Mattel, Inc.
Q2 2018 Earnings Call Transcript

Published: 26 Jul 2018

[Operator:]

Good day, ladies and gentlemen. Welcome to the Mattel Incorporated Second Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Instructions will be given at that time. As a reminder, this conference call is being recorded. I would now like to introduce your host for today's call, Whitney Steininger. Ms. Steininger, you may begin.

[Whitney Steininger:]

Thank you, operator. And good afternoon, everyone. Joining me today are Ynon Kreiz, Mattel's Chairman and Chief Executive Officer; Richard Dickson, Mattel's President and Chief Operating Officer; and Joe Euteneuer, Mattel's Chief Financial Officer. As you know, this afternoon, we reported Mattel's 2018 second quarter financial results. We will begin today's call with Ynon and Joe providing commentary on our results. And then we will provide time for Ynon, Richard and Joe to take your questions. To help guide our discussion today, we have provided you with a slide presentation. Our discussion and our slide presentation will reference non-GAAP financial measures such as gross sales; adjusted net sales; adjusted gross profit and adjusted gross margin; adjusted other and selling and administrative expenses; adjusted operating income or loss; adjusted earnings or loss per share; earnings before interest, depreciation and amortization or EBITDA; adjusted EBITDA and constant currency. Our earnings release also includes non-GAAP financial measures. The information required by Regulation G regarding non-GAAP financial measures is included in our earnings release and slide presentation. And both documents are available in the Investors section of our corporate website, corporate.mattel.com. Before we begin, I'd like to remind you that certain statements made during the call may include forward-looking statements relating to the future performance of our business, brands and product lines. These statements are based on currently available information and they are subject to a number of significant risks that could cause our actual results to differ materially from those projected in the forward-looking statements. We describe some of these uncertainties in the Risk Factors section of our 2017 Annual Report on Form 10-K, our 2018 Quarterly Reports on Form 10-Q, our earnings release and the presentation accompanying this call, in other filings we make with the SEC from time to time as well as in our other public statements. Mattel does not update forward-looking statements and expressly disclaims any obligation to do so except as required by law. Now, I'd like to turn the call over to Ynon.

[Ynon Kreiz:]

Thank you, everyone, for joining our second quarter earnings call. Mattel is a company with great potential. We see a lot of opportunities. But there's been a big discrepancy between our financial performance over the last few years and where the company should be. The industry is evolving. But the toy market is growing and we should be able to reverse our own trends given our strong standing and the quality of our assets. With that said, we are in a turnaround and as expected had a challenging second quarter driven primarily by the Toys "R" Us liquidation. At the same time, we saw continued strong performance by Barbie and Hot Wheels. And we made substantial progress in our Structural Simplification program to restore profitability and improve productivity in the near term. We are already seeing operational improvement as reflected by our inventory management, which has resulted in both lower owned and retail inventory. This positions us well for the holiday season. On today's call, I will provide an overview of our second quarter performance and share some of the steps we are taking to transform Mattel into an IP-driven high-performing toy company. I would also talk about steps we are taking to advance our strategy for long-term growth. Joe will then walk through the financials in more detail and Richard will join us for Q&A. Let me provide an overview of our second quarter performance. Worldwide gross sales in the quarter were down 11% as reported, which was in line with our expectations when considering the impact of Toys "R" Us and a tough comparison to last year's Cars 3 launch. This 11% decline included a negative 10% impact from Toys "R" Us and a negative 2% impact from a slowdown in our China business, which I will talk about shortly. Regarding the outlook for Toys "R" Us in particular, (00

[Joseph J. Euteneuer:]

