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

Good morning, everyone. I'm Drew Crum. I cover leisure products for Stifel. Thank you for joining us. We're pleased to welcome on stage the senior management of Mattel. Mattel is a leading global toy company featuring a portfolio of brands that includes Barbie, Hot Wheels, Fisher-Price, American Girl, among others. And we're pleased to welcome the company's CFO, Anthony DiSilvestro. Welcome back, Anthony. Good to see you again.

Thanks, Drew. It's good to be back in Boston. Thanks for having us.

Absolutely. So as I said, we had you here last year at this time. A lot has changed since. Maybe we could kind of walk through what has transpired over the course of the last 12 months and where that leaves you in terms of the outlook for '23?

Sure. Happy to start there. I mean what I would say is it's certainly been an interesting journey over the last 18 months. We've seen a lot of increased volatility, but that volatility is more related to inventory levels and our shipping patterns as reflected in our gross billings more than the underlying consumer takeaway, right, in terms of the performance of the business. And you have to go back to 2021 to understand the full story. And in '21, the industry experienced a high level of stock outs, and that was driven by a combination of high levels of consumer demand and a number of supply chain challenges that we all faced. So as we came into 2022 and in an effort to avoid a repeat of these issues, retailers accelerated purchases of product. And that drove for Mattel a significant growth in gross billings in the first half of 2022. So as we headed into the second half of 2022, we expected POS to accelerate and to pull through that -- those early inventory purchases. And we did see an acceleration of POS, particularly in Q4 and in December, but it came later and it wasn't to the quantum necessary, right, to pull through that inventory. At the same time, consumers were facing significant macroeconomic challenges in the form of interest rates, inflation, consumer confidence around the war in Ukraine. So there was a number of issues. This led retailers to employ more discounts and promotions to kind of work through. And they also took a more cautionary approach to inventory replenishment, which obviously had an impact on our sales performance, particularly in the fourth quarter. But if you step back and cut through all that volatility, our business actually performed pretty well. POS in that fourth quarter was up mid-single digits. And we finished the year with gross billings in constant currency, up 3%. So not to the level of our expectations, right, but actually pretty good performance nonetheless. The other issue we came out of '22 was retail inventory levels elevated. And I'll talk more about how we're dealing with that in 2023. So we look -- as we turn the corner then to 2023, the biggest impact is from our expectation that our shipping patterns, right, in terms of -- to retailer will revert back more towards historical norms. And what I mean by that is if you go back over 10 years, you'll find a pretty tight correlation that -- about 1/3 of our annual gross billings are in the first half, 2/3 are in the second half. And this is going to create additional volatility in our results in 2023. As we go back to those typical shipping patterns, we expect to see declines in the first half followed by growth in the second half, and I'll talk more about that because what we'll see is, again, declines in the first half, growth in the second half and an acceleration, particularly in Q4. And then acceleration isn't dependent on consumer takeaway or POS growth. It really is a function of what we're wrapping right, from 2022. And the other thing we have to deal with, as I mentioned, is elevated retail inventory levels, and I know we'll talk more about the guidance later, but we've factored in about a 3- to 4-point headwind in terms of our top line expectation into our 2023 guidance. So as we came through the first quarter, things are kind of playing out as we expected. We saw good growth in the market, single digit -- or mid-single-digit POS growth, strong consumer demand for our product. We actually outpaced the market overall in each of our leader categories, of Dolls, Vehicles, Infant, Toddler, Preschool as well as in Action Figures and Building Sets. So the in-market performance, very good, well ahead of the market. So while POS was up, our gross billings were down 21%, right? And that really is a reflection of the expected correction in retail inventory levels coming into 2023. And that retail inventory correction is expected to have a negative impact on our second quarter results, right? But as we get through the first half, we would say we expect most of that situation to be corrected as we go into the second half. So a bit of a long story. And the key point is that while we're seeing volatility, particularly in our gross billings, the fundamentals of the business remain strong, right? Growth in consumer takeaway, share gains in the first quarter, right? So we're kind of on track and off to an expected start to 2023.

And what -- just kind of delving into that in a little more detail, what is behind your confidence that you see a recovery in the second half? Is it just the easier comparisons? Or is there something else that you're seeing that drives that conviction?

