and systems, could expose Mattel or its customers to a risk of loss or misuse of such information, which could adversely affect Mattel’s operating results, result in regulatory enforcement, other litigation and potential liability for Mattel, and otherwise harm its business. Mattel’s ability to effectively manage its business and coordinate the production, distribution, and sale of its products and services depends significantly on the reliability and capacity of these systems and third-party service providers. Although Mattel has developed systems and processes that are designed to protect personal information and prevent data loss and other security breaches, including systems and processes designed to reduce the impact of a security breach at a third-party provider, such measures cannot provide absolute security.
Mattel has exposure to similar security risks faced by other large companies that have data stored on their information technology systems. To its knowledge, Mattel has not experienced any material breach of its network systems. If Mattel’s or its third-party service providers' systems fail to operate effectively or are damaged, destroyed, or shut down, or there are problems with transitioning to upgraded or replacement systems, or there are security breaches in these systems, any of which could occur as a result of natural disasters, software or equipment failures, telecommunications failures, loss or theft of equipment, acts of terrorism, circumvention of security systems, or other cyber-attacks, including denial-of-service attacks, Mattel could experience delays or decreases in product sales and reduced efficiency of its operations. Additionally, any of these events could lead to violations of privacy laws, loss of customers, or loss, misappropriation or corruption of confidential information, trade secrets, or data, which could expose Mattel to potential litigation, regulatory actions, sanctions, or other statutory penalties, any or all of which could adversely affect its business, and cause it to incur significant losses and remediation costs.
As a global company, Mattel is subject to a variety of continuously evolving and developing laws and regulations in the U.S. and abroad regarding privacy, data protection, and data security, including those related to the collection, storage, handling, use, disclosure, transfer, and security of personal data. Significant uncertainty exists as privacy and data protection laws may be interpreted and applied differently from country to country and may create inconsistent or conflicting requirements. For example, the EU General Data Protection Regulation, which greatly increases the jurisdictional reach of European Union law and became effective in May 2018, added a broad array of requirements for handling personal data, including the public disclosure of significant data breaches, and imposes substantial penalties for non-compliance. Mattel’s ongoing compliance with the EU General Data Protection Regulation and other privacy and data protection laws may impose significant costs and challenges that are likely to increase over time.
17
Mattel’s business depends in large part on the success of its vendors and outsourcers, and Mattel’s brands and reputation may be harmed by actions taken by third parties that are outside Mattel’s control. In addition, any material failure, inadequacy, or interruption resulting from such vendors or outsourcings could harm Mattel’s ability to effectively operate its business.
As a part of its efforts to cut costs, achieve better efficiencies and increase productivity and service quality, Mattel relies significantly on vendor and outsourcing relationships with third parties for services and systems including manufacturing, transportation, logistics, and information technology. Any shortcoming of a Mattel vendor or outsourcer, particularly an issue affecting the quality of these services or systems, may be attributed by customers to Mattel, thus damaging Mattel’s reputation and brand value, and potentially affecting its results of operations. In addition, problems with transitioning these services and systems to, or operating failures with, these vendors and outsourcers could cause delays in product sales and reduce efficiency of Mattel’s operations, and significant capital investments could be required to remediate the problem.
If Mattel is not able to adequately protect its proprietary intellectual property and information, and protect against third-party claims that Mattel is infringing on their intellectual property rights, its results of operations could be adversely affected.
The value of Mattel’s business depends on its ability to protect its intellectual property and information, including its trademarks, trade names, copyrights, patents, trade secrets, and rights under intellectual property license agreements and other agreements with third parties, in the U.S. and around the world, as well as its customer, employee, and consumer data. From time to time, third parties have challenged, and may in the future try to challenge, Mattel's ownership of its intellectual property in the U.S. and around the world. In addition, Mattel's business is subject to the risk of third parties counterfeiting its products or infringing on its intellectual property rights. The steps Mattel has taken may not prevent unauthorized use of its intellectual property, particularly in foreign countries where the laws may not protect its intellectual property as fully as in the U.S. Mattel may need to resort to litigation to protect its intellectual property rights, which could result in substantial costs and diversion of resources. If Mattel fails to protect its proprietary intellectual property and information, including with respect to any successful challenge to Mattel’s ownership of its intellectual property or material infringements of its intellectual property, this failure could have a significant adverse effect on Mattel’s business, financial condition, and results of operations.
Mattel has acquired certain intellectual properties from third parties. Declines in the profitability of these acquired brands may impact Mattel’s ability to recover the carrying value of the related assets and could result in an impairment charge. Reduction in net earnings caused by impairment charges could harm Mattel’s financial results.
Unfavorable resolution of or adverse developments in legal proceedings, other investigations, or regulatory matters could have a significant adverse effect on Mattel’s financial condition.
Mattel periodically receives claims of infringement of intellectual property rights held by other parties. Responding to any infringement claim, regardless of its validity, may be costly and time-consuming and may divert management and key personnel from business operations. If Mattel, its distributors, its licensors or its manufacturers are found to be infringing on the intellectual property rights of any third party, they may be required to obtain a license to use those rights, which may not be obtainable on reasonable terms, if at all.
Mattel is, from time to time, involved in litigation or other disputes, investigations, and regulatory matters. An unfavorable resolution of these matters could have a significant adverse effect on Mattel’s financial condition and its operations. Regardless of their outcome, these matters may result in substantial costs and expenses, significantly divert the attention of management, or interrupt Mattel’s normal business operations. There can be no assurance that Mattel will be able to prevail in, or achieve a favorable settlement of, any of these matters.
18
Mattel is subject to various laws and government policies or regulations in numerous jurisdictions, violation of which could subject it to sanctions. In addition, changes in such laws or policies or regulations may lead to increased costs, changes in Mattel’s effective tax rate, or the interruption of normal business operations that would negatively impact Mattel’s financial condition and results of operations.
Mattel operates in a highly regulated environment in the U.S. and international markets. U.S. federal, state, and local governmental entities, and foreign governments regulate many aspects of Mattel’s business, including its products and the importation and exportation of its products. These policies or regulations may include accounting standards, taxation requirements (including changes in applicable income tax rates, new tax laws, and revised tax law interpretations), product safety and other safety standards, trade restrictions, duties and tariffs (including international trade laws and regulations, export controls, and economic sanctions), and regulations regarding currency and financial matters, anticorruption standards (such as the U.S. Foreign Corrupt Practices Act), environmental matters, advertising directed toward children, product content, and privacy and data protection, as well as other administrative and regulatory restrictions. While Mattel takes all the steps it believes are necessary to comply with these laws and policies or regulations, there can be no assurance that Mattel will be in compliance in the future. Compliance with these various laws, regulations, and policies imposes significant costs on Mattel’s business, and failure to comply could result in monetary liabilities and other penalties and could lead to significant negative media attention and consumer dissatisfaction, which could have a significant adverse effect on Mattel’s business, financial condition, and results of operations.
In addition, changes in laws, policies or regulations may lead to increased costs, changes in Mattel’s effective tax rate, or the interruption of normal business operations, any of which could negatively impact its financial condition and results of operations. Specifically, in December 2017, the Tax Cuts and Jobs Act (the "U.S. Tax Act") was signed into law and significantly revised the Internal Revenue Code of 1986, as amended. This legislation, among other things, contains significant changes to corporate taxation, including the reduction of the corporate income tax rate from 35% to 21% beginning in 2018. Notwithstanding the reduction in the corporate income tax rate, Mattel is continuing to examine the long-term impact of the U.S. Tax Act. During 2018, the Department of the Treasury issued certain guidance in the form of notices and proposed regulations with respect to several provisions of the U.S. Tax Act. It is anticipated that additional regulations or other guidance may be issued with respect to the U.S. Tax Act in 2019 and subsequent years. As regulations and guidance evolve with respect to the U.S. Tax Act, this could have a material adverse effect on Mattel’s financial performance. In addition, it is uncertain if, and to what extent, various states will conform to the new tax law and how foreign jurisdictions will react to the new tax law by adopting tax legislation or taking other actions that could adversely affect Mattel's business.
In addition, increases in import and excise duties and/or sales or value added taxes in the jurisdictions in which Mattel operates could affect the affordability of Mattel’s products and, therefore, reduce demand.
Issues with products may lead to product liability, personal injury or property damage claims, recalls, withdrawals, replacements of products, or regulatory actions by governmental authorities that could divert resources, affect business operations, decrease sales, increase costs, and put Mattel at a competitive disadvantage, any of which could have a significant adverse effect on Mattel’s financial condition.
Mattel has experienced, and may in the future experience, issues with products that may lead to product liability, personal injury or property damage claims, recalls, withdrawals, replacements of products, or regulatory actions by governmental authorities. Any of these activities could result in increased governmental scrutiny, harm to Mattel’s reputation, reduced demand by consumers for its products, decreased willingness by retailer customers to purchase or provide marketing support for those products, adverse impacts on Mattel’s ability to enter into licensing agreements for products on competitive terms, absence or increased cost of insurance, or additional safety and testing requirements. Such results could divert development and management resources, adversely affect Mattel’s business operations, decrease sales, increase legal fees and other costs, and put Mattel at a competitive disadvantage compared to other manufacturers not affected by similar issues with products, any of which could have a significant adverse effect on Mattel’s financial condition and results of operations.
19
Mattel’s current and future operating procedures and product requirements may increase costs, significantly and adversely affect its relationship with vendors, and make it more difficult for Mattel to produce, purchase, and deliver products on a timely basis to meet market demands. Future conditions may require Mattel to adopt further changes that may increase its costs and further affect its relationship with vendors.
Mattel’s current operating procedures and product requirements, including testing requirements and standards, have imposed costs on both Mattel and the vendors from which it purchases products. Changes in business conditions, including those resulting from new legislative and regulatory requirements, have caused, and in the future could cause, further revisions in Mattel’s operating procedures and product requirements. Changes in Mattel’s operating procedures and product requirements may delay delivery of products and increase costs. Mattel’s relationship with its existing vendors may be adversely affected as a result of these changes, making Mattel more dependent on a smaller number of vendors. Mattel is not currently dependent on a single supplier or group of suppliers. Some vendors may choose not to continue to do business with Mattel or not to accommodate Mattel’s needs to the extent that they have done in the past. In addition, rising production costs, contraction of credit availability, and labor shortages have caused a substantial contraction in the number of toy manufacturers in China, decreasing the number of potential vendors to manufacture Mattel’s products. Because of the seasonal nature of Mattel’s business and the demands of its customers for deliveries with short lead times, Mattel depends upon the cooperation of its vendors to meet market demand for its products in a timely manner. There can be no assurance that existing and future events will not require Mattel to adopt additional requirements and incur additional costs, and impose those requirements and costs on its vendors, which may adversely affect its relationship with those vendors and Mattel’s ability to meet market demand in a timely manner.
The production and sale of private-label toys by Mattel’s retail customers may result in lower purchases of Mattel-branded products by those retail customers.
In recent years, consumer goods companies, including those in the toy business, generally have experienced the phenomenon of retail customers developing their own private-label products that directly compete with the products of traditional manufacturers. Some retail chains and online retailers that are customers of Mattel, including its largest retail customers, Walmart and Target, sell private-label toys designed, manufactured, and branded by the retailers themselves. These toys may be sold at prices lower than comparable toys sold by Mattel and may result in lower purchases of Mattel-branded products by these retailers. In some cases, retailers who sell these private-label toys are larger than Mattel and may have substantially more resources than Mattel.
Mattel depends on key personnel and may not be able to hire, retain, and integrate sufficient qualified personnel to maintain and expand its business.
Mattel’s future success depends partly on the continued contribution of key executives, designers, technical, sales, marketing, manufacturing, and other personnel. The loss of services of any of Mattel’s key personnel could harm Mattel’s business. Recruiting and retaining skilled personnel is costly and highly competitive. If Mattel fails to retain, hire, train, and integrate qualified employees and contractors, Mattel may not be able to maintain or expand its business.
20
Political developments, including trade relations, and the threat or occurrence of war or terrorist activities could adversely impact Mattel, its personnel and facilities, its customers and suppliers, retail and financial markets, and general economic conditions.
Mattel’s business is worldwide in scope, including operations in over 50 countries and territories. Political instability, civil unrest, the deterioration of the political situation in a country in which Mattel has significant sales or operations, or the breakdown of trade relations between the U.S. and a foreign country in which Mattel has significant manufacturing facilities or other operations, could adversely affect Mattel’s business, financial condition, and results of operations. For example, a change in trade status between the U.S. and China or Mexico could result in a substantial increase in the import duty of toys manufactured in these countries and imported into the U.S. There is currently significant uncertainty about the future relationship between the U.S. and China, including with respect to trade policies, tariffs, treaties, and government regulations. The current U.S. presidential administration has called for substantial changes to U.S. foreign trade policy with respect to China, including the possibility of imposing greater restrictions on international trade and significant increases in tariffs on goods imported into the U.S. Recently, the U.S. has increased tariffs on certain goods imported into the U.S. from China, following which the Chinese government increased tariffs on certain goods imported into China from the U.S., in response to which the U.S. announced plans to impose additional tariffs. There is a risk of further escalation and retaliatory actions between the two countries. In addition, the current administration, certain members of Congress, and federal officials have stated that the U.S. may seek to implement more protective trade measures, not just with respect to China, but with respect to other countries in the Asia Pacific region as well. Any increased trade barriers or restrictions on global trade, especially trade with China, could adversely impact our business and financial statements. In addition, the occurrence of war or hostilities between countries or threat of terrorist activities, and the responses to and results of these activities, could adversely impact Mattel, its personnel and facilities, its customers and suppliers, retail and financial markets, and general economic conditions.
Disruptions in Mattel’s manufacturing operations due to political instability, civil unrest, or disease could negatively impact Mattel’s business, financial position, and results of operations.