Thank you, Ynon. And good afternoon, everyone. Today I'll provide more detail on the important actions we're taking related to Structural Simplification and then walk you through the financial results. During the second quarter, we remained focused on execution and are pleased to report that our two-year $650 million Structural Simplification program is on track. We have made significant progress in the first half of the year including our most recent announcements on the important actions taken with regards to our organizational structure and our manufacturing footprint. During the second quarter, we completed our comprehensive review of the organization and today announced an extensive restructuring reducing the global non-manufacturing workforce by over 22%. As Ynon said, these reductions are weighted most heavily towards back office and support functions. While changes like this are not easy, this was a necessary action taken to realign our cost base with the top line and restructure the organization to better support the execution of our going forward strategy. This specific action is expected to result in full-year run rate SG&A savings of approximately $150 million with one-third expected to be realized in 2018. In aggregate, our actions to date are expected to result in full-year run rate SG&A savings of approximately $270 million. We estimate the severance costs related to this action to be approximately $75 million with $27 million expensed in the second quarter and expect the balance to be expensed in the second half of the year. At this point, we are ahead of schedule with our SG&A-related Structural Simplification actions. As a result, we are updating our outlook for adjusted SG&A from slightly higher than last year to now being slightly lower than last year. As it relates to cost of goods sold and the reassessment of our manufacturing footprint and supply chain, we have expanded the scope and are in the process of a thorough analysis. Given the expanded scope, some of the cost of goods sold savings we initially expected to benefit 2018 will now shift into 2019, impacting our full-year 2018 gross margin outlook. Our analysis to date has led to today's announcement of our decision to sell the real estate of our manufacturing plants located in Mexico. This is a first step that will help simplify our manufacturing footprint, reduce our asset base and increase the utilization of our remaining manufacturing footprint. We will provide more detail closer to the completion of the transaction, but this action is expected to be beneficial to our cost structure. Additionally, we will continue to (00

[Operator:]

Thank you, sir. Our first question comes from the line of Michael Ng of Goldman Sachs. Your question, please.

[Michael Ng:]

Great. Thank you so much for the question. I just had a follow-up on the comments about the transition from a manufacturing company to an IP owner. First, the real estate that you're selling in Mexico, what was produced in those factories? And then as a follow-up to that, is it fair to assume that you expect fixed cost leverage to be reduced as you sell some of your manufacturing capabilities? Thanks.

[Joseph J. Euteneuer:]

Okay. As far as what was produced, there was a lot of the Fisher-Price stuff and the BabyGear type of things. And the second question?

[Michael Ng:]

Do you expect your long-term fixed cost leverage to be reduced as you sell some of the factories?

[Joseph J. Euteneuer:]

Yeah. The whole goal of this is to eliminate fixed costs and increase the profitability and the gross margin as a result of those actions. So, yeah.

[Michael Ng:]

Okay. And then, second, could you talk a little bit about what you're seeing in terms of the retailer demand absorption? I think you mentioned that it's occurring a little bit better than expected. I was just wondering if you could give some examples of some retailers who may be expanding shelf space and what you're seeing there. Thanks.

[Ynon Kreiz:]

Yeah. Well, we can't get into specifics. But I can tell you that there's clear demand. We're seeing all of the major retailers stepping in and capturing and taking share. Our approach to this is that we don't think kids will consume less toys or be less interested in our brands because Toys "R" Us is out of business. And you have to remember that the industry is still growing. So there is demand and the retailers are stepping in and we're in active conversations with all of them. And as we said in the prepared statement that we do expect the Toys "R" Us situation to subside over the course of 2019 and 2018 and we'll move beyond that in 2019.

[Michael Ng:]

Great. And just lastly, you didn't mention the revenue outlook that you guys had for 2018, the bookend of flat to down $300 million. Is that still the case?

[Joseph J. Euteneuer:]

Yeah. Well, I gave you the bookends on the last quarter that said, worst case, we would be down $300 million. But the fact of the matter is that we are getting this positive feedback from all of the retailers, whether it's Walmart or Target or Amazon. So that will make that $300 million less. We'll be better than that, that number.

[Michael Ng:]

Great. Thank you so much.

[Operator:]

Thank you. Our next question comes from the line of Tim Conder of Wells Fargo Securities. Your question, please.

[Timothy Andrew Conder:]

Thank you. Maybe just a little more color, gentlemen – however you want to answer this – on your manufacturing footprint. At this point, where do you see the mix of manufacturing owned versus sourced by year-end 2019 or 2020?

