10-Q 1 d10q.htm FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2004 For The Quarterly Period Ended September 30, 2004
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 


 

Form 10-Q

 


 

x    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2004

 

OR

 

¨    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

 

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 Boulevard, El Segundo, California   90245-5012
(Address of principal executive offices)   (Zip Code)

 

(Registrant’s telephone number, including area code) (310) 252-2000

 

 

(Former name, former address and former fiscal year, if changed since last report)    None

 


 

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  x    No  ¨

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).    Yes  x    No  ¨

 

Number of shares outstanding of registrant’s common stock, $1.00 par value, as of November 5, 2004:

 

414,966,905 shares

 



Table of Contents

Mattel, Inc. and Subsidiaries

 

          Page

Part I.

   Financial Information     

Item 1.

   Financial Statements.     
     Consolidated Balance Sheets    3-4
     Consolidated Statements of Operations    5
     Consolidated Statements of Cash Flows    6
     Notes to Consolidated Financial Information    7-17

Item 2.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations.    18-40

Item 3.

   Quantitative and Qualitative Disclosures About Market Risk.    40-41

Item 4.

   Controls and Procedures.    41

Part II.

   Other Information     

Item 2.

   Unregistered Sales of Equity Securities and Use of Proceeds.    42

Item 6.

   Exhibits.    42

Signatures

   43

 

2


Table of Contents

PART I – FINANCIAL INFORMATION

 

Item 1. Financial Statements.

 

Mattel, Inc. and Subsidiaries

Consolidated Balance Sheets

 

(In thousands)


  

Sept. 30,

2004

(Unaudited)


   

Sept. 30,

2003

(Unaudited)


   

Dec. 31,

2003


 

Assets

                        

Current Assets

                        

Cash and short-term investments

   $ 331,140     $ 401,394     $ 1,152,681  

Accounts receivable, net

     1,220,526       1,258,096       543,888  

Inventories

     666,515       619,738       388,658  

Prepaid expenses and other current assets

     287,407       283,128       309,629  
    


 


 


Total current assets

     2,505,588       2,562,356       2,394,856  
    


 


 


Property, Plant and Equipment

                        

Land

     35,272       33,508       33,611  

Buildings

     261,370       258,537       267,068  

Machinery and equipment

     692,162       668,841       680,367  

Tools, dies and molds

     561,607       504,961       520,292  

Capitalized leases

     23,271       23,271       23,271  

Leasehold improvements

     103,955       94,627       96,448  
    


 


 


       1,677,637       1,583,745       1,621,057  

Less: accumulated depreciation

     (1,080,733 )     (964,397 )     (995,164 )
    


 


 


Property, plant and equipment, net

     596,904       619,348       625,893  
    


 


 


Other Noncurrent Assets

                        

Goodwill

     723,860       710,104       722,249  

Other assets

     686,468       712,232       767,952  
    


 


 


Total Assets

   $ 4,512,820     $ 4,604,040     $ 4,510,950  
    


 


 


 

The accompanying notes are an integral part of these financial statements.

 

3


Table of Contents

Mattel, Inc. and Subsidiaries

Consolidated Balance Sheets (Continued)

 

(In thousands, except share data)


  

Sept. 30,

2004

(Unaudited)


   

Sept. 30,

2003

(Unaudited)


   

Dec. 31,

2003


 

Liabilities and Stockholders’ Equity

                        

Current Liabilities

                        

Short-term borrowings

   $ 89,236     $ 33,727     $ 19,590  

Current portion of long-term debt

     191,013       12,158       52,274  

Accounts payable

     394,828       426,579       289,680  

Accrued liabilities

     665,993       773,292       852,978  

Income taxes payable

     240,872       187,554       253,224  
    


 


 


Total current liabilities

     1,581,942       1,433,310       1,467,746  
    


 


 


Long-Term Liabilities

                        

Long-term debt

     438,361       629,374       589,130  

Other

     244,489       206,929       237,853  
    


 


 


Total long-term liabilities

     682,850       836,303       826,983  
    


 


 


Stockholders’ Equity

                        

Common stock $1.00 par value, 1.0 billion shares authorized; 441.4 million shares, 440.6 million shares and 441.2 million shares issued, respectively

     441,369       440,580       441,212  

Additional paid-in capital

     1,598,460       1,585,722       1,599,278  

Treasury stock at cost; 26.6 million shares, 3.5 million shares and 12.7 million shares, respectively

     (485,091 )     (67,072 )     (244,691 )

Retained earnings

     995,805       664,899       707,429  

Accumulated other comprehensive loss

     (302,515 )     (289,702 )     (287,007 )
    


 


 


Total stockholders’ equity

     2,248,028       2,334,427       2,216,221  
    


 


 


Total Liabilities and Stockholders’ Equity

   $ 4,512,820     $ 4,604,040     $ 4,510,950  
    


 


 


 

The accompanying notes are an integral part of these financial statements.

 

4


Table of Contents

Mattel, Inc. and Subsidiaries

Consolidated Statements of Operations

 

     For the Three Months Ended

    For the Nine Months Ended

 

(Unaudited; in thousands, except per share amounts)


   Sept. 30,
2004


    Sept. 30,
2003


    Sept. 30,
2004


    Sept. 30,
2003


 

Net Sales (see Note 9)

   $ 1,667,461     $ 1,704,674     $ 3,252,407     $ 3,218,951  

Cost of sales (see Note 9)

     870,807       864,605       1,737,728       1,654,552  
    


 


 


 


Gross Profit

     796,654       840,069       1,514,679       1,564,399  

Advertising and promotion expenses

     192,088       196,638       363,927       361,192  

Other selling and administrative expenses

     243,710       263,275       733,971       716,675  

Restructuring and other charges

     —         (7,631 )     —         4,369  
    


 


 


 


Operating Income

     360,856       387,787       416,781       482,163  

Interest expense

     20,847       21,208       52,456       56,847  

Interest (income)

     (5,238 )     (3,083 )     (14,278 )     (14,749 )

Other non-operating (income), net

     (5,872 )     (3,770 )     (17,410 )     (6,840 )
    


 


 


 


Income Before Income Taxes

     351,119       373,432       396,013       446,905  

Provision for income taxes

     95,289       103,401       107,635       123,139  
    


 


 


 


Net Income

   $ 255,830     $ 270,031     $ 288,378     $ 323,766  
    


 


 


 


Income Per Common Share – Basic

                                

Net income

   $ 0.62     $ 0.61     $ 0.69     $ 0.74  
    


 


 


 


Weighted average number of common shares

     414,592       439,315       420,624       439,107  
    


 


 


 


Income Per Common Share – Diluted

                                

Net income

   $ 0.61     $ 0.61     $ 0.68     $ 0.73  
    


 


 


 


Weighted average number of common and common equivalent shares

     417,962       444,004       424,431       444,532  
    


 


 


 


 

The accompanying notes are an integral part of these financial statements.

