MAT
#Thank you, <UNK>, and good afternoon, everyone
My plan for today is to walk you through our second quarter results and discuss potential headwinds and tailwinds for the remainder of the year
But before going any further, I want to remind everyone that unless otherwise noted, I'll be referring to net and gross sales in constant currency to provide better visibility into the underlying top line trends
And to provide more transparency into the fundamentals of the business, I'll also reference some adjusted financial results that exclude non-recurring executive compensation and severance related to our business transformation
As always, reconciliation to GAAP numbers are provided in our press release and slide deck
So let's walk through the P&L, beginning with the top line
In the second quarter, net sales were up 2% as reported and up 3% in constant currency versus the prior year
Gross sales were up 1% as reported and 2% in constant currency
From a brand perspective, sales growth in the second quarter was driven primarily by Cars 3, and partially offset by continued declines in Monster High and Ever After High, continued softness in MEGA, American Girl, and Thomas, and a decline in Barbie due to a tough year-over-year comparison with last year's renewal of our content distribution agreement with Universal
Excluding last year's licensing revenues from the content distribution deal, Barbie was up low single digits on a global basis for the quarter, with global POS up double digits
Looking at the business by region, we were pleased by the broad-based strength of our international segment this quarter, with gross sales growth of 6% as reported and 8% in constant currency and POS up low double digits
More specifically, we saw sales acceleration in the quarter in our Latin American business
We also saw sequential improvement in our European business and continue to see strength in key emerging markets like China
International growth was partially offset by declines in North America
Gross sales in North America were down 2% as reported and in constant currency
For the quarter, POS for North America was up mid-single digit
While we faced some short-term headwinds in the second quarter, it's still early in the year, with the majority of the business for the year still in front of us, and we remain focused on executing the strategies we laid out for the organization
Exiting the first quarter, the retail inventory overhang from the 2016 holiday period have been addressed
While global POS continued to outpace shipping in the second quarter, the high single-digit POS momentum of Barbie, Hot Wheels, and Fisher-Price year to date resulted in leaner retail inventories versus the prior year as we entered the third quarter
The combination of strong POS and leaner retail inventories gives us confidence that shipping will align with POS over time
Moving on to the other P&L drivers, sales adjustments were 8.8% in the quarter versus 9.1% in the prior-year period
Our reported gross margin for the second quarter was 41%, down 430 basis points versus 45.3% in 2016. During the second quarter, gross margin was primarily impacted by increased royalties due to the higher sales of our licensed entertainment properties, unfavorable mix due to a shift away from our higher-margin doll business, lower licensing income, and slightly elevated product costs due to timing of year-over-year cost savings programs
Strategic pricing partially offset these headwinds
There was steady important in our gross margin rate from first quarter, as we continue to gain scale with revenues increasing sequentially in the second quarter
Additionally, we incurred a lower obsolescence expense in the second quarter and saw a very little impact in ForEx as compared to the first quarter
Continuing on, as planned, advertising was down slightly as a percentage of net sales for the second quarter
We remain disciplined in SG&A
Adjusted SG&A was up approximately $12 million or 4% year over year for the quarter, driven primarily by employee costs related to merit increases, investment in the expansion of American Girl, including the new store opening in New York City this fall, as well as continued investments in China growth
Finally, adjusted EPS for the second quarter was a loss of $0.14 compared to the prior-year loss of $0.02. Our year-to-date tax rate was 22.8%, including discrete items
Excluding discrete tax items, our tax rate was 21.6% year to date, which is consistent with our expectations for the full year
Now turning to the balance sheet and cash flow, receivables were up $123 million year over year, primarily due to the later sales in the quarter as well as country and customer mix with longer sales terms
We expect two-thirds of the increase in receivables to be collected in the third quarter
And as expected, our owned inventory was up year over year, partially due to lower year-to-date sales and to support the continued positive global POS trends we're seeing for Barbie, Hot Wheels, and Fisher-Price, and our licensed entertainment launches throughout the year