[Ynon Kreiz:]

We are not at this stage committed to any particular scenario. We are in the middle of analyzing our manufacturing footprint and we see opportunities clearly. We took the first steps. That was easy to execute. But we're being thoughtful about the way we approach this process because we need to remain committed to quality, safety, timely delivery. We can't afford to miss any holiday shopping demand. And, therefore, we're taking, as I said, a thoughtful approach to this. But at the same time, we are moving pretty rapidly. We're taking a very comprehensive view across the entire footprint and also the supply chain as a whole, not just our own factories. And as a result, as we said, we expect to – we said that there is a potential for even further savings above the target of $650 million.

[Timothy Andrew Conder:]

Okay. Joe, my apologies. If you could repeat the Barbie POS on a global basis.

[Joseph J. Euteneuer:]

Barbie POS?

[Timothy Andrew Conder:]

Yeah.

[Joseph J. Euteneuer:]

If you look at that. Yeah, I got this. On Barbie's POS on a global basis, we were up 21% for the year. And for the quarter, we were also up double digits.

[Timothy Andrew Conder:]

Okay. And that's inclusive of Toys "R" Us?

[Joseph J. Euteneuer:]

That's inclusive of Toys "R" Us. Actually, ex-Toys "R" Us, we were up over 20%.

[Timothy Andrew Conder:]

And that's in the quarter?

[Joseph J. Euteneuer:]

Yeah, in the quarter.

[Timothy Andrew Conder:]

Got it, okay. And then how would you, Joe, frame the age of the company inventories and channel inventories at this point? You talked about a little more obsolescence. But again, there can be optics skewed here given the first half is always a small piece of the full year. But just a little comment on the company age, quality of the inventories and then what you see in the channel.

[Joseph J. Euteneuer:]

Yeah, no, we're very well positioned on an inventory basis. We took all of those actions at yearend. And we worked down a lot of the obsolescence that we took at yearend. So that's been going really well. And our inventory levels, both at the retail level and in-house, we feel very, very comfortable with it as we move into the holiday season. It's mid-teens inventory, so we've done it very well.

[Timothy Andrew Conder:]

Okay. Thank you.

[Operator:]

Thank you. Our next question comes from the line of Arpiné Kocharyan of UBS. Your line is open.

[Arpiné Kocharyan:]

Hi, thanks. Thanks for taking the question. I want to go back to margins for a second, Joe. So now it's revised to high 30s. That would imply back half margins of more than 42%, give or take. When your top line is down at least mid-single digits and with increased sort of freight cost in the back half and raw materials, how do you maintain flat margins? I guess, could you give us some of the puts and takes of – I understand seasonally it's stronger quarters ahead. But how do you keep margins flat when you have declining top line?

[Joseph J. Euteneuer:]

Yes. Look, the realities are in the script we talked about how the mid to low 40s that you're talking about, the 42%, give or take; half of it comes as a result of just math. Two-thirds of your revenue comes in the back half of the year versus you only have one-third in the first half of the year. Then it's the corrective actions we've taken. So you take the Pennsylvania distribution plant that we spent the first half of the year getting up and running by the end of June, we're going to gain the benefits of that on the back half of the year. From a raw materials standpoint, the comps are a lot easier in the back half of the year than they were in the first half of the year. You have all of the Structural Simplification efforts that we've put in place, the benefits of the labor takedowns, the reduction of labor overhead in the manufacturing plants we took earlier in the year. And then the fact is we'll have less write-downs and obsolescence because we've worked so hard to get that done at the end of 2017 and then clean it up here in the first half of the year so we can get positioned well for the back half of the year. So we feel pretty confident about the back half of the year being into that low 40%. And we used the first half of the year to sort of get things cleaned up and in a position so that as we exit 2018, we are on a great positive runway, including the top line.

[Arpiné Kocharyan:]

Okay. And then I have a broader sort of strategy question to Ynon. It seems like you guys are moving forward with SG&A reduction in full speed. But I would imagine that cutting SG&A is sort of the easier part of this equation, right? Making sure that that doesn't disrupt top line is the tougher part in any turnaround. I guess, what are you doing today to protect top line for the back half outside of just the Toys "R" Us? What are some of the drivers outside of the channel disruption that would make investors comfortable that top line might not fall off the cliff?