Yes. I think for Mattel, it really starts with our portfolio. It's well balanced by category, genre, target demographic as well as the channel. And we have a number of new incremental toy and entertainment drivers for 2023. And we've talked about these before. The Disney Princess and Frozen franchise is back with Mattel in 2023. That's a significant business. We have the theatrical tie-in with Disney Wish. We have in the fall tying with Universal's Trolls. We have the global rollout of Monster High. And the premiere of the Barbie movie is going to be a catalyst, and we're seeing continued strength in Hot Wheels. So our portfolio is well positioned. We certainly have the capabilities around design and development, supply chain, marketing, distribution reach. We're in more than 500,000 doors globally. And as I said, the first quarter, POS was up mid-single digits. And we definitely certainly outpace the market and gain share. It really is about what we're wrapping and I'll go into a little more detail. As I said, typically gross billings are 1/3 in the first half, 2/3 in the second half. In 2022, we saw a very atypical pattern, 42% of our gross billings in the first half, 58% in the second half. So just wrapping that, right, you get significant declines followed by significant growth in the second half. And again, it doesn't -- it's not dependent on some acceleration on POS. Even if POS was flat, you'd get an acceleration, particularly in Q4, you get double-digit growth just because we're wrapping these atypical shipping patterns in 2022. So again, the underlying in-market performance has been very stable. growing in Q4, growing in Q1, market share gains. And you overlay that with the shipping patterns and the changes in retail inventory levels are what caused all this volatility. Again, it's not an issue with the consumer. It's volatility related to shipping patterns.

Okay. Got it. And I guess 1 of the variables or moving pieces is just the economy, right? Remind us how the toy industry performs during periods of economic weakness and how do you think Mattel is positioned to endure a recession, if that's the path the economy follows?

Yes. Look, I think if you look at the toy industry, it has certainly historically been a growth industry over the last decade. It's a decade. It's delivered consistent growth. And if you think about the fundamentals of the business, they are very strong. Play is a core behavior. It's not going away. Parents are always going to prioritize spending on their children, particularly when it comes to the development of that child, and quality product and known and trusted brands are definitely going to win in that environment. I mean toys are not expensive, right? We're not talking about multi-thousand dollar items here, right? We have a portfolio that ranges from $1 to $300 in terms of the Barbie Dreamhouse. So the portfolio, it's very affordable. The items themselves are not that expensive. The category is a strategic category for retailers. It drives traffic, it drives engagement, both in the stores and online. It's experiential. And for all those reasons, the toy industry has proven to be recession resilient. I wouldn't say recession proof, we're certainly impacted by what's facing the consumer. But definitely, if you look historically at prior recessions, it's not as volatile as the overall economy. So it's -- again, recession resilient holds up very well in times of economic challenges.

And how would you characterize or describe the current health of your consumer? You mentioned the POS trends and the fact that you expect to outpace the industry in 2023 Maybe you can touch on that and what's driving the confidence around the company's ability to gain share this year?

Yes, I think it starts with the fundamental strength of Mattel, and I mentioned some of these a minute ago. Our capabilities around design and development, to me, are second to none. And couple that with our supply chain capabilities, our commercial capabilities around localizing marketing, our distribution reach, both in the number of doors we get to over 500,000 as well as our online presence. We have significant capabilities around digital marketing and e-commerce, which are definitely helping the business. And a great example of our design and development capabilities is coming through with Disney Princess and Frozen. We have redone the entire line. We've introduced it to retailers. It's doing well in the marketplace. Monster High is another great example of our product capabilities. And that's coming to market with a movie as well as an animated series. The movie is live action musical on TV, which has done very well. We started that rollout in the U.S. North America in 2022 and are now rolling out globally in 2023. And again, we have Universal Trolls, Disney Wish, the tie-in with the Little Mermaid movie that recently came out. And of course, we're very excited about the Barbie movie and the impact that will have on the overall Barbie franchise. So again, given our capabilities, given our progress, given the momentum we have, and I did mention -- I should have mentioned Hot Wheels. Hot Wheels has been on a great run. It's on its way to its sixth consecutive record year. So it's got great momentum in the marketplace. And we're also benefiting from some very significant new innovation on Hot Wheels, both on RC and the Fingerboard or Skate product as we call it.

Good. Okay. So you hit on a couple of the revenue and product drivers I wanted to cover. So I'm going to maybe focus on or pivot to the entertainment strategy. It's a key tenet of the company's operations, and I talk about becoming an IP-driven toy company and expanding the entertainment offering. So maybe you can walk us through that part of the strategy, the progress you've made to date and what investors should focus on going forward?