Overall, we're comfortable with our inventory, both owned and at retail, as we entered the third quarter
We ended the second quarter with $275 million in cash
Year-to-date cash from operations was negative $549 million, down $308 million year over year, due to lower net income as well as heightened levels of receivables and inventory
More specifically, the year-over-year decline in cash flow from operations was driven primarily by lower net income of $77 million, higher accounts receivable of $126 million, and higher Mattel-owned inventories of $13 million
And as I said earlier, while our key power brands showed continued momentum, American Girl, Thomas, and parts of our innovation pipeline are performing below our expectations
In light of these challenges and our plans to continue to invest in our business as well as in our new strategies, we may not have sufficient flexibility under the current debt-to-EBITDA ratio of our credit facility at the end of the third quarter of 2017. Accordingly, we intend to amend the ratio under the credit facility before the end of the third quarter, and we are highly confident we'll be able to do so
At June 30, 2017, Mattel was in compliance with its debt-to-EBITDA ratio
We continue to deploy capital in a disciplined manner to both manage the business and reward shareholders
As expected, capital expenditures were up in the second quarter, as we continue to make investments to grow the business, including the increases in automation as well as to build a new American Girl store in New York City
Our second priority after investing in the business is to continue to reward our shareholders with a dividend
As announced at our June Investor Day, our board declared a third quarter dividend of $0.15 per share compared to $0.38 per share in the third quarter of 2016. The dividend was right-sized to facilitate the strategic investments Margo presented last month, increased financial flexibility over time, and strengthen our balance sheet
Our third priority will be to evaluate as appropriate strategic partnerships, M&A opportunities, and share buybacks, as we seek the highest available returns on our capital
And while we continue to target a year-end cash balance of about $800 million, we expect to come in below our target again this year
However, we believe we will continue to have sufficient liquidity to invest in the business
To position ourselves for a strong 2018, our overarching goals for 2017 are to exit the year with POS momentum overall, particularly in our key power brands, and to end the year with clean retail and Mattel-owned inventory levels
And as I said at our Investor Day in June, we recently completed a rigorous strategic review with Margo and the senior leadership team
We made some tough calls to temper our revenue expectations to low single digits for the full year
While we began 2017 expecting top line growth in the mid to high single digits for the year, our low single-digit expectations reflect lower sales for Thomas, American Girl, and MEGA, which represents about half of the reduction of our full-year revenue outlook, as well as the impact of lower sales from our fragmented innovation pipeline, which we're rebalancing and refocusing for the rest of 2017 for improved productivity
As we look ahead, we continue to target low single-digit sales growth for the year and expect the growth in the second half to be driven by: incremental licensed entertainment portfolio, including Disney's Cars 3 and Warner Bros
Justice League; our key power brands, Barbie, Hot Wheels, and Fisher-Price; and our strategic investments in emerging markets, which will partially be offset by continued declines in Monster High and Ever After High
Additionally, we expect second half sales to be more weighted towards the fourth quarter, as consumers continue to buy later, which reflects the timing of our promotional efforts and marketing spend, the timing of our new product launches, and how retailers are likely to tightly manage inventory leading up to the holiday season
We expect continued gross margin headwinds in the second half versus 2016 due to lower licensing income, including last year's franchise licensing agreement to expand American Girl into the Middle East, and mix royalties due to more entertainment-based properties, including Cars 3. However, we do expect sequential margin improvement in the second half of the year compared to the first half of the year due to the seasonal scale of our revenues relative to the first half of the year
The unfavorable year-over-year mix impact will be less severe in the second half since the weighting of Cars 3 revenue as a percentage of total Mattel revenue will be substantially less in the second half of the year than the first half of the year
And while we've already begun making progress on the strategies presented at Investor Day, we continue to focus on running the business and ensuring very strong execution in the upcoming holiday season
Additionally, we remain committed to continuous cost improvement with our two-year $240 million cost savings initiative, led by our global supply chain organization, which will help offset inflation, labor rates, and product costs