[Ynon Kreiz:]

Yeah. So as we said, the majority of the reductions came from back office and support functions. We definitely were very mindful of maintaining the revenue-generating part of the company and the creative capabilities. And in fact, we've been building up capacity especially in areas such as franchise management and other revenue-generating opportunities that we've identified. And you will see more on that in the coming weeks. Now the company is in a very strong position creatively and we're seeing good momentum. We are seeing good momentum in many parts across the organization. The Toys "R" Us is what it is. It's a market factor. We took a hit, but it doesn't change the fundamental quality of the IP that we own and the capabilities in the company. Barbie and Hot Wheels are great case studies. You see what happens when you have the right leadership, the right strategy, strong asset. And that defies even an impact like Toys "R" Us. We're on our way to do the same across all of the other brands and the company as a whole. And in terms of taking the way we're thinking about it, it's really a two-step approach. Step one is getting on top of our manufacturing infrastructure and the cost base. We are looking to – as we said, we want to stabilize revenue decline first and foremost and restore profitability. Once we do that, then we turn into growing top line, investing in other areas such as franchise management and content. I said earlier before the Q&As that taking content is one example. For us, up until now was pretty much a marketing and promotional tool and it's an area where we lost money. Going forward, this should be a profit engine, not just a great way to promote our brands. So there are a lot of areas that we see where we can turn things around both on the cost side and on the revenue side. But I also want to remind us, remind you, remind everyone it will take time. This is a turnaround process and we got to do things in the right order. Step one is cost. Step two, revenue.

[Arpiné Kocharyan:]

Thank you.

[Operator:]

Thank you. Our next question comes from the line of Felicia Hendrix of Barclays Capital. Your line is open.

[Felicia Hendrix:]

Hi, good evening. Thanks for taking my question. Ynon or Joe, I was just wondering. Can you just explain to us exactly what happened in China? I think, Ynon, in your prepared remarks, you said it was going to be discussed later. And I'm not sure, Joe, you actually really kind of went through that.

[Ynon Kreiz:]

Yeah. Let me give you the short version. We were basically overly optimistic in our own projections for Q1. And we ended up with more inventory that we expected and now we're basically absorbing it. We still see demand. The market is healthy and we remain positive on the Chinese market. And the way we see it; it was a one-off, literally driven by the wrong forecast for Q1.

[Felicia Hendrix:]

So I think, look, we have kind of a before and now scenario going on here. But I think before, the Chinese market was kind of being looked at as like this real kind of place to grow Fisher-Price and kind of be the leader in the developmental toy arena and with young moms and that sort of thing. Is that still a strategy? Is that an area where you had too much inventory? Maybe you can just talk about the China strategy going forward.

[Ynon Kreiz:]

Yeah. Again, as you said, there was an outlook in the past how we viewed the Chinese market. And as I said, we remain positive on this market. But the way we look at the International market right now is – we're taking a view on the entire market, all of the geographies because we also see, for example, opportunities in Europe, even in mature Europe where we see opportunities for growth. We actually did well in the second quarter. We had single digits, mid-single digit decline in Europe. And we believe we can also find opportunities there. So I'm taking a broader approach to the International market. Given my background, I feel very good in terms of where we are internationally. And we're not singling out China as one market where we see potential. We're going after the whole market and we'll come back with more updates on that. But it's fair to say that we see opportunities in developing markets as well as mature markets internationally.

[Felicia Hendrix:]

Okay, that's helpful. And, Joe, can we just talk for a second about the 2,200 head count reduction. I think I heard you – it sounds like it's a bit shy of a quarter of your back office. Can you help us just understand a bit more what these functions were? It was such a big number. Was this just a ton of redundancies? Are you automating a bunch of stuff? I'm just trying to understand kind of this part of your business and that kind of reduction and if you're cutting into bone or there was just so much fat. Could you give us some perspective?

