Mattel, Inc. (MAT) Earnings Call Transcript & Summary

Good morning, and thank you all for joining us today. I'm Arpine Kocharyan, leisure, gaming and lodging analyst at UBS. And I'm very pleased to have Anthony DiSilvestro, Chief Financial Officer of Mattel with us today. Anthony has been with Mattel since 2020 after nearly 4 decades of experience in various financial leadership roles within the consumer industry. We are going to talk about Mattel's strategy for growth, current state of the toy industry, balance sheet and capital allocation strategy for Mattel. But before we begin, as a research analyst, I am required to provide certain disclosures relating to the nature of my relationship and that of UBS with any company on which I express a view today. These disclosures are available at ubs.com/disclosures. Alternatively, please reach out to me, and I can provide them to you after this meeting. With that out of the way, thank you, Anthony, so much for being with us today.

Thanks for having me, Arpine. Good to be here.

Great. So I have a few questions to start off. But first, why don't we sort of begin with your outlook for Mattel broadly? Investors are increasingly concerned about a weaker consumer given persisting inflationary pressures, lapping government stimulus. Maybe if you could give a kind of a general sense of the sort of the state of the toy business coming out of a tough holiday season and outlook for Mattel?

Yes. Great. Let me start -- first of all, thank you for having us here today. It's great to be here. Let me start with some comments about Mattel and our outlook, specifically for 2023 in the first quarter. And then I'm going to come back and talk a little bit about the industry outlook. Today, we are reiterating our 2023 guidance for Mattel, and that is for our net sales in constant currency to be comparable to the prior year, and that includes a 3 to 4 percentage point negative headwind to accommodate an anticipated reduction in retail inventory levels. Our guidance does assume growth in consumer demand for our product with positive POS for the year, driven primarily by the performance of our Dolls and Vehicles categories. Our adjusted gross margin is expected to increase to approximately 47%, and that's compared to 45.9% in the prior year. And adjusted EPS is expected to be in the range of $1.10 to $1.20 per share. And adjusted EBITDA is expected to be in the range of $900 million to $950 million, and that compares to $968 million in the prior year. And it does reflect a significant increase in SG&A of about $100 million as incentive compensation is expected to return to target levels. And lastly, free cash flow, we expect to exceed $400 million of free cash flow in 2023. And as we've previously stated, we expect first half sales and earnings to be down significantly, and that's as we wrap 20% top line growth in the prior year and further impacted by the anticipated retail inventory reduction in 2023, which will be mostly felt in the first half of the year. Like I said, those retail inventory reductions are expected to be mostly in the first half with more of a concentration in Q1 and then diminish as we go through the second quarter. We also thought it would be helpful to provide a more specific outlook regarding our first quarter. And for context, the first half is seasonally small for Mattel and the industry, with each quarter representing about 15% of full year sales historically. Given that context, we expect first quarter net sales to decline by 25% to 30% in constant currency and for adjusted EBITDA to be in the range of a negative $30 million to $60 million. And that is due to the top line decline, as well as incremental costs associated with inventory management. Importantly, the fundamentals of our business are strong. Quarter-to-date, we have achieved growth in consumer takeaway, as measured by POS. And for the full year of 2023, despite continued macroeconomic challenges, we expect to outpace the industry and to gain market share. Coming back to the industry context and going back to the fourth quarter of 2022, we had a strong fourth quarter, right? We grew our consumer takeaway or POS by mid-single digits. We grew in each of our 4 regions. We outpaced the industry and gained market share. As you look at the industry for 2022, it was flat to 2021. And 2021 and 2020 were 2 record years. And for 10 years through 2021, the industry grew, right? So we believe we're in a growth industry. And the fact that it was flat in 2022, I think, demonstrates the resilience of the industry to kind of these macroeconomic challenges. And one other fact, if you compare 2022 to 2019, the industry is up 22%. So it's grown and it's holding steady. We really believe it's a growth industry for a number of reasons. I mean, toys are an important development and play pattern for children. Parents will always prioritize spending for their kids. The price points are affordable, right? Everything from $1 to a Barbie Dreamhouse and everything in between, so a lot of flexibility there. It's also a strategic category for retailers. It drives foot traffic, it's experiential. A toy shopper shops more often and buys more stuff. So again, a very important category for retailers. As we look to 2023, our expectation for the industry is it -- for it to be flat to slightly up, but we expect Mattel to outpace the industry and to gain market share.

Great. One of the key concerns that investors have about the toy sector in general is that 2023 outlook seems to be back-end loaded, and you just reiterated your guidance. What gives you confidence that after declines in the first half, you're going to see accelerated growth for the back half?