 

5


Table of Contents

Mattel, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

 

     For the Nine Months Ended

 

(Unaudited; in thousands)


   Sept. 30,
2004


    Sept. 30,
2003


 

Cash Flows From Operating Activities:

                

Net income

   $ 288,378     $ 323,766  

Adjustments to reconcile net income to net cash flows used for operating activities:

                

Gain on sale of investments

     (21,750 )     (6,945 )

Net (gain) loss on sale of other property, plant and equipment

     (532 )     138  

Noncash restructuring and other charges

     —         792  

Depreciation

     131,439       131,967  

Amortization

     4,527       3,768  

Increase (decrease) from changes in assets and liabilities:

                

Accounts receivable

     (671,766 )     (746,757 )

Inventories

     (279,328 )     (267,669 )

Prepaid expenses and other current assets

     20,527       14,849  

Accounts payable, accrued liabilities and income taxes payable

     (86,575 )     (90,076 )

Deferred income taxes

     57,183       60,158  

Deferred compensation and other retirement plans

     3,494       10,926  

Other, net

     5,337       11,011  
    


 


Net cash flows used for operating activities

     (549,066 )     (554,072 )
    


 


Cash Flows From Investing Activities:

                

Purchases of tools, dies and molds

     (68,480 )     (75,358 )

Purchases of other property, plant and equipment

     (40,910 )     (72,096 )

Payment for businesses acquired

     (12,955 )     (4,839 )

Proceeds from sale of investments

     31,695       11,055  

Proceeds from sale of other property, plant and equipment

     6,560       1,558  

Other, net

     —         (599 )
    


 


Net cash flows used for investing activities

     (84,090 )     (140,279 )
    


 


Cash Flows From Financing Activities:

                

Short-term borrowings, net

     69,153       7,656  

Payment of long-term debt

     (11,286 )     (180,000 )

Purchase of treasury stock

     (255,130 )     (45,484 )

Exercise of stock options

     12,625       40,855  

Other, net

     (771 )     (871 )
    


 


Net cash flows used for financing activities

     (185,409 )     (177,844 )
    


 


Effect of Currency Exchange Rate Changes on Cash

     (2,976 )     6,551  
    


 


Decrease in Cash and Short-term Investments

     (821,541 )     (865,644 )

Cash and Short-term Investments at Beginning of Period

     1,152,681       1,267,038  
    


 


Cash and Short-term Investments at End of Period

   $ 331,140     $ 401,394  
    


 


 

The accompanying notes are an integral part of these financial statements.

 

6


Table of Contents

Mattel, Inc. and Subsidiaries

Notes To Consolidated Financial Information

(Unaudited)

 

1. The accompanying unaudited consolidated financial statements and related disclosures have been prepared in accordance with accounting principles generally accepted in the United States of America applicable to interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. In the opinion of management, adjustments consisting of only those of a normal recurring nature, considered necessary for a fair presentation of the financial position and interim results of Mattel, Inc. and its subsidiaries (“Mattel”) as of and for the periods presented have been included. Certain amounts in the financial statements for prior periods have been reclassified to conform to the current period’s presentation. Because Mattel’s business is seasonal, results for interim periods are not necessarily indicative of those that may be expected for a full year.

 

The financial information included herein should be read in conjunction with Mattel’s consolidated financial statements and related notes in its 2003 Annual Report on Form 10-K.

 

2. Accounts receivable are shown net of allowances for doubtful accounts of $29.8 million (September 30, 2004), $25.1 million (September 30, 2003), and $27.5 million (December 31, 2003).

 

3. Inventories include the following:

 

(In thousands)


   Sept. 30, 2004

   Sept. 30, 2003

   Dec. 31, 2003

Raw materials and work in process

   $ 55,303    $ 57,749    $ 40,362

Finished goods

     611,212      561,989      348,296
    

  

  

     $ 666,515    $ 619,738    $ 388,658
    

  

  

 

4. Goodwill and other intangible assets are allocated to Mattel’s reporting units, which are either at the operating segment level or one reporting level below the operating segment. Mattel’s reporting units for purposes of applying the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 142, Goodwill and Other Intangible Assets, are: Mattel Brands US Girls division, Mattel Brands US Boys division, Fisher-Price Brands US, American Girl Brands and International.

 

The change in the carrying amount of goodwill by reporting unit for the nine-months ended September 30, 2004, is shown below. Brand-specific goodwill held by foreign subsidiaries is allocated to the US reporting units selling those brands, thereby causing foreign currency translation impact to the US reporting units.

 

(In thousands)


   Dec. 31,
2003


   Impact of Currency
Exchange Rate
Changes


   Sept. 30,
2004


Mattel Brands US Girls division

   $ 35,141    $ 475    $ 35,616

Mattel Brands US Boys division

     54,222      37      54,259

Fisher-Price Brands US

     216,678      90      216,768

American Girl Brands

     207,571      —        207,571

International

     208,637      1,009      209,646
    

  

  

     $ 722,249    $ 1,611    $ 723,860
    

  

  

 

7


Table of Contents

In the third quarter of 2004, Mattel performed the annual impairment test required by SFAS No. 142 and determined that its goodwill was not impaired as of September 30, 2004.