Mattel owns, operates and manages manufacturing facilities and utilizes third-party manufacturers throughout Asia, primarily in China, Indonesia, Malaysia, Thailand, Canada, and Mexico. The risk of political instability and civil unrest exists in certain of these countries, which could temporarily or permanently damage Mattel’s manufacturing operations located there. In the past, outbreaks of avian flu have been significantly concentrated in Asia, particularly in Hong Kong, and in the Guangdong province of China, where many of Mattel’s manufacturing facilities and third-party manufacturers are located. The design, development, and manufacture of Mattel’s products could suffer if a significant number of Mattel’s employees or the employees of its third-party manufacturers or their suppliers contract avian flu or other communicable diseases, or otherwise are unable to fulfill their obligations to Mattel. While Mattel has developed contingency plans designed to help mitigate the impact of disruptions in its manufacturing operations, its business, financial position, and results of operations could be negatively impacted by a significant disruption to its manufacturing operations or suppliers.
Earthquakes or other catastrophic events out of Mattel’s control may damage its facilities or those of its contractors and harm Mattel’s results of operations.
Mattel has significant operations near major earthquake faults, including its corporate headquarters in El Segundo, California. A catastrophic event where Mattel has important operations, such as an earthquake, tsunami, flood, typhoon, fire, or other natural or manmade disaster, could disrupt Mattel’s operations or those of its contractors and impair production or distribution of its products, damage inventory, interrupt critical functions, or otherwise affect its business negatively, harming Mattel’s results of operations.
21
Mattel may engage in acquisitions, mergers, dispositions, or other strategic transactions, which may affect the revenues, profit, profit margins, debt-to-capital ratio, capital expenditures, or other aspects of Mattel’s business. In addition, Mattel has certain anti-takeover provisions in its bylaws that may make it more difficult for a third party to acquire Mattel without its consent, which may adversely affect Mattel’s stock price.
Mattel regularly considers, and from time to time may engage in, discussions and negotiations regarding acquisitions, mergers, or dispositions, or other strategic transactions that could affect the profit, revenues, profit margins, debt-to-capital ratio, capital expenditures, or other aspects of Mattel’s business. There can be no assurance that Mattel will be able to identify suitable acquisition targets or merger partners or that, if identified, it will be able to complete these transactions on terms acceptable to Mattel and to potential merger partners. There can also be no assurance that Mattel will be successful in integrating any acquired company into its overall operations, or that any such acquired company will operate profitably or will not otherwise adversely impact Mattel’s results of operations. Further, Mattel cannot be certain that key talented individuals at those acquired companies will continue to work for Mattel after the acquisition or that they will continue to develop popular and profitable products or services. In addition, Mattel has certain anti-takeover provisions in its bylaws that may make it more difficult for a third party to acquire Mattel without its consent, which may adversely affect Mattel’s stock price.
The level of returns on pension plan assets and the actuarial assumptions used for valuation purposes could affect Mattel’s earnings in future periods. Changes in standards and government regulations could also affect its pension plan expense and funding requirements.
Assumptions used in determining projected benefit obligations and the fair value of plan assets for Mattel’s pension plan are evaluated by Mattel in consultation with outside actuaries. In the event that Mattel determines that changes are warranted in the assumptions used, such as the discount rate, expected long term rate of return, or health care costs, its future pension benefit expenses could increase or decrease. Due to changing market conditions or changes in the participant population, the actuarial assumptions that Mattel uses may differ from actual results, which could have a significant impact on its pension and postretirement liability and related costs. Funding obligations are determined based on the value of assets and liabilities on a specific date as required under relevant government regulations for each plan. Future pension funding requirements, and the timing of funding payments, could be affected by legislation enacted by the relevant governmental authorities.
If Mattel’s goodwill becomes impaired, Mattel’s results of operations could be adversely affected.
Mattel tests its goodwill for impairment annually or more often if an event or circumstance indicates that an impairment may have occurred. For purposes of evaluating whether goodwill is impaired, goodwill is allocated to various reporting units, which are at the operating segment level. Declines in profitability of Mattel’s reporting units may impact the fair value of its reporting units, which could result in an impairment of its goodwill, negatively impacting its results of operations. For more information, see Part I, Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations—Application of Critical Accounting Policies and Estimates—Goodwill and Nonamortizable Intangible Assets" and Part II, Item 8 "Financial Statements and Supplementary Data—Note 3 to the Consolidated Financial Statements—Goodwill and Other Intangibles."
Mattel’s stock price has been volatile over the past several years and could decline in the future, resulting in losses for Mattel's investors.
All the factors discussed in this section or any other material announcements or events could affect Mattel's stock price. In addition, quarterly fluctuations in Mattel's operating results, changes in investor and analyst perception of Mattel's business risks and conditions of our business, Mattel's ability to meet earnings estimates and other performance expectations of financial analysts or investors, unfavorable commentary or downgrades of Mattel's stock by research analysts, fluctuations in the stock prices of Mattel's peer companies or in stock markets in general, and general economic or political conditions could also cause the price of Mattel's stock to change. A significant drop in the price of Mattel's stock could expose Mattel to the risk of securities class action lawsuits, which could result in substantial costs and divert management’s attention and resources, adversely affecting Mattel's business. There is a purported class action alleging federal securities laws violations currently pending in the Ninth Circuit Court of Appeals following dismissal of the lawsuit by the United States District Court for the Central District of California against Mattel and individual defendants. In addition, a stockholder has filed a derivative action in the United States District Court for the District of Delaware making allegations that are substantially identical to, or are based upon, the allegations of the class action lawsuit. For more information, see Part II, Item 8 "Financial Statements and Supplementary Data—Note 12 to the Consolidated Financial Statements—Commitments and Contingencies—Litigation."
Item 1B. | Unresolved Staff Comments. |
None.
22
Item 2. | Properties. |
Mattel owns its corporate headquarters in El Segundo, California, consisting of approximately 335,000 square feet, and an adjacent office building consisting of approximately 55,000 square feet. Mattel also leases buildings in El Segundo consisting of approximately 327,000 square feet. All segments use these facilities. Mattel also owns facilities in East Aurora, New York, consisting of approximately 607,000 square feet, which is used by the North America segment and for brand and corporate support functions. American Girl owns its headquarters facilities in Middleton, Wisconsin, consisting of approximately 180,000 square feet, a warehouse in Middleton, consisting of approximately 215,000 square feet, and distribution facilities in Middleton, DeForest, and Wilmot, Wisconsin, consisting of a total of approximately 948,000 square feet, all of which are used by the American Girl segment. Additionally, Mattel leases a facility in Montreal, Canada, consisting of approximately 817,000 square feet, which is used for brand support and manufacturing functions. These facilities in Canada are used by both the North America and International segments. Mattel also owns its principal manufacturing facilities located in Indonesia, Malaysia, Mexico, and Thailand.
Mattel maintains leased offices in Arkansas, California, Minnesota, and New York, and leased warehouse and distribution facilities in California, Pennsylvania, and Texas, all of which are used by the North America segment. Mattel has leased retail and related office space in Chicago, Illinois, Los Angeles, California, and New York, New York for its American Girl Place stores, and in Alpharetta, Georgia, Bloomington, Minnesota, Charlotte, North Carolina, Columbus, Ohio, Dallas, Texas, Houston, Texas, Lone Tree, Colorado, Lynnwood, Washington, McLean, Virginia, Miami, Florida, Nashville, Tennessee, Natick, Massachusetts, Orlando, Florida, Overland Park, Kansas, Palo Alto, California, Hershey, Pennsylvania, and Scottsdale, Arizona for its American Girl stores. Internationally, Mattel has offices and/or warehouse space in Argentina, Australia, Austria, Belgium, Bermuda, Brazil, Canada, Chile, China, Colombia, the Czech Republic, Denmark, France, Germany, Greece, Hong Kong, Hungary, India, Indonesia, Italy, Japan, Malaysia, Mexico, the Netherlands, New Zealand, Panama, Peru, Poland, Portugal, Russia, Singapore, South Africa, South Korea, Spain, Switzerland, Taiwan, Turkey, and the United Kingdom, which are leased (with the exception of office and warehouse space in Chile and certain warehouse space in France that is owned by Mattel) and used by the International segment. Mattel also has office space and principal manufacturing facilities in China, which support the North America, International, and American Girl segments.
For leases that are scheduled to expire within the next twelve months, Mattel may negotiate new lease agreements, renew existing lease agreements, or utilize alternate facilities. See Part II, Item 8 "Financial Statements and Supplementary Data—Note 12 to the Consolidated Financial Statements—Commitments and Contingencies." Mattel believes that its owned and leased facilities, in general, are suitable and adequate for its present and currently foreseeable needs.
Item 3. | Legal Proceedings. |
See Part II, Item 8 "Financial Statements and Supplementary Data—Note 12 to the Consolidated Financial Statements—Commitments and Contingencies—Litigation."
Item 4. | Mine Safety Disclosures. |
Not applicable.
23
PART II
Item 5. | Market for the Registrant's Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities. |
Market Information
Mattel’s common stock, par value $1.00 per share, is traded under the symbol "MAT" on The Nasdaq Global Select Market.
Holders of Record
As of February 8, 2019, Mattel had approximately 26,000 holders of record of its common stock.
Recent Sales of Unregistered Securities
During the fourth quarter of 2018, Mattel did not sell any unregistered securities.
Issuer Purchases of Equity Securities
During 2018, 2017, and 2016, Mattel did not repurchase any shares of its common stock.
The following table provides certain information with respect to Mattel’s purchases of its common stock during the fourth quarter of 2018:
Total Number of Shares (or Units) Purchased (a) | Average Price Paid per Share (or Unit) | Total Number of Shares (or Units) Purchased as Part of Publicly Announced Plans or Programs | Maximum Number (or Approximate Dollar Value) of Shares (or Units) that May Yet Be Purchased Under the Plans or Programs (b) | ||||||||||
Period: | |||||||||||||
October 1—31 | 7,198 | $ | 13.61 | — | $ | 203,016,273 | |||||||
November 1—30 | 1,363 | 13.90 | — | 203,016,273 | |||||||||
December 1—31 | 26,710 | 9.96 | — | 203,016,273 | |||||||||
Total | 35,271 | $ | 10.86 | — | $ | 203,016,273 | |||||||
(a) | The total number of shares purchased includes 35,271 shares withheld from employees to satisfy minimum tax withholding obligations that occur upon vesting of restricted stock units. These shares were not purchased as part of a publicly announced repurchase plan or program. |
(b) | Mattel's share repurchase program was first announced on July 21, 2003. On July 17, 2013, the Board of Directors authorized Mattel to increase its share repurchase program by $500.0 million. At December 31, 2018, share repurchase authorizations of $203.0 million had not been executed. Repurchases under the program will take place from time to time, depending on market conditions. Mattel’s share repurchase program has no expiration date. |
24
Performance Graph
The following graph compares the performance of Mattel's common stock with that of the S&P 500 Index and the S&P 500 Consumer Discretionary Index. The Cumulative Total Return listed below assumes an initial investment of $100 on December 31, 2013 and reinvestment of dividends.
December 31, | |||||||||||||||||||||||
2013 | 2014 | 2015 | 2016 | 2017 | 2018 | ||||||||||||||||||
Cumulative Total Return: | |||||||||||||||||||||||
Mattel, Inc. | $ | 100.00 | $ | 67.93 | $ | 63.47 | $ | 67.55 | $ | 39.28 | $ | 25.51 | |||||||||||
S&P 500 | $ | 100.00 | $ | 113.68 | $ | 115.24 | $ | 129.02 | $ | 157.17 | $ | 150.27 | |||||||||||
S&P 500 Consumer Discretionary | $ | 100.00 | $ | 109.68 | $ | 120.76 | $ | 128.05 | $ | 157.47 | $ | 158.75 | |||||||||||
25
Item 6. | Selected Financial Data. |
For the Year Ended December 31, | |||||||||||||||||||
2018 | 2017 (b) | 2016 (b) | 2015 (b) | 2014 (b) | |||||||||||||||
(In thousands, except per share and percentage information) | |||||||||||||||||||
Operating Results: | |||||||||||||||||||
Net sales | $ | 4,510,852 | $ | 4,881,951 | $ | 5,456,650 | $ | 5,702,613 | $ | 6,023,819 | |||||||||
Gross profit | 1,794,725 | 1,820,829 | 2,554,391 | 2,806,358 | 3,001,022 | ||||||||||||||
% of net sales | 39.8 | % | 37.3 | % | 46.8 | % | 49.2 | % | 49.8 | % | |||||||||
Operating (loss) income | (236,507 | ) | (339,440 | ) | 527,675 | 549,596 | 665,717 | ||||||||||||
% of net sales | (5.2 | )% | (7.0 | )% | 9.7 | % | 9.6 | % | 11.1 | % | |||||||||
(Loss) income before income taxes | (419,261 | ) | (504,987 | ) | 409,742 | 463,915 | 586,910 | ||||||||||||
Provision for income taxes (a) | 111,732 | 548,849 | 91,720 | 94,499 | 88,036 | ||||||||||||||
Net (loss) income | $ | (530,993 | ) | $ | (1,053,836 | ) | $ | 318,022 | $ | 369,416 | $ | 498,874 | |||||||
Net (Loss) Income Per Common Share—Basic | $ | (1.54 | ) | $ | (3.07 | ) | $ | 0.93 | $ | 1.08 | $ | 1.46 | |||||||
Net (Loss) Income Per Common Share—Diluted | $ | (1.54 | ) | $ | (3.07 | ) | $ | 0.92 | $ | 1.08 | $ | 1.45 | |||||||
Dividends Declared Per Common Share | $ | — | $ | 0.91 | $ | 1.52 | $ | 1.52 | $ | 1.52 | |||||||||
December 31, | |||||||||||||||||||
2018 | 2017 | 2016 | 2015 | 2014 | |||||||||||||||
(In thousands) | |||||||||||||||||||
Financial Position: | |||||||||||||||||||
Total assets | $ | 5,243,465 | $ | 6,238,503 | $ | 6,493,794 | $ | 6,535,143 | $ | 6,721,983 | |||||||||
Noncurrent liabilities | 3,321,392 | 3,357,245 | 2,580,439 | 2,256,360 | 2,684,026 | ||||||||||||||
Stockholders’ equity | 669,465 | 1,257,455 | 2,407,782 | 2,633,254 | 2,949,071 | ||||||||||||||
(a) | The provision for income taxes in 2018 was negatively impacted by a $14.6 million expense related to changes to Mattel's indefinite reinvestment assertion, and a $3.7 million expense related to the deemed repatriation of accumulated foreign earnings (net of related valuation allowance change). The provision for income taxes in 2017 was negatively impacted by net tax expense of $454.4 million, primarily related to the establishment of a valuation allowance in the third quarter of 2017 on U.S. deferred tax assets that will likely not be realized and a provisional estimate of the impact of the U.S. Tax Act in the fourth quarter of 2017. The provision for income taxes in 2016 was positively impacted by net tax benefits of $16.8 million, primarily related to reassessments of prior years' tax liabilities based on the status of audits and tax filings in various jurisdictions around the world, settlements, and enacted tax law changes, and the adoption of a new accounting pronouncement. The provision for income taxes in 2015 was positively impacted by net tax benefits of $19.1 million, primarily related to reassessments of prior years' tax liabilities based on the status of audits and tax filings in various jurisdictions around the world, settlements, and enacted tax law changes. The provision for income taxes in 2014 was positively impacted by net tax benefits of $42.6 million, primarily related to reassessments of prior years’ tax liabilities based on the status of audits and tax filings in various jurisdictions around the world, settlements, and enacted tax law changes, partially offset by a tax charge related to a 2014 tax restructuring for the HIT Entertainment and MEGA Brands operations. |
(b) | In accordance with Accounting Standards Update ("ASU") 2017-07, Compensation - Retirement Benefits: Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost, prior period amounts have been retrospectively adjusted, which resulted in a reclassification of $3.4 million, $8.4 million, $8.7 million, and $12.0 million of expense, net from other selling and administrative expenses to other non-operating expense, net for the year ended December 31, 2017, 2016, 2015, and 2014, respectively. |
26
Item 7. | Management's Discussion and Analysis of Financial Condition and Results of Operations. |
The following discussion should be read in conjunction with the consolidated financial statements and the related notes. See Item 8 "Financial Statements and Supplementary Data." Note that amounts within this Item shown in millions may not foot due to rounding.