Yes. Let me give some context because you could miss perceive this idea of acceleration. And our quarterly performance in 2022 was significantly impacted by the timing and volatility of movements in retailer inventories, not by the underlying consumer takeaway of the business, which has been solid and growing. And let me just explain a little bit more. In the first half of 2022, our top line was up 20%, right? Driven primarily by an increase in retailer inventories. And then it kind of reversed. In the fourth quarter, our sales were down 19% as retailers took a more cautionary approach to replenishment, right? And while our gross billings were down 19% in constant currency, our POS was up mid-single digits. So we're wrapping that. So what we expect in 2023 is for the first half be down as we wrap that 20% growth and further impacted by the reduction in 2023 of retailer inventories. And then as we move into Q4, the reverse is going to happen, right? So we're lapping that material reduction in retail inventories. So we've got this bounce back. And all the while, we expect consumer takeaway to be solid and growing. So it really is about what happened in 2022. And as we wrap that, right? You're going to get these significant changes on percentage terms, right?

Yes, yes. Anthony, could you go through some of the key growth drivers, specifically for Mattel for this year and why not into 2024? Because -- you have some exciting licenses that you are taking over this year, but also lapping, as you said, tough comps and successful franchises like Jurassic, Lightyear by Disney last year. What are those puts and takes?

Sure. Let me comment on that in the context of our guidance. As I said a few minutes ago, our expectation is for net sales in constant currency to be comparable to the prior year. And that includes, again, a 3 to 4 percentage point headwind from the reduction in retailer inventories. We expect growth in both our dolls and vehicles categories, offset by declines in Infant, Toddler, and Preschool and in our challenger categories in aggregate. And let me break that down a little bit further. If you listen to our investor presentation, Richard Dickson calls 2023, the year of the doll. And we've got a significant amount of activity happening. First, we had the return of the Disney Princess and Frozen franchise to Mattel. That's a significant win for us and will be a significant driver of top line growth as well as profitability. Second, we had the global rollout of Monster High. This is something we started in 2022 in the U.S. and are expanding globally in 2023. The third is, we have a theatrical tie-in with Trolls later in the year with -- there's a nice doll property. And lastly, we have the Barbie movie in 2023 in July which will premier, again, another catalyst to the Dolls category growth. We also expect growth in the Vehicles category. Hot Wheels is on a tear and it just has great momentum. It just completed its fifth consecutive record year. And we also have a new innovation, right? We're extending the brand into RC as well as to what we call fingerboard or skate. I think, is a testament to the strength of the brand and where it can travel. So significant growth, Dolls and Vehicles, declines in Infant, Toddler, and Preschool. And then in our challenger categories, primarily in Action Figures, we're wrapping a very successful Jurassic World, theatrical tie-in. Now Jurassic World is an evergreen property for us, but 2022 was a movie year. So you typically have a fall off following that. And also, we had a light year in 2022, which we're wrapping. So those are the kind of the puts and takes in terms of 2023.

That's very helpful. Anthony, one of the questions that I get often from investors is, does your guidance range incorporate some level of macro uncertainty and likelihood that we do perhaps go into a recession? Or would you say that you're flat in constant currency revenue outlook, assumes current level of economic activity sort of continues to hold steady for the back half?

Yes, it's a good question. And we try to take into account what we have visibility to, what we have knowledge of, but certainly, the guidance is subject to further risk, volatility, things we can't really incorporate. But we've tried to incorporate this volatile and challenging environment into our guidance. And I think that's the reason why our estimate for the industry is for it to be flat to slightly up in 2023 and for us to outperform. So we do the best we can. Again, it's been a challenging consumer environment, and there's been a lot of volatility out there, and we try to factor that into the guidance.

Let's switch gears to margins, if that's okay.

Sure. I love margins.

I know, right? It seems as if some of the raw material costs like resin and metals have been easing and you also will be lapping lower freight costs starting from Q2 of this year. Spot prices in freight are down north of, I don't know, 50%, 60%. My question is, is there room for your margin outlook to be a bit better given also the fact that FX headwinds are also easing a little bit as you look sort of currencies that you're exposed to, at least what we can model?