 

5. Other assets include the following:

 

(In thousands)


   Sept. 30, 2004

   Sept. 30, 2003

   Dec. 31, 2003

Deferred income taxes

   $ 459,500    $ 438,342    $ 509,430

Identifiable intangibles

     23,808      16,291      15,106

Other

     203,160      257,599      243,416
    

  

  

     $ 686,468    $ 712,232    $ 767,952
    

  

  

 

6. Long-term debt consists of the following:

 

(In thousands)


   Sept. 30, 2004

    Sept. 30, 2003

    Dec. 31, 2003

 

6- 1/8% senior notes due July 2005

   $ 150,000     $ 150,000     $ 150,000  

Medium-term notes due 2004 to 2013

     440,000       450,000       450,000  

10.15% mortgage note due Dec. 2005

     39,374       40,290       40,069  

Other

     —         1,242       1,335  
    


 


 


       629,374       641,532       641,404  

Less: current portion

     (191,013 )     (12,158 )     (52,274 )
    


 


 


     $ 438,361     $ 629,374     $ 589,130  
    


 


 


 

In June 2004, Mattel repaid $10.0 million of medium-term notes upon maturity.

 

7. The calculation of comprehensive income, net of tax, is as follows:

 

    

For the Three

Months Ended


   

For the Nine

Months Ended


 

(In thousands)


  

Sept. 30,

2004


   

Sept. 30,

2003


   

Sept. 30,

2004


   

Sept. 30,

2003


 

Net income

   $ 255,830     $ 270,031     $ 288,378     $ 323,766  

Currency translation adjustments

     13,261       3,867       (10,463 )     27,608  

Change in net unrealized gain on securities:

                                

Unrealized holding (losses) gains

     (6,363 )     11,103       (2,885 )     16,645  

Less: reclassification adjustment for realized gains included in net income

     (5,548 )     (4,584 )     (11,539 )     (4,584 )
    


 


 


 


       (11,911 )     6,519       (14,424 )     12,061  
    


 


 


 


Change in net unrealized loss on derivative instruments:

                                

Unrealized holding (losses) gains

     (3,808 )     5,045       (14,723 )     (27,985 )

Less: reclassification adjustment for realized losses included in net income

     9,088       13,992       24,102       39,261  
    


 


 


 


       5,280       19,037       9,379       11,276  
    


 


 


 


     $ 262,460     $ 299,454     $ 272,870     $ 374,711  
    


 


 


 


 

8


Table of Contents

The components of accumulated other comprehensive loss, net of tax, are as follows:

 

(In thousands)


   Sept. 30, 2004

    Sept. 30, 2003

    Dec. 31, 2003

 

Currency translation adjustments

   $ (246,635 )   $ (266,411 )   $ (236,172 )

Minimum pension liability adjustments

     (60,042 )     (52,321 )     (60,042 )

Net unrealized gain on securities

     18,377       40,370       32,801  

Net unrealized loss on derivative instruments

     (14,215 )     (11,340 )     (23,594 )
    


 


 


     $ (302,515 )   $ (289,702 )   $ (287,007 )
    


 


 


 

During the third quarter of 2004, Mattel sold marketable securities for proceeds of $13.7 million. The year-to-date proceeds received in 2004 from sales of marketable securities totaled $28.2 million. Gains on sales of these securities totaling $8.8 million and $18.3 million, net of transaction costs, were recorded in other non-operating (income), net in the consolidated statement of operations for the three- and nine-months ended September 30, 2004, respectively. As of September 30, 2004, Mattel has no marketable securities for which cost exceeds the fair market value of the securities. During the third quarter of 2003, Mattel sold marketable securities for proceeds of $11.1 million. The gain on sale of these securities of $6.9 million, net of transaction costs, was recorded in other non-operating (income), net in the consolidated statement of operations for the three- and nine-months ended September 30, 2003.

 

8. Mattel’s financial position is impacted by currency exchange rate fluctuations on translation of its net investment in foreign subsidiaries. Assets and liabilities of foreign subsidiaries are translated into US dollars at fiscal period-end exchange rates. Income, expense and cash flow items are translated at weighted average exchange rates prevailing during the fiscal period. The resulting currency translation adjustments are recorded as a component of accumulated other comprehensive loss within stockholders’ equity. Mattel’s primary foreign currency translation exposures are on its net investment in entities having functional currencies denominated in the Euro, British pound sterling, Mexican peso and Indonesian rupiah. For the nine-months ended September 30, 2004, currency translation adjustments resulted in a net loss of $10.5 million, with losses from the weakening of the Euro, Indonesian rupiah, and Mexican peso against the US dollar being partially offset by gains from the strengthening of the British pound sterling against the US dollar. For the nine-months ended September 30, 2003, currency translation adjustments resulted in a net gain of $27.6 million, with gains from the strengthening of the Euro, British pound sterling, and Hong Kong dollar against the US dollar being partially offset by losses from the weakening of the Mexican peso against the US dollar.

 

Mattel’s foreign currency transaction exposures include gains and losses realized on unhedged inventory purchases and unhedged receivables and payables balances that are denominated in a currency other than the applicable functional currency. Gains and losses on unhedged inventory purchases and other transactions associated with operating activities are recorded in the components of operating income. Gains and losses on unhedged intercompany loans and advances are recorded as a component of other non-operating (income) expense, net in the period in which the currency exchange rate changes.

 

9


Table of Contents

Transaction gains and losses included in the consolidated statements of operations are as follows:

 

     For the Three Months Ended

    For the Nine Months Ended

 

(In thousands)


  

Sept. 30,

2004


   

Sept. 30,

2003


    Sept. 30,
2004


   

Sept. 30,

2003


 

Transaction (gains) losses included in:

                                

Operating income

   $ (13,114 )   $ (11,359 )   $ (38,120 )   $ (14,538 )

Other non-operating (income), net

     661       10,747       (483 )     9,512  
    


 


 


 


Net transaction (gain) loss

   $ (12,453 )   $ (612 )   $ (38,603 )   $ (5,026 )
    


 


 


 


 

9. During the fourth quarter of 2003, Mattel changed the way certain close out sales are classified in its consolidated statement of operations. Close out sales are sales of certain products that are no longer included in current product lines. These sales were previously classified as a reduction of cost of sales. Commencing October 1, 2003, close out sales are reported as net sales in Mattel’s consolidated statements of operations. This change in classification has no impact on gross profit, operating income, net income or any element of the consolidated balance sheets or consolidated statements of cash flows for any date or period presented. For the three- and nine-months ended September 30, 2003, close out sales classified as a reduction of cost of sales were $12.8 million and $38.1 million, respectively. Mattel does not believe that these amounts are material, and therefore has not revised previously reported net sales and cost of sales amounts for these periods.