Yes. That's a great question we get often. And I think to start, what I would say is, if you go back to our strategy, our strategy is to grow our IP-driven toy business and expand our entertainment offering. So as we pursued this strategy, we've evolved from being a toy manufacturer making items to an IP-driven company managing franchises, right? And that really is what the strategy is about. And the objective is to capture the full value of our IP in these highly accretive, high-margin verticals. And this includes content, both TV and theatrical. Consumer products, that's a great opportunity for us. And then what we call digital experiences, which includes things like digital gaming, NFTs, connected play. And the Barbie movie is a great example of franchise management. In case you missed it, which would be very hard to do, the trailer dropped last week and the excitement for the July 21 premier just continues to build. And related to the movie, our guidance reflects we're going to get a producer fee, we're going to get a participation in a movie's success because we're the owner of the IP, we licensed to Warner Bros. We have just last week launched a movie-specific toy line, which is, again, a fantastic toy line. There is a range of consumer products. Pink is going to be everywhere on this one. And obviously, we'll have a halo benefit over the entire brand. And this theatrical is going to be an important proof point, right, of our entertainment strategy. I think it will be a great example of how we're managing the whole franchise. It isn't just one vertical. It's all how they all can work together and will certainly set us up for future growth opportunities as we look to do the same thing for many of our other brands. So again, very excited about how this is playing out and very much looking forward to the movie premiere.

Good. Okay. Let me pivot to the something that's near and dear to your heart, the P&L and margins. You're targeting a gross margin of 47% in 2023, which is about 100 basis points better versus last year. Obviously, a lot of moving pieces here. But what are the some of the keys to achieving this number?

Yes, sure. Great question. So our adjusted gross margin, as you said, is expected to be approximately 47% in 2023, up from 45.9% in 2022. And there's a number of puts and takes. On the positive side, we will benefit from pricing. And this is primarily the carryover benefit of actions we took in 2022, right? We -- over the last 2 years, 2021, 2022, we have faced significant levels of cost inflation. So we have adjusted our pricing. We did it in '21. We did it again in 2022 midyear. So that's having a carryover benefit. -- will also benefit from our optimizing for Growth cost program. This is a program we launched in 2021 with a goal to achieve $250 million of savings by 2023. And most of those savings benefiting cost of goods sold. Coming into the year, we increased the target to $300 million, which implies about a $100 million P&L benefit in 2023. And again, a lion's share of that coming through cost of goods sold. So we have a great track record of setting these goals around cost savings and delivering against them. Now going the other way, we have a negative fixed cost absorption impact inside the gross margin related to lower production volumes. So I mentioned retail inventories before. Our own inventories came into 2023 elevated. We also built our levels in 2022 in anticipation of growth and to reduce risk. So we're going to address that in 2023. We think it's really important to get at that. And that will be a significant driver of our free cash flow performance, right? A meaningful reduction in inventory, free cash flow expected to exceed $400 million in 2023. And then cost inflation, which has been a significant headwind over the last 2 years, is expected to be about neutral to gross margin in 2023. So a number of puts and takes. I feel good that we're back on the upward trajectory after a couple of years of very significant cost inflation, I think, over 800 basis points between the 2 years.

And if I include your guidance for '23, the annual average gross margin from Mattel over the last 25 years as well as 47%. So is that a reasonable annual run rate for the business? Or would you aspire to achieve something higher? Is the business capable of supporting a higher gross margin, say, 50%?

Look, we think there's upside to where we are in 2023. We will finish our Optimizing for Growth program, but cost savings will always be part of our DNA, part of our earnings algorithm. The other thing is 2023 has the onetime negative impact, as I mentioned, of fixed cost absorption related to reducing inventory. So that should go away when we get into 2024. And when we get back to growth, right, there will be a scale benefit as well. So I see more potential upsides than downsides certainly when it comes to gross margin and our operating income margin overall.

Good. Okay. I'm going to jump ahead to uses of cash and cash flow. You mentioned that you're forecasting $400 million plus of free cash flow this year. How would you prioritize uses of cash, at least in the near term?

Yes. So our capital allocation priorities have been fairly consistent that really give us flexibility to manage our capital structure to invest for growth and to generate shareholder returns. Our first priority is to invest to drive organic growth. So this is things like investing in capabilities around areas like DTC or e-commerce or digital. It also includes capital investments, particularly in die-cast cars and fashion dolls. These are 2 areas where we have a significant and competitive cost advantage. And any investments we make in that area have a very high return on invested capital. The second priority is to achieve and maintain a leverage ratio of debt to adjusted EBITDA of 2x to 2.5x. And at the end of 2022, right? we were at 2.4x. We finished the year inside that range. We have recently been upgraded by S&P, coupled with the previous upgrade by Moody's, we are now investment grade. And that's a fantastic accomplishment for a company to lose its investment-grade rating and to regain it in a very short period of time. I think it's a testament and a reflection of the significant financial transformation that's occurred at Mattel. Now that we've improved the balance sheet and our financial condition, it opens up the opportunity for additional capital allocation priorities. One would be M&A. And our approach to M&A will be very disciplined, right? Anything we do will be -- we'll advance our strategy will be accretive to growth and will generate attractive financial returns. The other thing, the improved balance sheet enables us to do share repurchases. So share repurchase to us are a very effective and flexible tool to manage our capital structure. And with our improved position and our confidence in our strategy, we actually relaunched our share repurchase program in the first quarter. We bought $34 million of stock. We have about $170 million remaining under our current authorization. And this is the first time we've done share repurchases. I think it's been like 9 years, right? Again, another reflection of the progress that we've made. So those are our priorities for the near term that will guide our capital allocation decisions.