The following discussion also includes gross sales and currency exchange rate impact, non-GAAP financial measures within the meaning of Regulation G promulgated by the Securities and Exchange Commission ("Regulation G"), to supplement the financial results as reported in accordance with GAAP. Gross sales represent sales to customers, excluding the impact of sales adjustments, such as trade discounts and other allowances. The currency exchange rate impact reflects the portion (expressed as a percentage) of changes in Mattel's reported results that are attributable to fluctuations in currency exchange rates. Mattel uses these non-GAAP financial measures to analyze its continuing operations and to monitor, assess, and identify meaningful trends in its operating and financial performance. These measures are not, and should not be viewed as, a substitute for GAAP financial measures. Refer to "Non-GAAP Financial Measures" in this Annual Report on Form 10-K for a more detailed discussion, including a reconciliation of gross sales, a non-GAAP financial measure, to net sales, its most directly comparable GAAP financial measure.
Overview
Mattel is a leading global children’s entertainment company that specializes in the design and production of quality toys and consumer products. Mattel's products are among the most widely recognized toy products in the world. Mattel's mission is to "create innovative products and experiences that inspire, entertain, and develop children through play." In order to deliver on this mission, Mattel is focused on the following two-part strategy to transform Mattel from a toy manufacturing company into an IP-driven, high-performing toy company:
• | In the short- to mid-term, restore profitability by reshaping operations and regain topline growth by growing Mattel's Power Brands (Barbie, Hot Wheels, Fisher-Price and Thomas & Friends, and American Girl) and expanding Mattel's brand portfolio. |
• | In the mid- to long-term, capture the full value of Mattel's IP through franchise management and the development of Mattel's online retail and e-commerce capabilities. |
Results of Operations
2018 Compared to 2017
Consolidated Results
Net sales for 2018 were $4.51 billion, an 8% decrease, as compared to $4.88 billion in 2017. Net sales for 2018 were negatively impacted by 6% from lower Toys "R" Us sales as a result of its liquidation. Net loss for 2018 was $531.0 million, or $1.54 per share, as compared to a net loss of $1.05 billion, or $3.07 per share, in 2017, primarily due to lower income tax expense, related to the establishment in the third quarter of 2017 of a valuation allowance on U.S. deferred tax assets that will likely not be realized, and a lower advertising and promotion rate.
27
The following table provides a summary of Mattel’s consolidated results for 2018 and 2017:
For the Year Ended | Year/Year Change | ||||||||||||||||||
December 31, 2018 | December 31, 2017 | ||||||||||||||||||
Amount | % of Net Sales | Amount (a) | % of Net Sales | % | Basis Points of Net Sales | ||||||||||||||
(In millions, except percentage and basis point information) | |||||||||||||||||||
Net sales | $ | 4,510.9 | 100.0 | % | $ | 4,882.0 | 100.0 | % | -8 | % | — | ||||||||
Gross profit | $ | 1,794.7 | 39.8 | % | $ | 1,820.8 | 37.3 | % | -1 | % | 250 | ||||||||
Advertising and promotion expenses | 526.4 | 11.7 | 642.3 | 13.2 | -18 | % | (150 | ) | |||||||||||
Other selling and administrative expenses | 1,504.8 | 33.4 | 1,517.9 | 31.1 | -1 | % | 230 | ||||||||||||
Operating loss | (236.5 | ) | -5.2 | (339.4 | ) | -7.0 | -30 | % | 180 | ||||||||||
Interest expense | 181.9 | 4.0 | 105.2 | 2.2 | 73 | % | 180 | ||||||||||||
Interest (income) | (6.5 | ) | -0.1 | (7.8 | ) | -0.2 | -17 | % | 10 | ||||||||||
Other non-operating expense, net | 7.3 | 68.1 | |||||||||||||||||
Loss before income taxes | $ | (419.3 | ) | -9.3 | % | $ | (505.0 | ) | -10.3 | % | -17 | % | 100 | ||||||
(a) | In accordance with ASU 2017-07, prior period amounts have been retrospectively adjusted, which resulted in a reclassification of $3.4 million of expense, net from other selling and administrative expenses to other non-operating expense, net for the year ended December 31, 2017. |
Sales
Net sales for 2018 were $4.51 billion, an 8% decrease, as compared to $4.88 billion in 2017.
The following table provides a summary of Mattel’s consolidated gross sales by brand results for 2018 and 2017:
For the Year Ended | % Change as Reported | Currency Exchange Rate Impact | |||||||||||
December 31, 2018 | December 31, 2017 | ||||||||||||
(In millions, except percentage information) | |||||||||||||
Power Brands | |||||||||||||
Barbie | $ | 1,089.0 | $ | 954.9 | 14 | % | -1 | % | |||||
Hot Wheels | 834.1 | 777.3 | 7 | % | -2 | % | |||||||
Fisher-Price and Thomas & Friends | 1,185.7 | 1,370.5 | -13 | % | — | % | |||||||
American Girl | 342.4 | 473.3 | -28 | % | — | % | |||||||
Total Power Brands | 3,451.1 | 3,576.1 | -3 | % | -1 | % | |||||||
Toy Box | |||||||||||||
Owned Brands | 887.4 | 980.6 | -10 | % | -2 | % | |||||||
Partner Brands | 737.0 | 957.5 | -23 | % | -1 | % | |||||||
Total Toy Box | 1,624.4 | 1,938.0 | -16 | % | -1 | % | |||||||
Total Gross Sales | 5,075.5 | 5,514.1 | -8 | % | -1 | % | |||||||
Sales Adjustments | (564.7 | ) | (632.2 | ) | |||||||||
Total Net Sales | $ | 4,510.9 | $ | 4,882.0 | -8 | % | -1 | % | |||||
Gross sales were $5.08 billion in 2018, a decrease of $438.6 million, or 8%, as compared to $5.51 billion in 2017, with an unfavorable impact from changes in currency exchange rates of 1 percentage point. The decrease in gross sales was a result of lower Toy Box and Power Brands sales, and included lower Toys "R" Us sales of 6%.
28
The 3% decrease in Power Brands gross sales was primarily due to lower sales of American Girl products and Fisher-Price and Thomas & Friends products, partially offset by higher sales of Barbie products. The 28% decrease in American Girl gross sales was primarily due to lower sales in proprietary retail and direct channels, a strategic shift away from the utilization of external distribution channels, and the sale of Corolle in the first quarter of 2018. Of the 13% decrease in Fisher-Price and Thomas & Friends gross sales, 6% was due to lower sales of Fisher-Price infant products and 5% was due to lower sales of Thomas & Friends products. The 14% increase in Barbie gross sales was primarily driven by positive POS brand momentum.
The 16% decrease in Toy Box gross sales was due to lower sales of Toy Box Partner Brands and Toy Box Owned Brands products. Of the 23% decrease in Toy Box Partner Brands gross sales, 24% was due to lower sales of CARS products, primarily as a result of the 2017 CARS 3 theatrical release, 5% was due to lower sales of DC Comics action figures products, and 5% was due to lower sales of DC Comics Superhero Girls products, partially offset by initial sales of Jurassic World products of 21% as a result of the 2018 theatrical release of Jurassic World: Fallen Kingdom. Of the 10% decrease in Toy Box Owned Brands gross sales, 8% was due to lower sales of MEGA products.
Cost of Sales
Cost of sales as a percentage of net sales was 60.2% in 2018, as compared to 62.7% in 2017. Cost of sales decreased by $345.0 million, or 11%, to $2.72 billion in 2018 from $3.06 billion in 2017, as compared to an 8% decrease in net sales. Within cost of sales, product and other costs decreased by $295.0 million, or 12%, to $2.15 billion in 2018 from $2.44 billion in 2017; freight and logistics expenses decreased by $29.5 million, or 8%, to $344.2 million in 2018 from $373.7 million in 2017; and royalty expenses decreased by $20.5 million, or 8%, to $224.0 million in 2018 from $244.5 million in 2017.
Gross Margin
Gross margin increased to 39.8% in 2018 from 37.3% in 2017. The increase in gross margin was primarily driven by Structural Simplification savings and lower obsolescence expense, partially offset by input cost inflation of raw materials and plant labor.
Advertising and Promotion Expenses
Advertising and promotion expenses primarily consist of: (i) media costs, which primarily include the media, planning, and buying fees for television, print, and online advertisements, (ii) non-media costs, which primarily include commercial and website production, merchandising, and promotional costs, (iii) retail advertising costs, which primarily include consumer direct catalogs, newspaper inserts, fliers, and mailers, and (iv) generic advertising costs, which primarily include trade show costs. Advertising and promotion expenses as a percentage of net sales decreased to 11.7% in 2018 from 13.2% in 2017, primarily driven by Structural Simplification savings of approximately $30 million.
Other Selling and Administrative Expenses
Other selling and administrative expenses were $1.50 billion, or 33.4% of net sales, in 2018, as compared to $1.52 billion, or 31.1% of net sales, in 2017. The decrease in other selling and administrative expenses was primarily driven by Structural Simplification savings of approximately $165 million, substantially offset by higher incentive compensation expense of approximately $65 million, higher severance and restructuring costs of approximately $39 million, and bad debt expense, net, of approximately $32 million related to the Toys "R" Us liquidation in 2018.
Interest Expense
Interest expense was $181.9 million in 2018, as compared to $105.2 million in 2017. The increase in interest expense was due to higher interest rates on outstanding debt and higher outstanding borrowings throughout 2018.
Other Non-Operating Expense, Net
Other non-operating expense, net, was $7.3 million in 2018, as compared to $68.1 million in 2017. The decrease in other non-operating expense, net, was primarily driven by a $59.0 million loss related to the discontinuation of Mattel's Venezuelan operations in the fourth quarter of 2017. See Item 7A "Quantitative and Qualitative Disclosures About Market Risk—Venezuelan Operations" for more information.
29
Provision for Income Taxes
Mattel’s provision for income taxes was $111.7 million in 2018, as compared to $548.8 million in 2017. The 2018 income tax provision included a $14.6 million expense related to changes to its indefinite reinvestment assertion and a $3.7 million expense related to the deemed repatriation of accumulated foreign earnings (net of related valuation allowance change). The 2017 income tax provision included net tax expense of $454.4 million, primarily related to the establishment of a valuation allowance in the third quarter of 2017 on U.S. deferred tax assets that will likely not be realized and a provisional estimate of the impact of the U.S. Tax Act in the fourth quarter of 2017.
North America Segment
The following table provides a summary of Mattel’s gross sales by brand for the North America segment for 2018 and 2017:
For the Year Ended | % Change as Reported | Currency Exchange Rate Impact | |||||||||||
December 31, 2018 | December 31, 2017 | ||||||||||||
(In millions, except percentage information) | |||||||||||||
Power Brands | |||||||||||||
Barbie | $ | 535.7 | $ | 450.9 | 19 | % | — | % | |||||
Hot Wheels | 380.2 | 340.0 | 12 | % | — | % | |||||||
Fisher-Price and Thomas & Friends | 665.9 | 737.4 | -10 | % | — | % | |||||||
Total Power Brands | 1,581.8 | 1,528.3 | 4 | % | — | % | |||||||
Toy Box | |||||||||||||
Owned Brands | 434.0 | 506.8 | -14 | % | — | % | |||||||
Partner Brands | 406.3 | 501.5 | -19 | % | — | % | |||||||
Total Toy Box | 840.3 | 1,008.3 | -17 | % | — | % | |||||||
Total Gross Sales | 2,422.1 | 2,536.7 | -5 | % | -1 | % | |||||||
Sales Adjustments | (149.3 | ) | (162.8 | ) | |||||||||
Total Net Sales | $ | 2,272.8 | $ | 2,373.9 | -4 | % | — | % | |||||
Gross sales for the North America segment were $2.42 billion in 2018, a decrease of $114.6 million, or 5%, as compared to $2.54 billion in 2017, with an unfavorable impact from changes in currency exchange rates of 1 percentage point. The decrease in the North America segment gross sales was primarily a result of lower Toy Box gross sales and included an unfavorable impact from lower Toys "R" Us sales of 12%. Gross sales reflect Toys "R" Us gross sales reversals of approximately $27 million and $47 million in 2018 and 2017, respectively.