 

10. Selling and administrative expenses include research and development expenses of $43.3 million and $126.3 million for the three- and nine-months ended September 30, 2004, respectively, and $42.4 million and $121.9 million for the three- and
nine-months ended September 30, 2003, respectively.

 

11. Basic income per common share is computed by dividing net income by the weighted average number of common shares outstanding during each period.

 

Diluted income per common share is computed by dividing net income by the weighted average number of common shares and other common equivalent shares outstanding during each period. The calculation of common equivalent shares assumes the exercise of dilutive stock options, net of assumed treasury share purchases at average market prices, as applicable. Nonqualified stock options totaling 23.5 million and 26.6 million were excluded from the calculation of diluted earnings per share for the three- and nine-months ended September 30, 2004, respectively, because they were anti-dilutive. Nonqualified stock options totaling 20.7 million and 17.4 million were excluded from the calculation of diluted earnings per share for the three- and
nine-months ended September 30, 2003, respectively, because they were anti-dilutive.

 

12. Mattel and certain of its subsidiaries have qualified and nonqualified retirement plans covering substantially all employees of these companies, which are more fully described in Note 4 to the Consolidated Financial Statements in Mattel’s 2003 Annual Report on Form 10-K.

 

10


Table of Contents

The components of net periodic benefit cost for Mattel’s defined benefit pension plans are as follows:

 

     For the Three Months Ended

    For the Nine Months Ended

 

(In thousands)


   Sept. 30,
2004


    Sept. 30,
2003


    Sept. 30,
2004


    Sept. 30,
2003


 

Service cost

   $ 1,868     $ 1,641     $ 5,556     $ 4,599  

Interest cost

     5,089       4,700       15,503       13,236  

Expected return on plan assets

     (5,292 )     (4,832 )     (16,087 )     (14,385 )

Amortization of:

                                

Unrecognized prior service costs

     (129 )     (56 )     (390 )     (369 )

Unrecognized net loss

     1,958       604       5,809       1,803  
    


 


 


 


     $ 3,494     $ 2,057     $ 10,391     $ 4,884  
    


 


 


 


 

During the three- and nine-months ended September 30, 2004, Mattel made cash contributions totaling approximately
$1.4 million and $1.9 million, respectively, to its defined benefit pension plans. Mattel expects to make cash contributions totaling approximately $2 million to its defined benefit pension plans during 2004. Mattel’s 2004 funding requirements were not materially impacted as a result of applying the provisions of the Pension Funding Equity Act of 2004.

 

The components of net periodic benefit cost for Mattel’s postretirement benefit plans are as follows:

 

     For the Three Months Ended

   For the Nine Months Ended

 

(In thousands)


   Sept. 30,
2004


    Sept. 30,
2003


   Sept. 30,
2004


   Sept. 30,
2003


 

Service cost

   $ (50 )   $ 80    $ 91    $ 98  

Interest cost

     781       946      2,553      2,678  

Amortization of:

                              

Unrecognized prior service costs

     —         157      —        (1 )

Unrecognized net loss

     352       360      1,124      1,008  
    


 

  

  


     $ 1,083     $ 1,543    $ 3,768    $ 3,783  
    


 

  

  


 

The Medicare Prescription Drug Improvement and Modernization Act of 2003 (the “Act”), which was signed into law on December 8, 2003, provides plan sponsors a federal subsidy for certain qualifying prescription drug benefits covered under the sponsor’s postretirement health care plans.

 

On May 19, 2004, the Financial Accounting Standards Board (“FASB”) issued Staff Position 106-2, Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (“FSP 106-2”), which provides guidance as to how employers who sponsor post-65 prescription drug benefits should recognize the impact of the Act. Applying the guidance in FSP 106-2, Mattel, with the assistance of its outside actuaries, determined that the prescription drug benefits provided to certain retirees under one of its postretirement benefit plans are actuarially equivalent to the benefits provided under Medicare Part D, and that Mattel will be eligible to receive a federal subsidy beginning in 2006.

 

On July 1, 2004, Mattel adopted the provisions of FSP 106-2 and has reduced its accumulated benefit obligation by $7.6 million in recognition of the actuarial impact of the subsidy on benefits attributed to prior service.

 

11


Table of Contents

Mattel’s net periodic benefit cost for 2004 will be reduced by $1.0 million in the areas of interest cost ($0.5 million) and amortization of unrecognized net loss ($0.5 million).

 

 

13. Mattel has various stock compensation plans, which are more fully described in Note 7 to the Consolidated Financial Statements in its 2003 Annual Report on Form 10-K. Mattel applies the recognition and measurement principles of Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations in accounting for its stock option plans. Accordingly, no compensation cost has been recognized in the results of operations for nonqualified stock options granted under Mattel’s plans as such options are granted at not less than the quoted market price of Mattel’s common stock on the date of grant.

 

Mattel has adopted the disclosure-only provisions of SFAS No. 148, Accounting for Stock-Based Compensation – Transition and Disclosure, which amended SFAS No. 123, Accounting for Stock-Based Compensation. Had compensation cost for nonqualified stock options been recorded based on their fair value at the date of grant, consistent with the method of accounting prescribed by SFAS No. 123, Mattel’s net income and earnings per share would have been adjusted as follows:

 

    

For the

Three Months Ended


   

For the

Nine Months Ended


 

(In millions, except per share amounts)


   Sept. 30,
2004


    Sept. 30,
2003


    Sept. 30,
2004


    Sept. 30,
2003


 

Net income

                                

As reported

   $ 255.9     $ 270.0     $ 288.4     $ 323.7  

Stock option plans

     (9.6 )     (6.3 )     (24.7 )     (14.0 )
    


 


 


 


Pro forma income

   $ 246.3     $ 263.7     $ 263.7     $ 309.7  
    


 


 


 


Income per share

                                

Basic

                                

As reported

   $ 0.62     $ 0.61     $ 0.69     $ 0.74  

Stock option plans

     (0.02 )     (0.01 )     (0.06 )     (0.03 )
    


 


 


 


Pro forma basic income

   $ 0.60     $ 0.60     $ 0.63     $ 0.71  
    


 


 


 


Diluted

                                

As reported

   $ 0.61     $ 0.61     $ 0.68     $ 0.73  

Stock option plans

     (0.02 )     (0.01 )     (0.06 )     (0.03 )
    


 


 


 


Pro forma diluted income

   $ 0.59     $ 0.60     $ 0.62     $ 0.70  
    


 


 


 


 

The pro forma amounts shown above are not indicative of the pro forma effect in future periods since the estimated fair value of options is amortized to expense over the vesting period, and the number of options granted and the fair value of individual grants varies from period to period.