[Joseph J. Euteneuer:]

Yeah, no. So, look, it is a combination of everything you said. I think you've heard me comment on earlier con calls about the lack of automation here. So we're making a big push to get more and more automated, which helps us become far more efficient. The other thing is I think we're just re-looking at the cradle to grave processes that we have to streamline them to get rid of the excess steps so that we can operate more efficiently and create more profitability. So, Ynon, what have you got to add?

[Ynon Kreiz:]

Look, the way we think about this reduction, this is not simply about cost savings. We are transforming the way we operate. And there were systems and processes that have been in place for a long time in the company that are simply no longer needed or there are better ways to affect them. And I guess it goes back to an earlier question about how we're going to manage the company given these changes. So I can tell you that this was a process where we involved leaders across the organization and spent a lot of time on to make sure that we are doing the right thing, that we're not throwing the baby with the water, that we're not leaving the company with gaps and handicaps in any area. Even though we took it largely out of support functions and back office, even that is important. You want a healthy, robust company that can support itself. So we took while you can say – and it is significant approach into our restructuring and kicked off this process with a real action. We did it very methodically. This was developed and planned for. And we think, if anything, it will make us more efficient, more robust, more effective, better performing. It's not about cutting into the bone and weakening the company. We believe it will make us stronger even in the short term, let alone longer term.

[Felicia Hendrix:]

Okay, that's helpful. Thanks. Final question is you shipped a lot of your kind of core product, Barbie and Hot Wheels, in the quarter. One risk, certainly, is that people kind of throughout the Toys "R" Us liquidation have taken discounted products that they bought there and kind of putting them in their closets and waiting throughout the year for birthdays and Christmas and that sort of things. So as you are shipping into that, there's a potential risk that in the second half of the year people might buy less. So just wondering what you think about that thesis.

[Richard L. Dickson:]

Hey, it's Richard. It's pretty difficult to quantify the impact of pantry loading, essentially consumers buying now to save later. What we can see is based on some NPD publications that they've suggested that fourth quarter sales should be only slightly impacted by the liquidation. We're working really closely, obviously, with our retail partners who are incredibly aggressive and excited about the market share opportunities to grow their business.

[Felicia Hendrix:]

Okay, that's helpful. Thanks.

[Operator:]

Thank you. Our next question comes from the line of Susan Anderson of B. Riley FBR. Your question, please.

[Susan Anderson:]

Hi, good evening. Thanks for taking my question. If you could give us a little bit of an update just on American Girl and thoughts around timing on that turnaround strategy and getting product out of the mass market. It looks like sales were down a little bit more this quarter versus the past five. So just trying to figure out also when you would expect the brand to stabilize.

[Ynon Kreiz:]

Look, this brand is in turnaround. And we are taking a very proactive approach to getting on top of it. The brand remains strong and vibrant and there's still many passionate fans out there. But we just had the wrong strategy. And it took us a little bit to realize what exactly was the root cause of this issue. We believe we understand what it is and we are getting very active on it. So it will take time. It might be one of our more challenged brands in terms of where it is, but the value is still there. And it kind of goes back to what I said earlier about the discrepancy between the quality and the strength of a brand relative to its financial performance. So we will do what we have to do. Might take some time, but we are strong believers in the potential and will update you as we go forward. It's not a quarter – kind of next-quarter issue. It will take time. But the brand is strong, the fans are out there and we're going to fix it.

[Susan Anderson:]

Okay, got it. And then on Jurassic World, so it sounds like that's been pretty successful. I guess, how did that trend so far versus your expectations? And I think last quarter you said you had expected third quarter to be the bigger quarter for the product. So should we expect sales to even accelerate from where they had been in second quarter?

[Richard L. Dickson:]

I'll start on the context of Jurassic. But we've been extremely pleased with the Jurassic business. It's the hottest action figure brand out there. Our teams collectively with Universal are working really well and hard together to maximize the opportunity. Clearly, a terrific theatrical release aligned our teams with Universal. And the execution has been really beyond our expectations.