The 4% increase in Power Brands gross sales was primarily due to higher sales of Barbie and Hot Wheels products, partially offset by lower sales of Fisher-Price and Thomas & Friends products. The 19% increase in Barbie gross sales was primarily driven by positive POS brand momentum. The 12% increase in Hot Wheels gross sales was primarily driven by the brand's 50th anniversary. Of the 10% decrease in Fisher-Price and Thomas & Friends gross sales, 4% was due to lower sales of Thomas & Friends products and 4% was due to lower sales of Fisher-Price preschool products.
The 17% decrease in Toy Box gross sales was due to lower sales of Toy Box Partner Brands and Toy Box Owned Brands products. Of the 19% decrease in Toy Box Partner Brands gross sales, 19% was due to lower sales of CARS products, primarily as a result of the 2017 CARS 3 theatrical release, 6% was due to lower sales of DC Comics action figures products, and 5% was due to lower sales of DC Comics Superhero Girls products, partially offset by initial sales of Jurassic World products of 24% as a result of the 2018 theatrical release of Jurassic World: Fallen Kingdom. Of the 14% decrease in Toy Box Owned Brands gross sales, 8% was due to lower sales of MEGA products and 4% was due to lower sales of Monster High products.
30
Cost of sales decreased 9% in 2018, as compared to a 4% decrease in net sales, primarily due to lower product and other costs and lower freight and logistics expenses. Gross margin in 2018 increased primarily due to Structural Simplification savings and lower obsolescence expense, partially offset by input cost inflation of raw materials and plant labor. As a result of the Toys "R" Us net sales reversals in 2018 and 2017, gross margin included the cost of sales for the inventory sold, but excluded the corresponding net sales.
North America segment income was $221.3 million in 2018, as compared to segment income of $98.5 million in 2017, primarily due to higher gross margin and lower advertising and promotion expenses.
International Segment
The following table provides a summary of percentage changes in net sales within the International segment in 2018 versus 2017:
% Change in Net Sales as Reported | Currency Exchange Rate Impact | ||||
Total International Segment (a) | -7 | % | -2 | % | |
Europe | -3 | % | 2 | % | |
Latin America | -2 | % | -6 | % | |
Global Emerging Markets | -17 | % | -3 | % | |
The following table provides a summary of percentage changes in gross sales within the International segment in 2018 versus 2017:
% Change in Gross Sales as Reported | Currency Exchange Rate Impact | ||||
Total International Segment (a) | -8 | % | -2 | % | |
Europe | -4 | % | 1 | % | |
Latin America | -3 | % | -6 | % | |
Global Emerging Markets | -17 | % | -4 | % | |
(a) | Mattel reorganized its regional reporting structure in the first quarter of 2018. As a result, Global Emerging Markets, which was previously disclosed as Asia Pacific, includes Russia, Turkey, the Middle East, and Africa, which were previously included within Europe. Prior period amounts have been reclassified to conform to the current period presentation. |
31
The following table provides a summary of Mattel’s gross sales by brand for the International segment for 2018 and 2017:
For the Year Ended | % Change as Reported | Currency Exchange Rate Impact | |||||||||||
December 31, 2018 | December 31, 2017 | ||||||||||||
(In millions, except percentage information) | |||||||||||||
Power Brands | |||||||||||||
Barbie | $ | 553.2 | $ | 504.0 | 10 | % | -2 | % | |||||
Hot Wheels | 453.9 | 437.4 | 4 | % | -3 | % | |||||||
Fisher-Price and Thomas & Friends | 519.8 | 633.1 | -18 | % | -2 | % | |||||||
American Girl | 1.8 | 0.1 | |||||||||||
Total Power Brands | 1,528.6 | 1,574.6 | -3 | % | -2 | % | |||||||
Toy Box | |||||||||||||
Owned Brands | 452.8 | 473.0 | -4 | % | -2 | % | |||||||
Partner Brands | 330.7 | 456.0 | -27 | % | -1 | % | |||||||
Total Toy Box | 783.6 | 929.0 | -16 | % | -2 | % | |||||||
Total Gross Sales | 2,312.2 | 2,503.5 | -8 | % | -2 | % | |||||||
Sales Adjustments | (401.0 | ) | (442.7 | ) | |||||||||
Total Net Sales | $ | 1,911.2 | $ | 2,060.8 | -7 | % | -2 | % | |||||
Gross sales for the International segment were $2.31 billion in 2018, a decrease of $191.3 million, or 8%, as compared to $2.50 billion in 2017, with an unfavorable impact from changes in currency exchange rates of 2 percentage points, lower Toys "R" Us sales of 2%, and a negative impact from the slowdown in our China business of 4%. The decrease in the International segment gross sales was due to lower Toy Box and Power Brands sales.
The 3% decrease in Power Brands gross sales was primarily due to lower sales of Fisher-Price and Thomas & Friends products, partially offset by higher sales of Barbie products. Of the 18% decrease in Fisher-Price and Thomas & Friends products, 12% was due to lower sales of Fisher-Price infant products and 6% was due to lower sales of Thomas & Friends products. The 10% increase in Barbie gross sales was primarily driven by positive POS brand momentum.
The 16% decrease in Toy Box gross sales was primarily due to lower sales of Toy Box Partner Brands products. Of the 27% decrease in Toy Box Partner Brands gross sales, 29% was due to lower sales of CARS products, primarily as a result of the 2017 CARS 3 theatrical release, and 5% was due to lower sales of DC Comics Superhero Girls products, partially offset by initial sales of Jurassic World products of 18% as a result of the 2018 theatrical release of Jurassic World: Fallen Kingdom.
Cost of sales decreased 8% in 2018, as compared to a 7% decrease in net sales, primarily due to lower product and other costs. Gross margin in 2018 decreased as a result of higher input cost inflation of raw materials and plant labor and unfavorable foreign exchange, partially offset by Structural Simplification savings and price increases.
International segment income was $9.1 million in 2018, as compared to a segment loss of $5.9 million in 2017, primarily due to lower advertising and promotion expenses and lower other selling and administrative expenses, partially offset by lower gross profit.
32
American Girl Segment
The following table provides a summary of Mattel’s gross sales by brand for the American Girl segment for 2018 and 2017:
For the Year Ended | % Change as Reported | Currency Exchange Rate Impact | |||||||||||
December 31, 2018 | December 31, 2017 | ||||||||||||
(In millions, except percentage information) | |||||||||||||
American Girl Segment: | |||||||||||||
Total Gross Sales | $ | 341.2 | $ | 473.9 | -28 | % | — | % | |||||
Sales Adjustments | (14.4 | ) | (26.7 | ) | |||||||||
Total Net Sales | $ | 326.8 | $ | 447.2 | -27 | % | — | % | |||||
Gross sales for the American Girl segment were $341.2 million in 2018, a decrease of $132.7 million, or 28%, as compared to $473.9 million in 2017. The decrease in American Girl gross sales was primarily due to lower sales in proprietary retail and direct channels, a strategic shift away from the utilization of external distribution channels, and the sale of Corolle in the first quarter of 2018.
Cost of sales decreased 45% in 2018, as compared to a 27% decrease in net sales, primarily due to lower product and other costs and lower obsolescence expense. Gross margin in 2018 increased as a result of lower obsolescence expense.
American Girl segment loss was $17.5 million in 2018, as compared to segment loss of $73.0 million in 2017, primarily due to lower other selling and administrative expenses and lower obsolescence expense.
2017 Compared to 2016
Consolidated Results
Net sales for 2017 were $4.88 billion, an 11% decrease, as compared to $5.46 billion in 2016. Net loss for 2017 was $1.05 billion, or a loss of $3.07 per diluted share, as compared to net income of $318.0 million, or earnings of $0.92 per diluted share, in 2016. The net loss for 2017 was impacted by lower gross profit, a higher advertising rate, higher other selling and administrative expenses, higher interest expense, a $59.0 million non-operating expense related to the discontinuation of Mattel's Venezuelan subsidiary, and a net tax expense of $454.4 million primarily related to the establishment of a valuation allowance on U.S. deferred tax assets that will likely not be realized and a provisional estimate of the impact of the U.S. Tax Act in the fourth quarter of 2017.
The following table provides a summary of Mattel’s consolidated results for 2017 and 2016:
For the Year Ended | Year/Year Change | ||||||||||||||||||
December 31, 2017 | December 31, 2016 | ||||||||||||||||||
Amount (a) | % of Net Sales | Amount (a) | % of Net Sales | % | Basis Points of Net Sales | ||||||||||||||
(In millions, except percentage and basis point information) | |||||||||||||||||||
Net sales | $ | 4,882.0 | 100.0 | % | $ | 5,456.7 | 100.0 | % | -11 | % | — | ||||||||
Gross profit | $ | 1,820.8 | 37.3 | % | $ | 2,554.4 | 46.8 | % | -29 | % | (950 | ) | |||||||
Advertising and promotion expenses | 642.3 | 13.2 | 634.9 | 11.6 | 1 | % | 160 | ||||||||||||
Other selling and administrative expenses | 1,517.9 | 31.1 | 1,391.8 | 25.5 | 9 | % | 560 | ||||||||||||
Operating (loss) income | (339.4 | ) | -7.0 | 527.7 | 9.7 | -164 | % | (1,670 | ) | ||||||||||
Interest expense | 105.2 | 2.2 | 95.1 | 1.7 | 11 | % | 50 | ||||||||||||
Interest (income) | (7.8 | ) | -0.2 | (9.1 | ) | -0.2 | -15 | % | — | ||||||||||
Other non-operating expense, net | 68.1 | 32.0 | |||||||||||||||||
(Loss) income before income taxes | $ | (505.0 | ) | -10.3 | % | $ | 409.7 | 7.5 | % | -223 | % | (1,780 | ) | ||||||
(a) | In accordance with ASU 2017-07, prior period amounts have been retrospectively adjusted, which resulted in a reclassification of $3.4 million and $8.4 million of expense, net from other selling and administrative expenses to other non-operating expense, net for the year ended December 31, 2017 and 2016, respectively. |
33
Sales
Net sales for 2017 were $4.88 billion, an 11% decrease, as compared to $5.46 billion in 2016.
The following table provides a summary of Mattel’s consolidated gross sales by brand results for 2017 and 2016:
For the Year Ended | % Change as Reported | Currency Exchange Rate Impact | |||||||||||
December 31, 2017 | December 31, 2016 | ||||||||||||
(In millions, except percentage information) | |||||||||||||
Power Brands | |||||||||||||
Barbie | $ | 954.9 | $ | 971.8 | -2 | % | 1 | % | |||||
Hot Wheels | 777.3 | 797.0 | -2 | % | 2 | % | |||||||
Fisher-Price and Thomas & Friends | 1,370.5 | 1,546.1 | -11 | % | 1 | % | |||||||
American Girl | 473.3 | 592.1 | -20 | % | — | % | |||||||
Total Power Brands | 3,576.1 | 3,907.0 | -8 | % | 1 | % | |||||||
Toy Box | |||||||||||||
Owned Brands | 980.6 | 1,299.1 | -25 | % | — | % | |||||||
Partner Brands | 957.5 | 867.7 | 10 | % | 1 | % | |||||||
Total Toy Box | 1,938.0 | 2,166.7 | -11 | % | — | % | |||||||
Total Gross Sales | 5,514.1 | 6,073.7 | -9 | % | 1 | % | |||||||
Sales Adjustments | (632.2 | ) | (617.0 | ) | |||||||||
Total Net Sales | $ | 4,882.0 | $ | 5,456.7 | -11 | % | — | % | |||||
Gross sales were $5.51 billion in 2017, a decrease of $559.6 million, or 9%, as compared to $6.07 billion in 2016, with a favorable impact from changes in currency exchange rates of 1 percentage point. The decrease in gross sales was due to decreases in Toy Box and Power Brands sales, and was partially a result of the reversal of approximately $47 million of gross sales related to Toys "R" Us filing for bankruptcy. In addition, Mattel began to reduce shipping to Toys "R" Us in early September 2017, which resulted in a loss of revenue in the second half of 2017.
The 8% decrease in Power Brands gross sales was primarily due to lower sales of American Girl products and Fisher-Price and Thomas & Friends products. The 20% decrease in American Girl gross sales was primarily due to lower sales across channels. Of the 11% decrease in Fisher-Price and Thomas & Friends gross sales, 5% was due to lower sales of Fisher-Price infant products and 4% was due to lower sales of Thomas & Friends products.
The 11% decrease in Toy Box gross sales was primarily due to lower sales of Toy Box Owned Brands products, partially offset by higher sales of Toy Box Partner Brands products. Of the 25% decrease in Toy Box Owned Brands gross sales, 10% was due to lower sales of Monster High products and 8% was due to lower sales of MEGA products. Of the 10% increase in Toy Box Partner Brands gross sales, 29% was due to higher sales of CARS products, primarily as a result of the 2017 CARS 3 theatrical release, partially offset by lower sales of DC Comics Superhero Girls products of 6% and lower sales of Minecraft products of 5%.
Cost of Sales
Cost of sales as a percentage of net sales was 62.7% in 2017, as compared to 53.2% in 2016. Cost of sales increased by $158.9 million, or 5%, to $3.06 billion in 2017 from $2.90 billion in 2016, as compared to an 11% decrease in net sales. Within cost of sales, product and other costs increased by $92.4 million, or 4%, to $2.44 billion in 2017 from $2.35 billion in 2016, primarily as a result of higher obsolescence expense; freight and logistics expenses increased by $50.9 million, or 16%, to $373.6 million in 2017 from $322.7 million in 2016; and royalty expenses increased $15.6 million, or 7%, to $244.5 million in 2017 from $228.9 million in 2016.