 

14. On October 22, 2004, the American Jobs Creation Act of 2004 was signed into law. Management is currently evaluating whether to take advantage of the various provisions of the American Jobs Creation Act of 2004, including a provision that creates a temporary tax deduction for corporate profits earned outside the US that are repatriated. Based on the tax laws in effect at September 30, 2004, Mattel’s intention is to continue to

 

12


Table of Contents
     indefinitely invest its undistributed foreign earnings and, accordingly, no deferred tax liability has been recorded in connection with the American Jobs Creation Act of 2004.

 

15. Supplemental disclosure of cash flow information is as follows:

 

    

For the

Nine Months Ended


(In thousands)


   Sept. 30, 2004

    Sept. 30, 2003

Cash paid during the period for:

              

Income taxes

   $ 63,894     $ 67,558

Interest

     48,243       54,755

Noncash investing and financing activities:

              

Liability for businesses acquired

   $ 1,024     $ 2,213

Liability for equipment acquired

     2,369       —  

Asset writedowns

     (4,951 )     —  

 

16. Mattel’s reportable segments are separately managed business units and are divided on a geographic basis between domestic and international. The Domestic segment is further divided into Mattel Brands US, Fisher-Price Brands US and American Girl Brands.

 

Mattel’s portfolio of brands and products are grouped in the following categories:

 

Mattel Brands – including Barbie® fashion dolls and accessories (“Barbie®”), Polly Pocket! and ello (collectively “Other Girls Brands”), Hot Wheels®, Matchbox® and Tyco® R/C vehicles and playsets (collectively “Wheels”) and Nickelodeon®, Harry Potter, Yu-Gi-Oh!, He-Man® and Masters of the Universe®, Batman, Justice League, and games and puzzles (collectively “Entertainment”).

 

Fisher-Price Brands – including Fisher-Price®, Little People®, Rescue Heroes®, See ’N Say®, BabyGear, PowerTouch and View-Master® (collectively “Core Fisher-Price®”), Sesame Street®, Barney, Dora the Explorer, Winnie the Pooh and Disney preschool and plush (collectively “Fisher-Price® Friends”) and Power Wheels®.

 

American Girl Brands – including American Girl Today®, The American Girls Collection® and Bitty Baby®. American Girl Brands products are sold directly to consumers and its children’s publications are also sold to certain retailers.

 

The International segment sells products in all toy categories, except American Girl Brands.

 

The tables below present information about revenues, income and assets by segment. Mattel does not include sales adjustments such as trade discounts and other allowances in the calculation of segment revenues (hereinafter referred to as “gross sales”). Mattel records these adjustments in its financial accounting systems at the time of sale to each customer, but the adjustments are not allocated to individual products. For this reason, Mattel’s chief operating decision maker uses gross sales by segment as one of the metrics to measure segment performance. Such sales adjustments are included in the determination of segment income (loss) from operations based on the adjustments recorded in the financial accounting systems. Segment income (loss) from operations represents operating income, while consolidated income from operations represents income before income taxes as reported in the consolidated statements of operations. The corporate and other category includes costs not allocated to individual segments, including charges related to the financial realignment plan,

 

13


Table of Contents

incentive compensation and corporate headquarters functions managed on a worldwide basis. Segment assets are comprised of accounts receivable and inventories, net of applicable reserves and allowances.

 

     For the Three Months Ended

    For the Nine Months Ended

 

(In thousands)


   Sept. 30, 2004

    Sept. 30, 2003

    Sept. 30, 2004

    Sept. 30, 2003

 

Revenues

                                

Domestic:

                                

Mattel Brands US

   $ 503,874     $ 614,038     $ 991,063     $ 1,135,459  

Fisher-Price Brands US

     480,607       476,418       879,300       857,017  

American Girl Brands

     61,393       56,254       164,662       144,246  
    


 


 


 


Total Domestic

     1,045,874       1,146,710       2,035,025       2,136,722  

International

     759,687       714,603       1,503,452       1,370,308  
    


 


 


 


Gross sales

     1,805,561       1,861,313       3,538,477       3,507,030  

Sales adjustments

     (138,100 )     (156,639 )     (286,070 )     (288,079 )
    


 


 


 


Net sales

   $ 1,667,461     $ 1,704,674     $ 3,252,407     $ 3,218,951  
    


 


 


 


Segment Income (Loss)

                                

Domestic:

                                

Mattel Brands US

   $ 134,220     $ 183,731     $ 207,819     $ 289,886  

Fisher-Price Brands US

     95,334       89,675       99,163       104,620  

American Girl Brands

     2,144       2,326       (764 )     (2,211 )
    


 


 


 


Total Domestic

     231,698       275,732       306,218       392,295  

International

     137,592       146,118       159,852       186,372  
    


 


 


 


       369,290       421,850       466,070       578,667  

Corporate and other expense (a)

     8,434       34,063       49,289       96,504  
    


 


 


 


Operating income

     360,856       387,787       416,781       482,163  

Interest expense

     20,847       21,208       52,456       56,847  

Interest (income)

     (5,238 )     (3,083 )     (14,278 )     (14,749 )

Other non-operating (income), net

     (5,872 )     (3,770 )     (17,410 )     (6,840 )
    


 


 


 


Income before income taxes

   $ 351,119     $ 373,432     $ 396,013     $ 446,905  
    


 


 


 



(a) For the nine-months ended September 30, 2004, corporate and other expense includes $15.2 million of charges related to severance. For the three- and nine-months ended September 30, 2003, corporate and other expense includes $0.3 million and $25.0 million of charges, respectively, related to the financial realignment plan and income of $7.9 million representing an adjustment to a reserve accrued in 1999 associated with the closure of a manufacturing facility in Beaverton, Oregon.