That's a good question. Look, we are expecting our adjusted gross margin to expand in 2023. Our guidance is for approximately 47% compared to 45.9% in last year. So we are anticipating gross margin expansion. And there's a few positive and negative drivers. On the positive side, we're going to get a benefit from pricing. So over the last couple of years, we've absorbed, I think, close to 800 basis points of cost inflation. So we took pricing in 2021, took pricing again in 2022. We'll have a carryover benefit of that '22 pricing actions into '23. So that's a positive. The second is our cost savings initiative. So recently, we increased the target on our Optimizing for growth program to $300 million from $250 million. This is the program that ends in 2023. And the majority of that $300 million will benefit cost of goods sold. So we've got a great track record of identifying and delivering against cost savings initiatives, and that will continue into 2023 and beyond. On the negative side, we ended 2022 with our owned inventory levels a bit elevated. So we want to bring those back down. The way we do that is, we lower our production levels to below what we anticipate to sell to correct that. Unfortunately, that comes with a negative fixed cost absorption impact on gross margin. And the last, which is a slight negative, is cost inflation. Cost inflation has moderated significantly compared to 2020 and 2021. Actually, the primary driver of the cost inflation is labor rates. We're seeing pressure in some of our key supply chain markets, which is creating some cost inflation. With respect to ocean freight, we will -- we are seeing spot prices come down, but there's a bit of a lag between the spot prices and when it hits our P&L for 2 reasons. One is, the majority of our ocean freight is contracted through annual contracts that we enter into in the second quarter, right? So as we redo those negotiations, we'll benefit. And then we have our normal inventory turnover, 60 to 90 days. So inventory gets hung up on the balance sheet, comes through 60 to 90 days later in terms of the P&L. So that cost inflation moderation will be mostly kind of a second half impact, but it's good to see some of these input costs coming down and look forward to benefiting from that.

Right. Absolutely. And in terms of SG&A and your cost savings strategy there and where you are.

Yes. So we've made great progress. If you look back 2017, SG&A was 31% of sales and we're about at 24% now. We've done a really good job of managing our dollar level of SG&A, and then as you grow the top line, you get a nice scale benefit coming through. The challenge for us in 2023, right, is incentive compensation, right? Significantly down in 2022. The assumption is, we returned to target levels in 2023. So that's creating a bit of a headwind on SG&A. But looking beyond 2023, we would expect to continue to scale and continue to reduce SG&A as a percentage of net sales.

Great. Anthony, Mattel has been very clear about its asset-light approach to IP monetization. Maybe if you could go over that strategy and what that could mean for growth for the company in the medium term.

Sure. This goes back to our strategy and our investment thesis, which really has 2 parts: one is to grow our IP-driven toy business; and the second is to capture the value of our intellectual property in a number of adjacencies, things like consumer products, digital gaming, location-based entertainment, content both theatrical and TV. And with respect to something like theatrical, for example, we take a capital-light approach. So we're not investing in the production of these movies. What we bring is our IP. And what that does is, it enables us to work with multiple studios. We -- in addition to the Barbie movie, we have 14 films in development. So we're able to spread that around, work with, again, different studios in a capital-light approach. And we benefit from -- and I'll give you an example of the Barbie movie, producer fees, participations in box office, participations and profit levels. But again, it's a capital-light approach. We're not putting capital at risk to do this. And we think it gives us a nice diversification, a nice upside potential in terms of profitability. But when you think about these adjacencies, whether it's consumer products, digital gaming or the theatrical piece, it's very high margin, right? It should be very accretive to our overall profitability as we continue to expand that side of the business. And look, we're starting to put some points on the board. We've got a long way to go, but I think it's a great opportunity and we certainly have the assets in terms of IP, both what you see today and also what's in the library, right? A good example of that is Barney. We announced Barney and it's on CNN and Wall Street Journal, and everybody is excited about Barney coming back. And to me, that's just a great example of, again, there's more stuff in the library. Bringing that content back and then capitalizing on it, not only in content, but not from a full franchise approach, right? Whether it's toys or consumer products, we have the capability to extend across. And again, I think it's a tremendous opportunity for the company.

With essentially no risk to the balance sheet.

That's correct.

Capital-light.

Capital-light.

Barbie, I was amazed to hear Barbie cited at the Oscars the other night. It was amazing. There's a lot of concern that the brand is still at pretty sort of elevated levels of sales versus 2019 and that there could be a reversal back to 2019 levels, which could mean the brand could decline despite a key marquee box office event this summer. What's your response to that? What's your take on that?

Yes. So we certainly don't expect that to happen, right? Our guidance is the expectation that Barbie will grow in 2023. And look, it's had a great run. It's doubled over the last 5 years. It hit a record in 2021. It held its own in 2022. And the way to think about Barbie is, we have what we call the Mattel playbook. And for each of our brands, it's about each brand having a brand purpose, also relevance, design-led innovation, commercial execution. And we have capabilities across all of those. And Barbie is the best example of how successful we've been. And look, if you think about the Barbie movie, there's 2 pictures and a teaser out there. And the buzz on the Barbie movie is just tremendous, right? So with the Barbie movie, again, we mentioned some of the direct movie economics, all right? But we'll have a dedicated toy line, which will appeal to collector audience as well. The movie is really a great catalyst to reengage on the consumer product side, right? And again to move into -- further into some of these adjacencies. And I think if you have the opportunity to watch or listen to Richard Dickson's investor presentation, he does a much better job than I could in articulating the Barbie and the future for Barbie. But again, we're very pleased with the performance and couldn't be more confident about the future outlook.