34
Gross Margin
Gross margin decreased to 37.3% in 2017 from 46.8% in 2016. The decrease in gross margin was primarily due to higher obsolescence expense, unfavorable product mix, higher freight and logistics expenses, asset impairments, and an unfavorable impact from Toys "R" Us filing for bankruptcy in the third quarter of 2017. As a result of the Toys "R" Us net sales reversal, gross margin includes the cost of sales for the inventory sold, but excludes the corresponding net sales.
Advertising and Promotion Expenses
Advertising and promotion expenses primarily consist of: (i) media costs, which primarily include the media, planning, and buying fees for television, print, and online advertisements, (ii) non-media costs, which primarily include commercial and website production, merchandising, and promotional costs, (iii) retail advertising costs, which primarily include consumer direct catalogs, newspaper inserts, fliers, and mailers, and (iv) generic advertising costs, which primarily include trade show costs. Advertising and promotion expenses as a percentage of net sales increased to 13.2% in 2017 from 11.6% in 2016, primarily as a result of lower net sales and higher non-media costs.
Other Selling and Administrative Expenses
Other selling and administrative expenses were $1.52 billion, or 31.1% of net sales, in 2017, as compared to $1.39 billion, or 25.5% of net sales, in 2016. The increase in other selling and administrative expenses was primarily due to asset impairments of approximately $36 million, higher severance and restructuring expenses of approximately $25 million, higher employee-related costs of approximately $19 million, higher incentive and equity compensation of approximately $16 million, and costs associated with the new American Girl flagship store in New York City of approximately $14 million.
Other Non-Operating Expense, Net
Other non-operating expense, net, was $68.1 million in 2017, as compared to $32.0 million in 2016. In the fourth quarter of 2017, Mattel initiated actions to discontinue operations in Venezuela, which resulted in a $59.0 million loss in other non-operating expense, net, related to the associated cumulative translation adjustments. In 2016, Mattel recognized approximately $26 million of foreign currency exchange loss related to a change in the remeasurement rate used by Mattel's Venezuelan subsidiary. See Item 7A "Quantitative and Qualitative Disclosures About Market Risk—Venezuelan Operations" for more information.
Provision for Income Taxes
Mattel’s provision for income taxes was $548.8 million in 2017, as compared to $91.7 million in 2016. Mattel's effective tax rate on loss before income taxes was (108.7)% in 2017, as compared to an effective tax rate on income before income taxes of 22.4% in 2016. The 2017 income tax provision included net tax expense of $454.4 million, primarily related to the establishment of a valuation allowance in the third quarter of 2017 on U.S. deferred tax assets that will likely not be realized and a provisional estimate of the impact of the U.S. Tax Act in the fourth quarter of 2017. The 2016 income tax provision included net tax benefits of $16.8 million primarily related to reassessments of prior years' tax liabilities based on the status of audits and tax filings in various jurisdictions around the world, settlements, and enacted tax law changes, and the adoption of ASU 2016-09, Improvements to Employee Share-Based Payment Accounting.
35
North America Segment
The following table provides a summary of Mattel’s gross sales by brand for the North America segment for 2017 and 2016:
For the Year Ended | % Change as Reported | Currency Exchange Rate Impact | |||||||||||
December 31, 2017 | December 31, 2016 | ||||||||||||
(In millions, except percentage information) | |||||||||||||
Power Brands | |||||||||||||
Barbie | $ | 450.9 | $ | 489.1 | -8 | % | — | % | |||||
Hot Wheels | 340.0 | 380.6 | -11 | % | — | % | |||||||
Fisher-Price and Thomas & Friends | 737.4 | 880.7 | -16 | % | — | % | |||||||
Total Power Brands | 1,528.3 | 1,750.4 | -13 | % | — | % | |||||||
Toy Box | |||||||||||||
Owned Brands | 506.8 | 770.0 | -34 | % | — | % | |||||||
Partner Brands | 501.5 | 515.8 | -3 | % | — | % | |||||||
Total Toy Box | 1,008.3 | 1,285.7 | -22 | % | — | % | |||||||
Total Gross Sales | 2,536.7 | 3,036.2 | -16 | % | 1 | % | |||||||
Sales Adjustments | (162.8 | ) | (198.5 | ) | |||||||||
Total Net Sales | $ | 2,373.9 | $ | 2,837.7 | -16 | % | — | % | |||||
Gross sales for the North America segment were $2.54 billion in 2017, a decrease of $499.5 million, or 16%, as compared to $3.04 billion in 2016, with a favorable impact from changes in currency exchange rates of 1 percentage point. The decrease in the North America segment gross sales was a result of lower Toy Box and Power Brands sales. As a result of Toys "R" Us filing for bankruptcy, Mattel reversed approximately $47 million of gross sales in the third quarter of 2017. In addition, Mattel began to reduce shipping to Toys "R" Us in early September 2017, which resulted in a loss of revenue in the second half of 2017.
The 13% decrease in Power Brands gross sales was primarily due to lower sales of Fisher-Price and Thomas & Friends and Hot Wheels products. Of the 16% decrease in Fisher-Price and Thomas & Friends gross sales, 7% was due to lower sales of Fisher-Price infant products and 4% was due to lower sales of Thomas & Friends products. The 11% decrease in Hot Wheels gross sales was primarily driven by a tough comparison from CARS 3 in 2017.
The 22% decrease in Toy Box gross sales was primarily due to lower sales of Toy Box Owned Brands products. Of the 34% decrease in Toy Box Owned Brands gross sales, 10% was due to lower sales of MEGA products, 10% was due to lower sales of Monster High products, 4% was due to lower sales of Ever After High products, and 3% was due to lower sales of Power Wheels products.
Cost of sales decreased 2% in 2017, as compared to a 16% decrease in net sales, primarily due to lower product and other costs, partially offset by higher freight and logistics expenses. Gross margins in 2017 decreased due to higher freight and logistics expenses, an unfavorable impact from Toys "R" Us filing for bankruptcy, and higher obsolescence expense. As a result of the Toys "R" Us net sales reversal, gross margin includes the cost of sales for the inventory sold, but excludes the corresponding net sales.
North America segment income decreased by 83% to $98.5 million in 2017, as compared to $564.4 million in 2016, primarily due to lower gross profit.
36
International Segment
The following table provides a summary of percentage changes in net sales within the International segment in 2017 versus 2016:
% Change in Net Sales as Reported | Currency Exchange Rate Impact | ||||
Total International Segment (a) | — | % | 1 | % | |
Europe | -2 | % | 2 | % | |
Latin America | 3 | % | 2 | % | |
Global Emerging Markets | 2 | % | 1 | % | |
The following table provides a summary of percentage changes in gross sales within the International segment in 2017 versus 2016:
% Change in Gross Sales as Reported | Currency Exchange Rate Impact | ||||
Total International Segment (a) | 2 | % | 2 | % | |
Europe | -1 | % | 2 | % | |
Latin America | 6 | % | 2 | % | |
Global Emerging Markets | 4 | % | 1 | % | |
(a) | Mattel reorganized its regional reporting structure in the first quarter of 2018. As a result, Global Emerging Markets, which was previously disclosed as Asia Pacific, includes Russia, Turkey, the Middle East, and Africa, which were previously included within Europe. Prior period amounts have been reclassified to conform to the current period presentation. |
The following table provides a summary of Mattel’s gross sales by brand for the International segment for 2017 and 2016:
For the Year Ended | % Change as Reported | Currency Exchange Rate Impact | |||||||||||
December 31, 2017 | December 31, 2016 | ||||||||||||
(In millions, except percentage information) | |||||||||||||
Power Brands | |||||||||||||
Barbie | $ | 504.0 | $ | 482.7 | 4 | % | 2 | % | |||||
Hot Wheels | 437.4 | 416.3 | 5 | % | 2 | % | |||||||
Fisher-Price and Thomas & Friends | 633.1 | 665.4 | -5 | % | 1 | % | |||||||
American Girl | 0.1 | 2.4 | |||||||||||
Total Power Brands | 1,574.6 | 1,566.9 | — | % | 1 | % | |||||||
Toy Box | |||||||||||||
Owned Brands | 473.0 | 528.9 | -11 | % | 2 | % | |||||||
Partner Brands | 456.0 | 351.9 | 30 | % | 2 | % | |||||||
Total Toy Box | 929.0 | 880.7 | 5 | % | 2 | % | |||||||
Total Gross Sales | 2,503.5 | 2,447.6 | 2 | % | 2 | % | |||||||
Sales Adjustments | (442.7 | ) | (392.8 | ) | |||||||||
Total Net Sales | $ | 2,060.8 | $ | 2,054.8 | — | % | 1 | % | |||||
Gross sales for the International segment were $2.50 billion in 2017, an increase of $55.9 million or 2%, as compared to $2.45 billion in 2016, with a favorable impact from changes in currency exchange rates of 2 percentage points. The increase in the International segment gross sales was driven primarily by higher Toy Box sales.
37
The 5% increase in Toy Box gross sales was primarily due to higher sales of Toy Box Partner Brands products, partially offset by lower sales of Toy Box Owned Brands products. Of the 30% increase in Toy Box Partner Brands gross sales, 46% was due to higher sales of CARS products, primarily as a result of the 2017 CARS 3 theatrical release, partially offset by lower sales of Partner Brands action figures products of 9% and lower sales of DC Comics Superhero Girls products of 4%. The 11% decrease in Toy Box Owned Brands gross sales was primarily driven by lower sales of Monster High products of 10%.
Cost of sales increased 9% in 2017, as compared to flat net sales, primarily due to higher product and other costs and higher royalty expenses. Gross margins in 2017 decreased as a result of unfavorable product mix and higher royalty expense.
International segment loss was $5.9 million in 2017, as compared to segment income of $291.2 million in 2016, primarily due to lower gross profit and higher other selling and administrative expenses.
American Girl Segment
The following table provides a summary of Mattel’s gross sales by brand for the American Girl segment for 2017 and 2016:
For the Year Ended | % Change as Reported | Currency Exchange Rate Impact | |||||||||||
December 31, 2017 | December 31, 2016 | ||||||||||||
(In millions, except percentage information) | |||||||||||||
American Girl Segment: | |||||||||||||
Total Gross Sales | $ | 473.9 | $ | 589.9 | -20 | % | — | % | |||||
Sales Adjustments | (26.7 | ) | (25.8 | ) | |||||||||
Total Net Sales | $ | 447.2 | $ | 564.1 | -21 | % | — | % | |||||
Gross sales for the American Girl segment were $473.9 million in 2017, a decrease of $116.0 million or 20%, as compared to $589.9 million in 2016. The decrease in American Girl segment gross sales was primarily due to lower sales of American Girl brands products as a result of lower sales across channels. Cost of sales increased 14% in 2017, as compared to a 21% decrease in net sales, primarily due to higher inventory obsolescence expense. Gross margins in 2017 decreased as a result of higher obsolescence expense, unfavorable product mix, lower licensing income, and higher freight and logistics expenses.
American Girl segment loss was $73.0 million in 2017, as compared to segment income of $106.4 million in 2016, primarily due to lower gross profit and higher other selling and administrative expenses.
Cost Savings Programs
Structural Simplification Cost Savings Program
During the third quarter of 2017, Mattel initiated its Structural Simplification cost savings program and expects to exceed $650 million in cost savings by 2020.
The major initiatives of the Structural Simplification cost savings program include:
• | Reducing manufacturing complexity, including SKU reduction, and implementing process improvement initiatives at owned and co-manufacturing facilities; |
• | Streamlining the organizational structure and reducing headcount expense to better align with the revenue base; and |
• | Optimizing advertising spend. |
Mattel realized cost savings (before severance, investments, and cost inflation) of approximately $372 million (approximately $177 million within gross profit, approximately $165 million within other selling and administrative expenses, and approximately $30 million within advertising and promotion expenses) during the year ended December 31, 2018. Mattel continues to assess opportunities for incremental savings through its expanded scope of work to optimize its manufacturing footprint and supply chain.
38
In connection with the Structural Simplification cost savings program, Mattel recorded severance and other restructuring charges of $109.8 million during the year ended December 31, 2018. Of the total charges recorded during the year ended December 31, 2018, $62.9 million relate to severance charges and $47.0 million relate to other restructuring costs. Of the $47.0 million of other restructuring costs, $5.7 million relate to non-cash plant restructuring charges, and the remainder consists primarily of consulting fees. To date, Mattel has recorded cumulative severance and other restructuring charges of $155.0 million and expects to incur total charges of approximately $200 million related to the Structural Simplification cost savings program.
Income Taxes
Mattel’s provision for income taxes was $111.7 million in 2018, as compared to $548.8 million in 2017 and $91.7 million in 2016. The 2018 income tax provision included a $14.6 million expense related to changes to its indefinite reinvestment assertion and a $3.7 million expense related to the deemed repatriation of accumulated foreign earnings (net of related valuation allowance change). The 2017 income tax provision included a net expense of $454.4 million, primarily related to the establishment of a valuation allowance in the third quarter of 2017 on U.S. deferred tax assets that will likely not be realized and a provisional estimate of the impact of the U.S. Tax Act in the fourth quarter of 2017. The 2016 income tax provision included a net tax benefit of $16.8 million, primarily related to reassessments of prior years’ tax liabilities based on the status of audits and tax filings in various jurisdictions around the world, settlements, and enacted tax law changes, and the adoption of ASU 2016-09.