 

(In thousands)


   Sept. 30, 2004

   Sept. 30, 2003

   Dec. 31, 2003

Assets

                    

Domestic:

                    

Mattel Brands US

   $ 478,561    $ 533,048    $ 243,934

Fisher-Price Brands US

     413,563      382,530      149,158

American Girl Brands

     85,791      96,549      64,877
    

  

  

Total Domestic

     977,915      1,012,127      457,969

International

     871,703      797,990      434,286
    

  

  

       1,849,618      1,810,117      892,255

Corporate and other

     37,423      67,717      40,291
    

  

  

Accounts receivable and inventories

   $ 1,887,041    $ 1,877,834    $ 932,546
    

  

  

 

14


Table of Contents

Mattel sells a broad variety of toy products, which are grouped into three major categories: Mattel Brands, Fisher-Price Brands and American Girl Brands. The table below presents worldwide revenues by category:

 

     For the Three Months Ended

    For the Nine Months Ended

 

(In thousands)


   Sept. 30, 2004

    Sept. 30, 2003

    Sept. 30, 2004

    Sept. 30, 2003

 

Worldwide Revenues

                                

Mattel Brands

   $ 1,060,945     $ 1,160,188     $ 2,106,345     $ 2,187,223  

Fisher-Price Brands

     683,072       641,085       1,261,684       1,169,981  

American Girl Brands

     61,393       56,254       164,662       144,246  

Other

     151       3,786       5,786       5,580  
    


 


 


 


Gross sales

     1,805,561       1,861,313       3,538,477       3,507,030  

Sales adjustments

     (138,100 )     (156,639 )     (286,070 )     (288,079 )
    


 


 


 


Net sales

   $ 1,667,461     $ 1,704,674     $ 3,252,407     $ 3,218,951  
    


 


 


 


 

As discussed in Note 9 to the consolidated financial information, effective October 1, 2003, Mattel changed the way certain close out sales are classified in its consolidated statement of operations. Close out sales are sales of certain products that are no longer included in current product lines. These sales were previously classified as a reduction of cost of sales. Commencing October 1, 2003, close out sales are reported as net sales in Mattel’s consolidated statements of operations. This change in classification has no impact on gross profit, operating income, net income, income per common share, or any element of the consolidated balance sheets or consolidated statements of cash flows for any date or period presented. For purposes of comparing gross sales from 2003 to 2004, the following table provides the quantification of close out sales classified as a reduction of cost of sales by segment and worldwide for the three- and nine-months ended September 30, 2003:

 

(In thousands)


   For the Three
Months Ended


   For the Nine
Months Ended


Segment

             

Domestic:

             

Mattel Brands US

   $ 6,202    $ 17,814

Fisher-Price Brands US

     2,015      10,313

American Girl Brands

     —        —  
    

  

Total Domestic

     8,217      28,127

International

     4,530      9,997
    

  

     $ 12,747    $ 38,124
    

  

Worldwide

             

Mattel Brands

   $ 9,636    $ 25,492

Fisher-Price Brands

     3,095      12,556

American Girl Brands

     —        —  

Other

     16      76
    

  

     $ 12,747    $ 38,124
    

  

 

17. In 2003, Mattel completed its financial realignment plan, originally announced during the third quarter of 2000, designed to improve gross profit; selling and administrative expenses; operating income; and cash flows. Since its inception, Mattel recorded a total pre-tax charge of $250.0 million, or approximately $171 million after-tax, of which approximately $123 million represented cash expenditures and $48 million represented noncash writedowns.

 

15


Table of Contents

A summary of the components of the financial realignment plan is as follows:

 

     For the Year Ended

  

Total


(In millions)


   2000

   2001

   2002

   2003

  

Gross profit

   $ 78.6    $ 28.2    $ 10.4    $ 4.1    $ 121.3

Advertising and promotion expenses

     4.8      0.3      —        —        5.1

Other selling and administrative expenses

     13.4      6.0      13.3      8.6      41.3

Restructuring and other charges

     22.9      15.7      24.6      12.7      75.9

Other non-operating expense, net

     5.5      —        —        0.9      6.4
    

  

  

  

  

Pre-tax charges

   $ 125.2    $ 50.2    $ 48.3    $ 26.3    $ 250.0
    

  

  

  

  

Approximate after-tax charges

   $ 84    $ 35    $ 32    $ 20    $ 171
    

  

  

  

  

 

During the three-months ended September 30, 2003, Mattel recorded pre-tax charges of $0.3 million related to the financial realignment plan. The 2003 third quarter charges were related to the consolidation of two manufacturing facilities in Mexico and were included in Restructuring and Other Charges in the consolidated statement of operations. For the nine-months ended September 30, 2003, Mattel recorded total pre-tax charges related to the financial realignment plan of $25.9 million. The
year-to-date charges relate to the actions described above and the consolidation of the US Girls and US Boys-Entertainment segments under the Mattel Brands US segment, termination of a licensing arrangement, restructuring of Corolle, Mattel’s French doll business, and streamlining of back office functions. The year-to-date charges are included in Cost of Sales ($4.1 million), Other Selling and Administrative Expenses ($8.6 million), Restructuring and Other Charges ($12.3 million) and Other Non-Operating (Income), Net ($0.9 million) in the consolidated statement of operations.

 

For the three- and nine-months ended September 30, 2003, Mattel recorded net restructuring (income) charges totaling
$(7.6) million and $4.4 million, respectively, in its consolidated statements of operations, representing $0.3 million and
$25.9 million, respectively, of restructuring charges related to the financial realignment plan that were partially offset by income of $7.9 million, representing an adjustment to a reserve accrued in 1999 associated with the closure of a manufacturing facility in Beaverton, Oregon.