As a point of clarification from Investor Day, over the medium term we expect the cumulative incremental investment in our strategy of around $250 million to $350 million
Our goal is to partially offset our strategic investments over time by freeing up an additional $150 million to $200 million as we reshape our operations and seize savings via commercial realignment, supply chain transformation, and the future benefits of IT transformation process to optimize critical business decisions
As for the timing of our strategic investments, we're still working through the exact phasing of some of the investments
When we complete this work, we'll provide milestones against which you can measure our progress
Before I close, I'd like to address the recent announcement of my departure from Mattel and CFO transition
Having spent over 17 years on the leadership team here, it's time for me to pass the baton
However, I do plan to stay on board in the interim to ensure a smooth transition
I'm excited about the new strategy and confident that the new leadership team will both transform Mattel and regain our leadership in the industry
It's truly been an honor and a privilege to be part of this great company, and I will truly miss all the very talented people at Mattel
With that, we'll now open the call for questions
Operator? Question-and-Answer Session
Yes, I think it's pretty simple
We're highly confident that we can amend the ratio under the credit agreement before the end of the third quarter
We've been talking to our lead bank, and we're highly confident that we will be making that amendment
I think with regard to the $300 million, I think at this point we don't think we're going to exceed the $300 million, but we're tracking it closely, and we're going to build what we think we can sell
I think we've got some good results outside the U.S
We're going to track the U.S
closely
And if it's slower, we'll build lower and we don't expect it to be substantially lower than the $300 million
With regard to the current covenant, we renegotiated it in the second quarter to 3.75 times
And at the time of the June amendment, we did not have Q2 actual results
When we look at the timing of revenues in the second half, which currently we see more of that shifting from the third quarter to the fourth quarter, so given our 2Q performance and the shift in revenues, we want to make sure we have sufficient flexibility on the current debt-to-EBITDA ratio of our credit facility at the end of the third quarter of 2017. We're still looking at that
We've talked to our lead banks, and we haven't determined what we're going to take that ratio up to, but it will be higher than 3.75 times
And accordingly, we're going to attempt to amend that in the third quarter, and we're highly confident that we can get that amendment based on the discussions with banks
I think, as you said, we are sticking to our low single-digit growth for the year
And when we look at the drivers, first, we've got POS momentum in our key core brands, and we're looking at incremental licensed entertainment portfolio, including Disney's Cars 3 and Warner Bros
Justice League, as I said, our key power brands of Barbie, Hot Wheels, and Fisher-Price, and our strategic investments in emerging markets, which again I think will be partially offset by continued declines in Monster High and Ever After High
Okay, let me first take the revolver versus commercial paper
We haven't really accessed the revolver since 2009. We basically have great liquidity in the commercial paper markets, and the revolver is a backup facility to those commercial paper markets
Regarding inventories, again, I think what we're really looking at is to tightly manage our inventory, both our owned inventory
We want to end the year clean with regard to retail inventories
So as I said earlier, we've made the tough decisions really right now as to what we expect to sell in the second half based upon our POS trends
And what we're trying to do is ship in what's going to sell through, and then we want to end the year with clean inventories at retail as well as our owned inventories
I think with regard to the Cars question, we're going to wait and see what happens with regard to the release of the DVD and streaming on-demand, and we will adjust accordingly our production in the back half of the year to support revenues in 2018 if there is more revenue that we generate because of the strong POS around the globe
I think with regard to making those tough calls we talked about to temper our revenue expectations for the year, we're doing that right now
We're looking at year-to-date POS, and we're aligning our full-year revenues with regard to what we think POS is going to be for the balance of the year, so we went from mid-to-high single digits to low single digits
And I think that's going to be a big part of execution in the fall that we ship in what's going to sell through, and then we end with clean retail inventories as well as our owned inventories in our warehouses