Liquidity and Capital Resources
Mattel’s primary sources of liquidity are its cash and equivalents balances, including access to earnings of its foreign subsidiaries, short-term borrowing facilities, including its $1.60 billion senior secured revolving credit facilities ("the senior secured revolving credit facilities"), and issuances of long-term debt securities. Cash flows from operating activities could be negatively impacted by decreased demand for Mattel’s products, which could result from factors such as adverse economic conditions and changes in public and consumer preferences, or by increased costs associated with manufacturing and distribution of products or shortages in raw materials or component parts. Additionally, Mattel’s ability to issue long-term debt and obtain seasonal financing could be adversely affected by factors such as global economic crises and tight credit environments, an inability to meet its debt covenant requirements and its senior secured revolving credit facility covenants, or a deterioration of Mattel’s credit ratings. Mattel’s ability to conduct its operations could be negatively impacted should these or other adverse conditions affect its primary sources of liquidity.
Of Mattel’s $594.5 million in cash and equivalents as of December 31, 2018, approximately $400 million is held by foreign subsidiaries. Mattel has several liquidity options to fund its operations and obligations; such obligations may include investing and financing activities such as debt service, dividends, and share repurchases. Cash flows generated by its worldwide operations, the senior secured revolving credit facilities, alternative forms of financing, and access to capital markets are available to fund Mattel's operations and obligations.
The U.S. Tax Act, enacted on December 22, 2017, provides Mattel with a reduced cost to access the earnings of its foreign subsidiaries. As such, Mattel has evaluated its intentions related to its indefinite reinvestment assertion and has recorded a $14.6 million tax charge related to approximately $400 million of foreign earnings that will not be indefinitely reinvested. Mattel also recorded a $3.7 million one-time transition tax change related to the deemed repatriation tax of the historical earnings of Mattel's foreign subsidiaries.
In October 2017, Mattel's Board of Directors determined to suspend Mattel's quarterly dividend beginning in the fourth quarter of 2017 in order to increase financial flexibility, strengthen the balance sheet, and facilitate strategic investments. Mattel paid dividends of $0.38 per share to holders of its common stock in the first and second quarter of 2017 and $0.15 per share in the third quarter of 2017.
Current Market Conditions
Mattel is exposed to financial market risk resulting from changes in interest and foreign currency exchange rates. Mattel continues to actively manage its capital structure and believes that it has sufficient liquidity to run its business.
Subject to market conditions, Mattel intends to utilize its senior secured revolving credit facilities or alternative forms of financing to meet its short-term liquidity needs. As of December 31, 2018, there were no amounts outstanding under the senior secured revolving credit facilities. Market conditions could affect certain terms of other debt instruments that Mattel enters into from time to time.
39
Mattel monitors the third-party depository institutions that hold Mattel's cash and equivalents. Mattel’s emphasis is primarily on safety and liquidity of principal, and secondarily on maximizing the yield on those funds. Mattel diversifies its cash and equivalents among counterparties and securities to minimize risks.
Mattel is subject to credit risks relating to the ability of its counterparties in hedging transactions to meet their contractual payment obligations. The risks related to creditworthiness and nonperformance have been considered in the fair value measurements of Mattel’s foreign currency forward exchange contracts. Mattel closely monitors its counterparties and takes action, as necessary, to manage its counterparty credit risk.
Mattel expects that some of its customers and vendors may experience difficulty in obtaining the liquidity required to buy inventory or raw materials. Mattel monitors its customers’ financial condition and their liquidity in order to mitigate Mattel’s accounts receivable collectibility risks, and customer terms and credit limits are adjusted, if necessary. Additionally, Mattel uses a variety of financial arrangements to ensure collectibility of accounts receivable of customers deemed to be a credit risk, including requiring letters of credit, factoring, purchasing various forms of credit insurance with unrelated third parties, or requiring cash in advance of shipment. As a result of the Toys "R" Us liquidation in the first quarter of 2018, Mattel reversed net sales that occurred during the first quarter of 2018 and related accounts receivable of approximately $30 million. In addition, for the year ended December 31, 2018, Mattel recorded bad debt expense, net of approximately $32 million related to outstanding Toys "R" Us receivables at the time of the Toys "R" Us liquidation.
Mattel sponsors defined benefit pension plans and postretirement benefit plans for its employees. Actual returns below the expected rate of return, along with changes in interest rates that affect the measurement of the liability, would impact the amount and timing of Mattel’s future contributions to these plans.
Operating Activities
Cash flows used for operating activities were $27.3 million during 2018, which were in line with the $27.6 million cash flows used for operating activities during 2017. During 2016, cash flows provided by operating activities were $594.5 million. The change in 2017 from 2016 was due to the net loss for the year, excluding the net impact of the establishment of a valuation allowance on U.S. deferred tax assets that will likely not be realized and an estimate of the impact of the U.S. Tax Act, and other non-cash charges.
Investing Activities
Cash flows used for investing activities were $160.8 million during 2018, as compared to $235.7 million during 2017 and $311.9 million during 2016. The decrease in cash flows used for investing activities in 2018 from 2017 was primarily driven by lower capital spending, partially offset by higher payments for foreign currency forward exchange contracts. The decrease in cash flows used for investing activities in 2017 from 2016 was primarily due to higher proceeds from foreign currency forward exchange contracts and 2016 payments related to the acquisitions of Fuhu assets and Sproutling, Inc., partially offset by higher capital spending.
Financing Activities
Cash flows used for financing activities were $285.2 million during 2018, as compared to cash flows provided by financing activities of $458.5 million during 2017 and cash flows used for financing activities of $281.5 million during 2016. The change in cash flows from financing activities in 2018 from 2017 was primarily driven by lower net proceeds from long-term and short-term borrowings of approximately $1.1 billion, partially offset by $312.0 million of dividend payments during 2017. The change in cash flows provided by financing activities in 2017 from 2016 was primarily due to the $1.00 billion issuance of senior notes in December 2017, partially offset by higher net repayments of short-term borrowings.
During 2018, 2017, and 2016, Mattel did not repurchase any shares of its common stock. Mattel's share repurchase program was first announced on July 21, 2003. On July 17, 2013, the Board of Directors authorized Mattel to increase its share repurchase program by $500.0 million. At December 31, 2018, share repurchase authorizations of $203.0 million had not been executed. Repurchases under the program will take place from time to time, depending on market conditions. Mattel's share repurchase program has no expiration date.
During 2018, Mattel did not pay any dividends to holders of its common stock. During 2017 and 2016, Mattel paid total dividends per share of $0.91 and $1.52 respectively, to holders of its common stock. The Board of Directors declared the dividends, if any, on a quarterly basis, and Mattel paid the dividends during the quarters in which the dividends were declared, if applicable. The payment of dividends on common stock is at the discretion of the Board of Directors and is subject to customary limitations. Dividend payments were $312.0 million and $518.5 million in 2017, and 2016, respectively.
40
Seasonal Financing
See Item 8 "Financial Statements and Supplementary Data—Note 5 to the Consolidated Financial Statements—Seasonal Financing and Debt."
Credit Rating
In July 2018, Fitch changed Mattel's long-term credit rating from B+ to B-, with a negative outlook. In May 2018, Moody's changed Mattel's long-term credit rating from Ba3 to B1, with a stable outlook. In April 2018, Standard & Poor's removed Mattel from credit watch with negative implications and affirmed Mattel's long-term credit rating of BB-, with a negative outlook.
Financial Position
Mattel’s cash and equivalents decreased $484.7 million to $594.5 million at December 31, 2018, as compared to $1.08 billion at December 31, 2017. The decrease was primarily due to the net loss for the year, excluding non-cash charges, and net repayments of long-term borrowings of $278.2 million.
Accounts receivable decreased $158.5 million to $970.1 million at December 31, 2018, as compared to $1.13 billion at December 31, 2017. Inventory decreased $57.8 million to $542.9 million at December 31, 2018, as compared to $600.7 million at December 31, 2017. The decrease in accounts receivable was primarily as a result of lower sales volume and improved collections. The decrease in inventory was primarily due to efforts to tightly manage inventory.
Accounts payable and accrued liabilities decreased $125.9 million to $1.24 billion at December 31, 2018, as compared to $1.36 billion at December 31, 2017. The decline was primarily due to the timing and amount of payments for various liabilities, including advertising and taxes other than income taxes.
As of December 31, 2018, and 2017, Mattel had $4.2 million and $0, respectively, of short-term borrowings outstanding.
A summary of Mattel’s capitalization is as follows:
December 31, 2018 | December 31, 2017 | ||||||||||||
(In millions, except percentage information) | |||||||||||||
Cash and equivalents | $ | 594.5 | $ | 1,079.2 | |||||||||
Short-term borrowings | 4.2 | — | % | — | — | % | |||||||
2010 Senior Notes due October 2020 and October 2040 | 500.0 | 14 | 500.0 | 11 | |||||||||
2011 Senior Notes due November 2041 | 300.0 | 8 | 300.0 | 7 | |||||||||
2013 Senior Notes due March 2018 and March 2023 | 250.0 | 7 | 500.0 | 11 | |||||||||
2014 Senior Notes due May 2019 | — | — | 500.0 | 11 | |||||||||
2016 Senior Notes due August 2021 | 350.0 | 10 | 350.0 | 8 | |||||||||
2017/2018 Senior Notes due December 2025 | 1,500.0 | 42 | 1,000.0 | 23 | |||||||||
Debt issuance costs and debt discount | (48.3 | ) | — | (26.9 | ) | — | |||||||
Total debt | 2,855.9 | 81 | 3,123.1 | 71 | |||||||||
Stockholders’ equity | 669.5 | 19 | 1,257.5 | 29 | |||||||||
Total capitalization (debt plus equity) | $ | 3,525.4 | 100 | % | $ | 4,380.6 | 100 | % | |||||
Total debt decreased by approximately $267 million to $2.86 billion at December 31, 2018, as compared to $3.12 billion at December 31, 2017, primarily due to repayment of $250.0 million of the 2013 Senior Notes due March 2018 and $500.0 million of the 2014 Senior Notes due May 2019, partially offset by the issuance of $500.0 million aggregate principal amount of 6.75% senior unsecured notes due December 31, 2025 ("2018 Senior Notes").
Stockholders’ equity decreased $588.0 million to $669.5 million at December 31, 2018, as compared to $1.26 billion at December 31, 2017, primarily due to the net loss for the year.
41
Off-Balance Sheet Arrangements
Mattel is required to provide standby letters of credit to support certain obligations that arise in the ordinary course of business and may choose to provide letters of credit in place of posting cash collateral. Although the letters of credit are off-balance sheet, the majority of the obligations in which they relate are reflected as liabilities in the consolidated balance sheets. Outstanding letters of credit totaled approximately $90 million as of December 31, 2018.
Commitments
In the normal course of business, Mattel enters into debt agreements and contractual arrangements to obtain and protect Mattel’s right to create and market certain products and for future purchases of goods and services to ensure availability and timely delivery. These arrangements include commitments for future inventory and service purchases and royalty payments pursuant to licensing agreements. Certain of these commitments routinely contain provisions for guarantees or minimum expenditures during the terms of the contracts. Mattel also has defined benefit and postretirement benefit plans, which require future cash contributions and benefit payments. Additionally, Mattel routinely enters into noncancelable lease agreements for premises and equipment used, which contain minimum rental payments.
The following table summarizes Mattel’s contractual commitments and obligations:
Total | 2019 | 2020 | 2021 | 2022 | 2023 | Thereafter | |||||||||||||||||||||
(In millions) | |||||||||||||||||||||||||||
Long-term debt | $ | 2,900.0 | $ | — | $ | 250.0 | $ | 350.0 | $ | — | $ | 250.0 | $ | 2,050.0 | |||||||||||||
Interest on long-term debt | 1,495.7 | 160.1 | 160.1 | 146.1 | 141.0 | 134.7 | 753.7 | ||||||||||||||||||||
Capital leases (a) | 0.3 | 0.3 | — | — | — | — | — | ||||||||||||||||||||
Operating leases | 516.0 | 110.8 | 83.6 | 72.6 | 59.2 | 56.1 | 133.7 | ||||||||||||||||||||
Minimum guarantees under licensing and similar agreements | 282.3 | 112.5 | 92.9 | 45.3 | 30.4 | 1.2 | — | ||||||||||||||||||||
Defined benefit and postretirement benefit plans | 378.5 | 46.9 | 37.5 | 37.2 | 38.0 | 36.4 | 182.5 | ||||||||||||||||||||
Purchases of inventory, services, and other | 448.3 | 314.9 | 47.0 | 32.6 | 26.8 | 26.9 | — | ||||||||||||||||||||
Total | $ | 6,021.1 | $ | 745.5 | $ | 671.1 | $ | 683.8 | $ | 295.4 | $ | 505.3 | $ | 3,119.9 | |||||||||||||
(a) | Represents total obligation, including minimal imputed interest. |
Liabilities for uncertain tax positions for which a cash tax payment is not expected to be made in the next twelve months are classified as other noncurrent liabilities. Due to the uncertainty about the periods in which examinations will be completed and limited information related to current audits, Mattel is not able to make reasonably reliable estimates of the periods in which cash settlements will occur with taxing authorities for the noncurrent liabilities.
Litigation
The content of Item 8 "Financial Statements and Supplementary Data—Note 12 to the Consolidated Financial Statements—Commitments and Contingencies—Litigation" is hereby incorporated by reference in this Item 7.
Effects of Inflation
Inflation rates in the U.S. and in major foreign countries where Mattel does business have not had a significant impact on its results of operations or financial position during 2018, 2017, or 2016. Mattel receives some protection from the impact of inflation from high turnover of inventories and its ability, under certain circumstances and at certain times, to pass on higher prices to its customers.
42
Employee Savings Plan
Mattel sponsors a 401(k) savings plan, the Mattel, Inc. Personal Investment Plan (the "Plan"), for its domestic employees. Contributions to the Plan include voluntary contributions by eligible employees and employer automatic and matching contributions by Mattel. The Plan allows employees to allocate both their voluntary contributions and their employer automatic and matching contributions to a variety of investment funds, including a fund that is invested in Mattel common stock (the "Mattel Stock Fund"). Employees are not required to allocate any of their Plan account balance to the Mattel Stock Fund, allowing employees to limit or eliminate their exposure to market changes in Mattel’s stock price. Furthermore, the Plan limits the percentage of the employee’s total account balance that may be allocated to the Mattel Stock Fund to 25%. Employees may generally reallocate their account balances on a daily basis. However, pursuant to Mattel’s insider trading policy, employees classified as insiders and restricted personnel under Mattel’s insider trading policy are limited to certain periods in which they may make allocations into or out of the Mattel Stock Fund.