 

Since inception, included in the total pre-tax charges of $250.0 million were total pre-tax restructuring charges of $75.9 million, of which $0.2 million has not yet been paid as of September 30, 2004. The restructuring charges were largely related to the elimination of positions at Mattel’s US-based headquarters locations in El Segundo, Fisher-Price and American Girl, asset writedowns and other costs associated with the closure of Mattel’s manufacturing and distribution facilities in Murray, Kentucky (“North American Strategy”), closure of certain international offices, and consolidation of facilities.

 

18. In March 2004, the FASB published an Exposure Draft, Share-Based Payment, an Amendment of FASB Statements No. 123 and 95. The proposed change in accounting would replace existing requirements under SFAS No. 123 and APB Opinion No. 25. The proposed statement would require public companies to recognize the cost of employee services received in exchange for equity instruments, based on the grant-date fair value of those instruments, with limited exceptions. Mattel is currently determining what impact the proposed statement

 

16


Table of Contents

would have on its results of operations or financial position. In October 2004, the FASB determined that adoption of the proposed statement would be required for interim and annual periods beginning after June 15, 2005.

 

In November 2003 and March 2004, the Emerging Issues Task Force (“EITF”) reached final consensus on EITF Issue No. 03-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments. The EITF requires a company to apply a three-step model to determine whether an impairment of an investment, within the scope of SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, is other-than-temporary. EITF Issue No. 03-1 was to be applied prospectively to all current and future investments, in interim or annual reporting periods beginning after June 15, 2004. However, in October 2004, the FASB issued FSP 03-1-1, which delayed the effective date for the recognition and measurement guidance of EITF Issue No. 03-1 until certain implementation issues are addressed and a final FSP providing implementation guidance is issued. Mattel believes the adoption of EITF Issue No. 03-1 will not have a material impact on its results of operations or financial position.

 

17


Table of Contents

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

The following discussion should be read in conjunction with the consolidated financial information and related notes that appear in Part I of this Quarterly Report. Mattel’s business is seasonal, and, therefore, results of operations are comparable only with corresponding periods.

 

Overview

 

Mattel designs, manufactures and markets a broad variety of toy products worldwide through sales to retailers and wholesalers (i.e., “customers”) and directly to consumers. Mattel’s business is dependent in great part on its ability each year to redesign, restyle and extend existing core products and product lines, to design and develop innovative new products and product lines, and to successfully market those products and product lines. Mattel plans to continue to focus on its portfolio of traditional brands that have historically had worldwide appeal, to create new brands utilizing its knowledge of children’s play patterns and to target customer and consumer preferences around the world.

 

Mattel’s portfolio of brands and products are grouped in the following categories:

 

Mattel Brands – including Barbie® fashion dolls and accessories (“Barbie®”), Polly Pocket! and ello (collectively “Other Girls Brands”), Hot Wheels®, Matchbox® and Tyco® R/C vehicles and playsets (collectively “Wheels”) and Nickelodeon®, Harry Potter, Yu-Gi-Oh!, He-Man® and Masters of the Universe®, Batman, Justice League, and games and puzzles (collectively “Entertainment”).

 

Fisher-Price Brands – including Fisher-Price®, Little People®, Rescue Heroes®, See ’N Say®, BabyGear, PowerTouch and View-Master® (collectively “Core Fisher-Price®”), Sesame Street®, Barney, Dora the Explorer, Winnie the Pooh and Disney preschool and plush (collectively “Fisher-Price® Friends”) and Power Wheels®.

 

American Girl Brands – including American Girl Today®, The American Girls Collection® and Bitty Baby®. American Girl Brands products are sold directly to consumers and its children’s publications are also sold to certain retailers.

 

During the third quarter of 2004, retailers continued to tightly manage their inventory levels and appeared to be reluctant to take inventory risk for the holiday season in response to broad consumer economic uncertainty. Higher gasoline prices and a lackluster employment picture has translated into uninspiring consumer confidence levels. Mattel’s management expects that some or all of these factors may continue and may have an impact on future results of operations.

 

Mattel previously announced plans to increase its focus on revenue growth in 2004. These plans include strategies aimed at strengthening its core brands and expanding its presence in the interactive learning category. Mattel has initiated value enhancement strategies that include more open packaging and additional items in the package to enhance value perception with consumers.

 

Management is focused on rebuilding Mattel’s presence in the fashion doll category. In 2004, Mattel commenced its strategy to re-position the Barbie® brand into content-driven product lines pursuant to a “worlds of” strategy in which stories are told through movies, books, magazines and music. Product lines, including dolls and accessories,

 

18


Table of Contents

complement these stories. The “worlds of” Barbie® products introduced in 2004 are geared to different age segments in an attempt to maintain the brand’s broad appeal among girls and their parents. For instance, for younger girls, there are stories and products with a fantasy theme such as princesses and fairies, while for older girls, the My Scene line includes a full-length DVD accompanied by a product line that complements the targeted theme. During the first half of 2004, approximately one-third of the Barbie® products available at retail were developed using the “worlds of” strategy, which should increase to approximately two-thirds during the 2004 holiday season. The full product line available to customers in 2005 will reflect the new strategy.

 

In the interactive learning category, Mattel intends to capitalize on a sizable opportunity by developing innovative platforms, such as Laugh & Learn for infants, Learn Through Music for toddlers, and InteracTV for preschoolers.

 

Additionally, Mattel intends to continue its emphasis on globalizing its brands. Management believes the reorganization in the first quarter of 2003, which combined the US Girls and US Boys-Entertainment segments under the Mattel Brands US segment, should allow Mattel to help achieve this goal through optimizing the strengths, and leveraging the talents of, personnel managing the brands on a global basis. The International segment continues to benefit from Mattel’s strategic focus on globalizing its brands, including improved product availability and better alignment of worldwide marketing and sales plans. Management intends to continue focusing on maintaining a high level of business performance in the eight geographies that represented approximately 75% of the gross sales of Mattel’s International segment in 2003: United Kingdom, France, Germany, Italy, Spain, Northern Europe, Canada, and Mexico. Management expects that this strategy should enable Mattel to seek opportunities in smaller and less developed markets, while maintaining stability in these larger markets. Mattel’s long-term goal is to generate 50% of its sales in markets outside of the US by continuing to grow its international business at a higher rate than in the US. However, while management believes that Mattel will continue to grow its International segment sales at a higher rate than in the US, primarily due to gains in market share, it will be difficult to maintain the same level of sales growth achieved over the last three years, especially if the value of the US dollar strengthens against the major foreign currencies.