[Ynon Kreiz:]

And it points to another thing. Another important part of what we're doing is we're now working really hard to position Mattel as a great partner. We're treating third-party IP as if it's our own. And Jurassic World was one of the first franchises that we approached with that in mind under a new leadership and have done extremely well. They knocked the ball out of the park. We've worked in close collaboration with Universal, so we can't claim all of the credit. But clearly, on the toy line, distribution, marketing, we've done a terrific job. And this is really a start of a new day in terms of the way Mattel works with third-party partners. And you will see success with the other brands that we will have in the future.

[Susan Anderson:]

Great, thanks. That's great to hear. Thanks so much. Good luck next quarter.

[Operator:]

Thank you. Our last question comes from the line of Greg Badishkanian of Citigroup. Your line is open.

[Gregory Robert Badishkanian:]

Great, thanks. So with respect to overall POS excluding Toys "R" Us in the U.S. and then if you could also break out International.

[Joseph J. Euteneuer:]

Yeah, sure. Richard, do you want to take that one?

[Richard L. Dickson:]

Yeah, hi. On our core brands, we were up 2% – in total brands, we were up 2%. Our total core brands' extremely successful performance as we've indicated with Barbie and Hot Wheels. And important to note also, ex-TRU, Fisher-Price and Thomas was also flat. So again, a clear performance against core brands. And within the Toy Box portfolio, obviously, the switch with Cars and Jurassic has had a hit in the context of that segment for us. But in our Owned Brands within Toy Box also performed very strongly ex-TRU, also up single digits.

[Gregory Robert Badishkanian:]

And when would you expect your shipment growth to match the POS growth? When is that going to be fully aligned, would you say?

[Joseph J. Euteneuer:]

Well, yeah, I think as you go into the second half of the year. We've worked really hard to get our inventory levels right ex China (00

[Gregory Robert Badishkanian:]

All right. And then, Ynon, you mentioned you're treating third-party IP like your own. So are there some very significant opportunities to win additional contracts over the next 18 months?

[Ynon Kreiz:]

We're working on it. Look, historically, we were very internally focused literally because the strength of our IP. So you say why go anywhere else. But this is not mutually exclusive. We clearly have very strong generational IP with a very deep and wide catalog. In fact, probably one of the strongest catalogs out there. But that does not mean we cannot work with third parties and do a great job with that. And I want to take this and extend the answer a little bit and say that we're now transitioning to become an IP-driven company. And what that means is that our job is to take great IPs and build it into commercial enterprises. The opportunity is beyond making great toys, even though being a toy company is a great business to be at. So we're very proud of that and we can capture a lot of value. If we do nothing, just reorganize the company and transform the way we operate; there is a lot of value to recapture just by that alone. But we're not looking to stop there. If you think as an IP-driven company, you can take great franchises to many different directions and turn this company into something a lot bigger than was ever imagined. So to do that, you got to do it with your own IP and we have a lot to play with. You can do it with new IPs that you develop in-house. But there's no reason not to work in collaboration with IPs that we don't own. And because you don't own it, clearly the economics are somewhat different. But if you take it as an add-on or you don't take it as a mutually exclusive opportunity, it comes on top. So we feel that we are heading in the right direction. As I said earlier, we're seeing early signs of success. But it will take time to do that. And we got to prioritize the areas where we take action. We're moving as fast as possible without weakening the company. We want to remain competitive because the company is still a going concern, a very active, vibrant player in the toy industry. So while we're restructuring our own company, we're looking to maintain growth and momentum. And you got to do it at the same time. But we feel very good about where we are. And we're positive and confident as we head to the second half of the year.

[Gregory Robert Badishkanian:]

Great. Thank you.

[Operator:]

Thank you. This concludes today's Q&A session. I would now like to turn the call back over to Whitney Steininger for any closing remarks. Ma'am.

[Whitney Steininger:]

Thank you. There will be a replay of this call available via webcast and audio beginning at 8

[Operator:]

Ladies and gentlemen, thank you for participating in today's conference. This concludes the program and you may now disconnect. Have a great day.