Application of Critical Accounting Policies and Estimates
Mattel makes certain estimates and assumptions that affect the reported amounts of assets and liabilities and the reported amounts of revenues and expenses. The accounting policies and estimates described below are those Mattel considers most critical in preparing its consolidated financial statements. Management has discussed the development and selection of these critical accounting policies and estimates with the Audit Committee of its Board of Directors, and the Audit Committee has reviewed the disclosures included below. These accounting policies and estimates include significant judgments made by management using information available at the time the estimates are made. As described below, however, these estimates could change materially if different information or assumptions were used instead.
For a summary of Mattel’s significant accounting policies, estimates, and methods used in the preparation of Mattel’s consolidated financial statements, see Item 8 "Financial Statements and Supplementary Data—Note 1 to the Consolidated Financial Statements—Summary of Significant Accounting Policies." In most instances, Mattel must use an accounting policy or method because it is the only policy or method permitted under accounting principles generally accepted in the United States of America ("U.S. GAAP").
Accounts Receivable—Allowance for Doubtful Accounts
The allowance for doubtful accounts represents adjustments to customer trade accounts receivable for amounts deemed partially or entirely uncollectible. Management believes the accounting estimate related to the allowance for doubtful accounts is a "critical accounting estimate" because significant changes in the assumptions used to develop the estimate could materially affect key financial measures, including other selling and administrative expenses, net income, and accounts receivable. In addition, the allowance requires a high degree of judgment since it involves estimation of the impact of both current and future economic factors in relation to its customers’ ability to pay amounts owed to Mattel.
Mattel’s products are sold throughout the world. Products within the North America segment are sold directly to retailers, including discount and free-standing toy stores, chain stores, department stores, other retail outlets and, to a limited extent, wholesalers, and directly to consumers. Products within the International segment are sold directly to retailers and wholesalers in most European, Latin American, and Asian countries, and in Australia and New Zealand, and through agents and distributors in those countries where Mattel has no direct presence.
In recent years, the mass-market retail channel has experienced significant shifts in market share among competitors, causing some large retailers to experience liquidity problems. Mattel’s sales to customers are typically made on credit without collateral and are highly concentrated in the third and fourth quarters due to the seasonal nature of toy sales, which results in a substantial portion of trade receivables being collected during the latter half of the year and the first quarter of the following year. There is a risk that customers will not pay, or that payment may be delayed, because of bankruptcy or other factors beyond the control of Mattel. This could increase Mattel’s exposure to losses from bad debts.
A small number of customers account for a large share of Mattel’s net sales and accounts receivable. In 2018, Mattel’s two largest customers, Walmart and Target, in the aggregate, accounted for approximately 34% of net sales, and its ten largest customers, in the aggregate, accounted for approximately 49% of net sales. As of December 31, 2018, Mattel’s two largest customers accounted for approximately 33% of net accounts receivable, and its ten largest customers accounted for approximately 49% of net accounts receivable. The concentration of Mattel’s business with a relatively small number of customers may expose Mattel to a material adverse effect if one or more of Mattel’s large customers were to experience financial difficulty.
43
Mattel has procedures to mitigate its risk of exposure to losses from bad debts. Credit limits and payment terms are established based on the underlying criteria that collectibility must be reasonably assured at the levels set for each customer. Extensive evaluations are performed on an ongoing basis throughout the fiscal year of each customer’s financial performance, cash generation, financing availability, and liquidity status. Customers are reviewed at least annually, with more frequent reviews being performed, if necessary, based on the customers’ financial condition and the level of credit being extended. For customers who are experiencing financial difficulties, management performs additional financial analyses prior to shipping to those customers on credit. Customers’ terms and credit limits are adjusted, if necessary, to reflect the results of the review. Mattel uses a variety of financial arrangements to ensure collectibility of accounts receivable of customers deemed to be a credit risk, including requiring letters of credit, factoring, purchasing various forms of credit insurance with unrelated third parties, or requiring cash in advance of shipment.
The following table summarizes Mattel’s allowance for doubtful accounts:
December 31, 2018 | December 31, 2017 | December 31, 2016 | |||||||||
(In millions, except percentage information) | |||||||||||
Allowance for doubtful accounts | $ | 22.0 | $ | 25.4 | $ | 21.4 | |||||
As a percentage of total accounts receivable | 2.2 | % | 2.2 | % | 1.4 | % | |||||
Mattel’s allowance for doubtful accounts is based on management’s assessment of the business environment, customers’ financial condition, historical collection experience, accounts receivable aging, and customer disputes. Changes in the allowance for doubtful accounts reflect management’s assessment of the factors noted above, including past due accounts, disputed balances with customers, and the financial condition of customers. The allowance for doubtful accounts is also affected by the time at which uncollectible accounts receivable balances are actually written off.
Mattel believes that its allowance for doubtful accounts at December 31, 2018 is adequate and proper. However, as described above, Mattel’s business is greatly dependent on a small number of customers. Should one or more of Mattel’s major customers experience liquidity problems, the allowance for doubtful accounts may not be sufficient to cover such losses. Any incremental bad debt charges would negatively affect the results of operations of one or more of Mattel’s business segments.
Inventories—Allowance for Obsolescence
Inventories, net of an allowance for excess quantities and obsolescence, are stated at the lower of cost or net realizable value. Inventory obsolescence reserves are recorded for damaged, obsolete, excess, and slow-moving inventory. Inventory allowances are charged to cost of sales and establish a lower cost basis for the inventory. Management believes that the accounting estimate related to the allowance for obsolescence is a "critical accounting estimate" because changes in the assumptions used to develop the estimate could materially affect key financial measures, including gross profit, net income, and inventories. As more fully described below, valuation of Mattel’s inventory could be impacted by changes in public and consumer preferences, demand for product, or changes in the buying patterns of both retailers and consumers and inventory management of customers.
In the toy industry, orders are typically subject to cancellation or change at any time prior to shipment. Actual shipments of products ordered and order cancellation rates are affected by consumer acceptance of product lines, strength of competing products, marketing strategies of retailers, changes in buying patterns of both retailers and consumers, and overall economic conditions. Unexpected changes in these factors could result in excess inventory in a particular product line, which would require management to record a valuation adjustment on such inventory.
Mattel bases its production schedules for toy products on customer orders and forecasts, taking into account historical trends, results of market research, and current market information. Mattel ships products in accordance with delivery schedules specified by its customers, who usually request delivery within three months. In anticipation of retail sales in the traditional holiday season, Mattel significantly increases its production in advance of the peak selling period, resulting in a corresponding build-up of inventory levels in the first three quarters of its fiscal year. These seasonal purchasing patterns and requisite production lead times create risk to Mattel’s business associated with the underproduction of popular toys and the overproduction of toys that do not match consumer demand. Retailers are also attempting to manage their inventories more tightly, requiring Mattel to ship products closer to the time the retailers expect to sell the products to consumers. These factors increase inventory valuation risk since Mattel’s inventory levels may be adversely impacted by the need to pre-build products before orders are placed.
44
When current conditions in the domestic and global economies become uncertain, it is difficult to estimate the level of growth or contraction for the economy as a whole. It is even more difficult to estimate growth or contraction in various parts of the economy, including the economies in which Mattel participates. Because all components of Mattel’s budgeting and forecasting are dependent upon estimates of growth or contraction in the markets it serves and demand for its products, economic uncertainty makes estimates of future demand for product more difficult. Such economic changes may affect the sales of Mattel’s products and its corresponding inventory levels, which could potentially impact the valuation of its inventory.
At the end of each quarter, management within each business segment, North America, International, and American Girl, performs a detailed review of its inventory on an item-by-item basis and identifies products that are believed to be impaired. Management assesses the need for, and the amount of, an obsolescence reserve based on the following factors:
• | Customer and/or consumer demand for the item; |
• | Overall inventory positions of Mattel’s customers; |
• | Strength of competing products in the market; |
• | Quantity on hand of the item; |
• | Sales price of the item; |
• | Mattel’s cost for the item; and |
• | Length of time the item has been in inventory. |
The timeframe between when an estimate is made and the time of disposal depends on the above factors and may vary significantly. Generally, slow-moving inventory is liquidated during the next annual selling cycle.
The following table summarizes Mattel’s obsolescence reserve:
December 31, 2018 | December 31, 2017 | December 31, 2016 | |||||||||
(In millions, except percentage information) | |||||||||||
Allowance for obsolescence | $ | 47.2 | $ | 118.4 | $ | 36.8 | |||||
As a percentage of total inventory | 8.2 | % | 16.8 | % | 5.5 | % | |||||
Management believes that its allowance for obsolescence at December 31, 2018 is adequate and proper. However, the impact resulting from the aforementioned factors could cause actual results to vary. Any incremental obsolescence charges would negatively affect the results of operations of one or more of Mattel’s business segments. During 2017, Mattel recorded obsolescence expense of $58.3 million, $22.4 million, and $46.9 million in the North America, International, and American Girl segments, respectively, due to a decline in 2017 sales and expected demand and the discontinuation of certain product lines.
Goodwill and Nonamortizable Intangible Assets
Mattel tests goodwill and nonamortizable intangible assets for impairment annually or more often if an event or circumstance indicates that an impairment may have occurred. Management believes that the accounting estimates related to the fair value estimates of its goodwill and nonamortizable intangible assets are "critical accounting estimates" because significant changes in the assumptions used to develop the estimates could materially affect key financial measures, including net income, goodwill, and other intangible assets.
Assessing goodwill for impairment involves a high degree of judgment due to the assumptions that underlie the valuation. For purposes of evaluating whether goodwill is impaired, goodwill is allocated to various reporting units, which are at the operating segment level. Mattel’s reporting units are: (i) North America, (ii) International, and (iii) American Girl. Mattel then assesses qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying value. This qualitative assessment is used as a basis for determining whether it is necessary to perform the quantitative goodwill impairment test.
When the quantitative goodwill impairment test is necessary, impairment is determined by estimating the fair value of a reporting unit and comparing that value to the reporting unit’s book value. In the third quarter of 2017, Mattel early adopted ASU 2017-04 Intangibles - Goodwill and Other: Simplifying the Test for Goodwill Impairment, which removes Step 2 of the goodwill impairment test. If the carrying amount of the reporting unit exceeds its fair value, an impairment charge is recognized in an amount equal to the excess, limited by the amount of goodwill in that reporting unit.
45
When performing the quantitative goodwill impairment test, Mattel utilizes the fair value based upon both the discounted cash flows that the business can be expected to generate in the future (the "Income Approach") and the Market Approach. The Income Approach valuation method requires Mattel to make projections of revenue, operating costs, and working capital investment for the reporting unit over a multi-year period. Additionally, management must make an estimate of a weighted-average cost of capital that a market participant would use as a discount rate. Changes in these projections or estimates would impact the estimated fair value, which could significantly change the amount of any impairment ultimately recorded. The Market Approach utilizes earnings multiples of comparable public companies, which are reflective of the market in which each respective reporting unit operates, and recent comparable market transactions.
In the third quarter of 2018, Mattel performed its annual impairment tests and determined that goodwill was not impaired since each reporting unit's fair value exceeded its carrying value. The fair value of the North America and American Girl reporting units were substantially in excess of their carrying value. Mattel’s International reporting unit was deemed to be at risk of failing the goodwill impairment test. The estimated fair value was approximately 1.24x its carrying value. The valuation model assumes incremental growth in sales and gross margin from current levels. If Mattel is unable to successfully execute its plans in international markets to achieve further growth in emerging markets, improve gross margin, or has lower-than-expected market demand, goodwill may be impaired.
Testing nonamortizable intangible assets for impairment also involves a high degree of judgment due to the assumptions that underlie the valuation. Mattel had no nonamortizable intangible assets as of and for the year ended December 31, 2018. Prior to 2018, Mattel evaluated its nonamortizable intangible asset by comparing the estimated fair value with the carrying value. The fair value was measured using a multi-period excess earnings method, which reflected the incremental after-tax cash flows after deducting the appropriate contributory asset charges.
In the third quarter of 2017, Mattel performed the annual impairment test for its nonamortizable intangible asset as required and determined that the nonamortizable intangible asset was not impaired as the fair value exceeded its carrying value.
In the fourth quarter of 2017, Mattel determined a triggering event had occurred due to a change in brand strategy, which resulted in lower forecasted revenue attributable to the nonamortizable intangible asset. As a result, Mattel performed an interim impairment test which determined that the fair value was in excess of its carrying value, with an estimated fair value approximately 1.05x its carrying value. As such, Mattel determined that the intangible asset should no longer be designated as a nonamortizable intangible asset, but should be amortized starting in the fourth quarter of 2017.
Sales Adjustments
Mattel routinely enters into arrangements with its customers to provide sales incentives, support customer promotions, and provide allowances for returns and defective merchandise. Such programs are based primarily on customer purchases, customer performance of specified promotional activities, and other specified factors such as sales to consumers. Accruals for these programs are recorded as sales adjustments that reduce gross sales in the period the related sale is recognized. Sales adjustments for such programs totaled $564.7 million, $632.2 million, and $617.0 million during 2018, 2017, and 2016, respectively.
The above-described programs primarily involve fixed amounts or percentages of sales to customers. Accruals for such programs are calculated based on an assessment of customers’ purchases and performance under the programs and any other specified factors. While the majority of sales adjustment amounts are readily determinable at period end and do not require estimates, certain of the sales adjustments require management to make estimates. In making these estimates, management considers all available information, including the overall business environment, historical trends, and information from customers. Management believes that the accruals recorded for customer programs as of December 31, 2018 are adequate and proper.