What about a dividend? Mattel used to pay an annual dividend, then moved to a quarterly dividend, and that was eliminated maybe 5 or 6 years ago. Would the Board reconsider reinstating a dividend at some point?

Yes. Look, the way I look at capital allocation, it's a very dynamic process. You continuously evaluate it. It evolves over time. In the near term, we're not contemplating a dividend, right? We're employing the 4 strategies I just articulated. But again, these can change over time. I use the word near term, right, meaning that, hey, the situation might change. And we'll continue to reevaluate those and certainly discuss with our Board.

Okay. We have about 5 minutes left. Are there any questions from the audience we can take? Please?

You started off by talking about [indiscernible]. I'm just trying to understand, when -- how much confidence do you have that the inventory that you're talking about that your end customers or whether POS you actually get numbers. So do you have the right inventory [indiscernible] setting every to the massive fourth quarter so we can both get and demand doesn't change. So I'm just trying to understand how close to that? How do you [indiscernible].

Yes, so this is a process. We work very closely with each of our major retailers. We know what their inventory levels are. We know what their purchasing patterns are, right? And our commercial group works again with each of these retailers to understand what they're trying to do, what we're trying to do, what the consumer programs are, right, in terms of the back half and what the flow of inventory needs to be. Now obviously, you make a number of assumptions around what's the underlying consumer demand or takeaway, right? What's the anticipated replenishments? And so what gives us confidence is the 2023 is really unfolding the way we expected, right? In terms of what happened in the first quarter, we came into the year with retailer inventories elevated. We ended the quarter with retailer inventory slightly below the prior year same point, right? So this is kind of working its way through, right? Again, but it's always going to be based on assumptions around what's the consumer is saying. And so we are seeing a little more volatility in terms of the macroeconomic challenges that the consumer is facing. But when you back up from this and look at the performance of our business in market fourth quarter, first quarter, right, consistent mid-single-digit growth in POS. It really gives us a really good handle on what's happening in inventory. And I did also want to step back and take the opportunity today to reaffirm our 2023 guidance, right? We expect net sales in constant currency to be comparable to last year. That implies POS growth, but we also have that 3- to 4-point headwind on the top line. We talked about gross margin at 47% EBITDA expected to be in the range of $900 million to $950 million and adjusted EPS of $1.10 to $1.20, and free cash flow greater than $400 million. So off to a good start and look forward to delivering against the tide.

So when you started off [indiscernible] growth drivers, one of the things you noted was that you're now an IP-driven company and no longer Can you give us a couple of instances about how this could adjust how you're investing money in operating business [indiscernible]?

Yes. So to date, right, and I mentioned, look, we've got the toy business, and we have the entertainment side, digital, consumer products, location-based entertainment, publishing as a few examples. And for the most part, right, we have taken a capital-light approach on that side. But as we've improved our balance sheet, improved our credit rating, generating significant positive free cash flow, we do have the opportunity to think about that part of the strategy. But to date, it's been capital light, right, working with many different partners, film and theatrical is a great example. 14 films in various stages of development. with different counterparties. And that really has enabled us to diversify. So we think it's the right approach for us at the time. But significant upside opportunity as we move from being just a toy company to an IP company. Again, it just changes the lens. in terms of what opportunities are there beyond toy. And again, Barbie, to me, is a great example of that.

Is there anything in the core part itself away from the entertainment side of as a result of business as being an IP-driven company had a little less by this.

I would say the entertainment is additive. right? It's not -- you do less of something on toy to do more here. I think it really does amplify the whole, right? And we have an extremely strong IP-driven toy business. Our intent is to maximize that opportunity and build the entertainment strategy on top of that.

Okay. I think we've exceeded our time. So thank you, everyone, for joining us, and thank you, Anthony.

Thanks, Andrew.