Benefit Plan Assumptions
Mattel and certain of its subsidiaries have retirement and other postretirement benefit plans covering substantially all employees of these companies. See Item 8 "Financial Statements and Supplementary Data—Note 4 to the Consolidated Financial Statements—Employee Benefit Plans."
46
Actuarial valuations are used in determining amounts recognized in the financial statements for certain retirement and other postretirement benefit plans. These valuations incorporate the following significant assumptions:
• | Weighted-average discount rate to be used to measure future plan obligations and interest cost component of plan income or expense; |
• | Rate of future compensation increases (for defined benefit pension plans); |
• | Expected long-term rate of return on plan assets (for funded plans); and |
• | Health care cost trend rates (for other postretirement benefit plans). |
Management believes that these assumptions are "critical accounting estimates" because significant changes in these assumptions could impact Mattel’s results of operations and financial position. Management believes that the assumptions utilized to record its obligations under its plans are reasonable based on the plans’ experience and advice received from its outside actuaries. Mattel reviews its benefit plan assumptions annually and modifies its assumptions based on current rates and trends as appropriate. The effects of such changes in assumptions are amortized as part of plan income or expense in future periods.
At the end of each fiscal year, Mattel determines the weighted-average discount rate used to calculate the projected benefit obligation. The discount rate is an estimate of the current interest rate at which the benefit plan liabilities could be effectively settled at the end of the year. The discount rate also impacts the interest cost component of plan income or expense. As of December 31, 2018, Mattel determined the discount rate for its domestic benefit plans used in determining the projected and accumulated benefit obligations to be 4.1%, as compared to 3.4% and 3.9% as of December 31, 2017 and 2016, respectively. In estimating this rate, Mattel reviews rates of return on high-quality corporate bond indices, which approximate the timing and amount of benefit payments. Assuming all other benefit plan assumptions remain constant, the increase in the discount rate from 3.4% to 4.1% would result in an increase in benefit plan expense during 2019 of $0.2 million.
As a result of the curtailment of Mattel's domestic defined benefit pension plans, the rate of future compensation increase was not applicable for the 2018, 2017, and 2016 benefit obligation and net periodic pension cost calculations.
The long-term rate of return on plan assets is based on management’s expectation of earnings on the assets that secure Mattel’s funded defined benefit pension plans, taking into account the mix of invested assets, the arithmetic average of past returns, economic and stock market conditions and future expectations, and the long-term nature of the projected benefit obligation to which these investments relate. The long-term rate of return is used to calculate the expected return on plan assets that is used in calculating pension income or expense. The difference between this expected return and the actual return on plan assets is deferred, net of tax, and is included in accumulated other comprehensive loss. The net deferral of past asset gains or losses affects the calculated value of plan assets and, ultimately, future pension income or expense. Mattel’s long-term rate of return used in determining plan expense for its domestic defined benefit pension plans was 6.0% in 2018, as compared to 6.3% in 2017 and 6.5% in 2016. Assuming all other benefit plan assumptions remain constant, a one percentage point decrease in the expected return on plan assets would result in an increase in benefit plan expense during 2019 of $3.1 million.
The health care cost trend rates used by Mattel for its other postretirement benefit plans reflect management’s best estimate of expected claim costs over the next ten years. These trend rates impact the service and interest cost components of plan expense. Rates ranging from 7.3% in 2018 to 4.5% in 2025, with rates assumed to stabilize in 2025 and thereafter, were used in determining plan expense for 2018. These rates are reviewed annually and are estimated based on historical costs for participants in the other postretirement benefit plans as well as estimates based on current economic conditions. As of December 31, 2018, Mattel maintained the health care cost trend rates for its other postretirement benefit plan obligation at 7.0% for participants younger than age 65, and 6.8% for participants age 65 and older. For all participants, the cost trend rates are estimated to reduce to 4.5% by 2025, with rates assumed to stabilize in 2025. Assuming all other postretirement benefit plan assumptions remain constant, a one percentage point increase in the assumed health care cost trend rates would result in a minimal increase in benefit plan expense during 2019.
A one percentage point increase/(decrease) in the assumed health care cost trend rate for each future year would result in a minimal impact to the postretirement benefit obligation as of December 31, 2018 and the service and interest cost recognized for 2018.
47
Share-Based Payments
Mattel recognizes the cost of employee share-based payment awards on a straight-line attribution basis over the requisite employee service period, net of estimated forfeitures. Determining the fair value of share-based awards at the measurement date requires judgment, including estimating the expected term that stock options will be outstanding prior to exercise, the associated volatility, and the expected dividends. With the exception of certain performance options granted in 2018, which are valued using a Monte Carlo valuation methodology, Mattel estimates the fair value of options granted using the Black-Scholes valuation model. The expected life of the options used in this calculation is the period of time the options are expected to be outstanding and has been determined based on historical exercise experience. Expected stock price volatility is based on the historical volatility of Mattel’s stock for a period approximating the expected life, the expected dividend yield is based on Mattel’s most recent actual annual dividend payout, and the risk-free interest rate is based on the implied yield available on U.S. Treasury zero-coupon issues approximating the expected life. Judgment is also required in estimating the amount of share-based awards that will be forfeited prior to vesting. Management believes that these assumptions are "critical accounting estimates" because significant changes in the assumptions used to develop the estimates could materially affect key financial measures, including net income.
The weighted-average grant-date fair value of options granted during 2018 valued using a Monte Carlo valuation methodology was $4.21. The weighted-average grant-date fair value of options granted during 2018, 2017, and 2016 valued using the Black-Scholes valuation model was $5.46, $3.37, and $4.09, respectively. The following weighted-average assumptions were used in determining the fair value of options granted:
2018 | 2017 | 2016 | ||||||
Expected life (in years) | 5.1 | 5.0 | 5.0 | |||||
Risk-free interest rate | 2.8 | % | 1.8 | % | 1.1 | % | ||
Volatility factor | 33.6 | % | 27.2 | % | 25.3 | % | ||
Dividend yield | — | % | 4.0 | % | 4.7 | % | ||
The following tables summarizes the sensitivity of valuation assumptions within the calculation of stock option fair values, if all other assumptions are held constant:
Increase in Assumption Factor | Increase (Decrease) in Fair Value | ||||
Expected life (in years) | 1 | 9.9 | % | ||
Risk-free interest rate | 1 | % | 5.5 | % | |
Volatility factor | 1 | % | 2.2 | % | |
Dividend yield | 1 | % | (10.0 | )% | |
(Decrease) in Assumption Factor | Increase (Decrease) in Fair Value | ||||
Expected life (in years) | (1) | (10.9 | )% | ||
Risk-free interest rate | (1 | )% | (5.3 | )% | |
Volatility factor | (1 | )% | (2.2 | )% | |
Dividend yield | (1 | )% | 10.9 | % | |
Mattel recognized compensation expense of $8.4 million, $14.1 million, and $10.5 million for stock options during 2018, 2017, and 2016, respectively, which is included within other selling and administrative expenses. Compensation expense recognized related to grants of restricted stock units ("RSUs"), including performance-based restricted stock units ("Performance RSUs"), was $40.5 million, $53.0 million, and $43.4 million in 2018, 2017, and 2016, respectively, and is also included within other selling and administrative expenses. As of December 31, 2018, total unrecognized compensation cost related to unvested share-based payments totaled $93.0 million and is expected to be recognized over a weighted-average period of 2.2 years.
48
Income Taxes
Mattel accounts for income taxes in accordance with Accounting Standards Codification ("ASC") 740—Income Taxes. Mattel’s income tax provision and related income tax assets and liabilities are based on actual and expected future income, U.S. and foreign statutory income tax rates, and tax regulations and planning opportunities in the various jurisdictions in which Mattel operates. Management believes that the accounting estimates related to income taxes are "critical accounting estimates" because significant judgment is required in interpreting tax regulations in the U.S. and in foreign jurisdictions, evaluating Mattel’s worldwide uncertain tax positions, and assessing the likelihood of realizing certain tax benefits. Actual results could differ materially from those judgments, and changes in judgments could materially affect Mattel’s consolidated financial statements.
Certain income and expense items are accounted for differently for financial reporting and income tax purposes. As a result, the income tax expense reflected in Mattel’s consolidated statements of operations is different than that reported in Mattel’s tax returns filed with the taxing authorities. Some of these differences are permanent, such as expenses that are not deductible in Mattel’s tax return, and some are temporary differences that reverse over time, such as depreciation expense. These timing differences create deferred income tax assets and liabilities. Deferred income tax assets generally represent items that can be used as a tax deduction or credit in Mattel’s tax returns in future years for which Mattel has already recorded a tax benefit in its consolidated statements of operations. Mattel records a valuation allowance to reduce its deferred income tax assets if, based on the weight of available evidence, management believes expected future taxable income is not likely to support the use of a deduction or credit in that jurisdiction. Management evaluates the level of Mattel’s valuation allowances at least annually, and more frequently if actual operating results differ significantly from forecasted results.
Mattel records unrecognized tax benefits for U.S. federal, state, local, and foreign tax positions related primarily to transfer pricing, tax credits claimed, tax nexus, and apportionment. For each reporting period, management applies a consistent methodology to measure unrecognized tax benefits and all unrecognized tax benefits are reviewed periodically and adjusted as circumstances warrant. Mattel’s measurement of its unrecognized tax benefits is based on management’s assessment of all relevant information, including prior audit experience, the status of audits, conclusions of tax audits, lapsing of applicable statutes of limitations, identification of new issues, and any administrative guidance or developments. Mattel recognizes unrecognized tax benefits in the first financial reporting period in which information becomes available indicating that such benefits will more-likely-than-not (a greater than 50 percent likelihood) be realized.
Mattel’s provision for income taxes was $111.7 million in 2018, compared to $548.8 million in 2017. The 2018 income tax provision included a $14.6 million expense related to changes to Mattel's indefinite reinvestment assertion and a $3.7 million expense related to the deemed repatriation of accumulated foreign earnings (net of related valuation allowance change). The 2017 income tax provision included a net expense of $454.4 million, primarily related to the establishment of a valuation allowance in the third quarter of 2017 on U.S. deferred tax assets that will likely not be realized and a provisional estimate of the impact of the U.S. Tax Act in the fourth quarter of 2017.
In the normal course of business, Mattel is regularly audited by federal, state, local, and foreign tax authorities. The ultimate settlement of any particular issue with the applicable taxing authority could have a material impact on Mattel’s consolidated financial statements.
New Accounting Pronouncements
See Item 8 "Financial Statements and Supplementary Data—Note 1 to the Consolidated Financial Statements—Summary of Significant Accounting Policies."
Non-GAAP Financial Measures
To supplement the financial results presented in accordance with U.S. GAAP, Mattel presents certain non-GAAP financial measures within the meaning of Regulation G promulgated by the Securities and Exchange Commission. The non-GAAP financial measures that Mattel presents include currency exchange rate impact and gross sales. Mattel uses these metrics to analyze its continuing operations and to monitor, assess, and identify meaningful trends in its operating and financial performance. Mattel believes that the disclosure of non-GAAP financial measures provides useful supplemental information to investors to be able to better evaluate ongoing business performance and certain components of Mattel's results. These measures are not, and should not be viewed as, substitutes for GAAP financial measures and may not be comparable to similarly-titled measures used by other companies.
49
Currency Exchange Rate Impact
The currency exchange rate impact reflects the portion (expressed as a percentage) of changes in Mattel's reported results that are attributable to fluctuations in currency exchange rates.
For entities reporting in currencies other than the U.S. dollar, Mattel calculates the percentage change of period-over-period results at constant currency exchange rates (established as described below) by translating current period and prior period results using these rates. It then determines the currency exchange rate impact percentage by calculating the difference between the percentage change at such constant currency exchange rates and the percentage change at actual exchange rates.
The constant currency exchange rates are determined by Mattel at the beginning of each year and are applied consistently during the year. They are generally different from the actual exchange rates in effect during the current or prior period due to volatility in actual foreign exchange rates. Mattel considers whether any changes to the constant currency rates are appropriate at the beginning of each year. The exchange rates used for these constant currency calculations are generally based on prior year actual exchange rates.
Mattel believes that the disclosure of the percentage impact of foreign currency changes is useful supplemental information for investors to be able to gauge Mattel’s current business performance and the longer term strength of its overall business since foreign currency changes could potentially mask underlying sales trends. The disclosure of the percentage impact of foreign exchange allows investors to calculate the impact on a constant currency basis and also enhances their ability to compare financial results from one period to another.
Gross Sales
Gross sales represent sales to customers, excluding the impact of sales adjustments. Net sales, as reported, include the impact of sales adjustments, such as trade discounts and other allowances. Mattel presents changes in gross sales as a metric for comparing its aggregate, brand, and geographic results to highlight significant trends in Mattel’s business. Changes in gross sales are discussed because, while Mattel records the details of such sales adjustments in its financial accounting systems at the time of sale, such sales adjustments are generally not associated with brands and individual products, making net sales less meaningful. Because sales adjustments are not allocated to individual products, net sales are only presented on a consolidated and segment basis and not on a brand level.
Since sales adjustments are determined by customer rather than at the brand level, Mattel believes that the disclosure of gross sales by brand is useful supplemental information for investors to be able to assess the performance of its underlying brands (e.g., Barbie) and also enhances their ability to compare sales trends over time.
A reconciliation from Mattel's consolidated net sales to its consolidated gross sales is as follows:
For the Year Ended | 2018 vs 2017 | 2017 vs 2016 | |||||||||||||||||||||
December 31, 2018 | December 31, 2017 | December 31, 2016 | % Change as Reported | Currency Exchange Rate Impact | % Change as Reported | Currency Exchange Rate Impact | |||||||||||||||||
(In millions, except percentage information) | |||||||||||||||||||||||
Net sales | $ | 4,510.9 | $ | 4,882.0 | $ | 5,456.7 | -8 | % | -1 | % | -11 | % | — | % | |||||||||
Sales adjustments | 564.7 | 632.2 | 617.0 | ||||||||||||||||||||