 

19


Table of Contents

Third Quarter

 

Consolidated Results

 

Net sales in the third quarter of 2004 were $1.67 billion, a 2% decrease compared to $1.70 billion in the third quarter of 2003, including a benefit from changes in currency exchange rates of 2 percentage points. Net income for the third quarter of 2004 was $255.9 million, or $0.61 per diluted share, as compared to net income of $270.0 million, or $0.61 per diluted share, in the third quarter of 2003. Profitability in the third quarter of 2004 compared to the prior year was negatively impacted by lower sales volume and a 150 basis point decline in gross profit, as a percentage of net sales, resulting from sales of lower margin products, including the impact of sales mix, value enhancement initiatives, change in classification of close out sales, and ongoing external cost pressures, which was partially offset by a positive benefit from changes in currency exchange rates. Profitability in the third quarter of 2003 was positively impacted by income of $7.9 million representing an adjustment to a reserve accrued in 1999 associated with the closure of a manufacturing facility in Beaverton, Oregon.

 

Shares repurchased during the last twelve months under Mattel’s share repurchase program caused a positive benefit to Mattel’s earnings per share in the third quarter of 2004 by reducing the number of common shares outstanding.

 

The following table provides a summary of Mattel’s consolidated results for the third quarter of 2004 and 2003:

 

     For the Three Months Ended September 30,

 
     2004

    2003

 

(In millions, except percentage information)


   Amount

    % of
Net Sales


    Amount

   

% of

Net Sales


 

Net sales

   $ 1,667.5     100.0 %   $ 1,704.7     100.0 %
    


 

 


 

Gross profit

   $ 796.7     47.8 %   $ 840.1     49.3 %

Advertising and promotion expenses

     192.1     11.5       196.6     11.5  

Other selling and administrative expenses

     243.7     14.7       263.3     15.5  

Restructuring and other charges

     —       —         (7.6 )   (0.4 )
    


 

 


 

Operating income

     360.9     21.6       387.8     22.7  

Interest expense

     20.8     1.2       21.2     1.2  

Interest (income)

     (5.2 )   (0.3 )     (3.0 )   (0.2 )

Other non-operating (income), net

     (5.9 )   (0.4 )     (3.8 )   (0.2 )
    


 

 


 

Income before income taxes

   $ 351.2     21.1 %   $ 373.4     21.9 %
    


 

 


 

 

Worldwide gross sales in the third quarter of 2004 decreased 3%, which included a benefit from changes in currency exchange rates of 2 percentage points. Gross sales in the US decreased 9% from the third quarter of 2003 and accounted for 58% of consolidated gross sales in 2004 compared to 62% in 2003, reflecting continued reduction in inventory of Mattel products held by retailers and continued competitive challenges. In the third quarter of 2004, gross sales in international markets increased 6% compared to 2003, including a 4 percentage point benefit from changes in currency exchange rates.

 

During the fourth quarter of 2003, Mattel changed the way certain close out sales are classified in its consolidated statement of operations. Close out sales are sales of certain products that are no longer included in current product lines. Effective October 1, 2003, close out sales previously classified as a reduction of cost of sales are now classified as net sales in Mattel’s consolidated statements of operations. This change in classification has no impact

 

20


Table of Contents

on gross profit, operating income, net income, income per common share, or any element of the consolidated balance sheets or consolidated statements of cash flows for any date or period presented. For the third quarter of 2003, close out sales, which were classified as a reduction of cost of sales, were $12.8 million, resulting in a 70 basis point benefit to net sales for the third quarter of 2004 when compared to the third quarter of 2003.

 

Worldwide gross sales of Mattel Brands decreased 9% in the third quarter of 2004 to $1.06 billion, including a 2 percentage point benefit from changes in currency exchange rates. Domestic gross sales decreased 18% and international gross sales increased 2%, including a 5 percentage point benefit from changes in currency exchange rates. Worldwide gross sales of Barbie® declined 13% from 2003, including a benefit from changes in currency exchange rates of 3 percentage points. International gross sales of Barbie® were flat, including a benefit of 5 percentage points from changes in currency exchange rates while domestic gross sales of Barbie® declined 26%. Management believes it has made significant progress in its efforts to re-position the Barbie® brand by executing the “worlds of” strategy, improving the product line and enhancing the marketing. While management continues to have confidence in the actions taken to re-position the Barbie® brand, additional time and effort is required to regain the confidence of retailers. The current challenge for management is to drive stronger sell-through of Barbie® product so that retailers will be more favorably inclined to allocate more shelf space and advertising support to Barbie® product. Worldwide gross sales of Other Girls Brands decreased 25% compared to 2003, including a benefit of 3 percentage points from changes in currency exchange rates. The double-digit decline was driven primarily by lower domestic fall shipments of Polly Pocket! this quarter compared to the same period last year. Worldwide gross sales in the Wheels category were down 3%, including a 2 percentage point benefit from changes in currency exchange rates. Strong sales growth of Tyco® R/C worldwide and double-digit growth in international sales of Hot Wheels® were more than offset by declines in domestic sales of Hot Wheels® and Matchbox® worldwide. Worldwide gross sales in the Entertainment category increased 13%, including a 2 percentage point benefit from changes in currency exchange rates, primarily due to increased sales of Yu-Gi-Oh! worldwide and Megaman domestically, and strong sales of games and puzzles, including domestic sales of JuiceBox, Mattel’s new personal media player.

 

Worldwide gross sales of Fisher-Price Brands increased 7% in the third quarter of 2004 to $683.1 million, including a 2 percentage point benefit from changes in currency exchange rates, reflecting strength in worldwide sales of Core Fisher-Price® and Fisher-Price® Friends, partially offset by declines in domestic sales of Power Wheels®. International gross sales increased 23%, including a
6 percentage point benefit from changes in currency exchange rates, while domestic gross sales increased 1%. Worldwide gross sales of Core Fisher-Price® products were up 7%, including a benefit of 2 percentage points from changes in currency exchange rates, reflecting low single-digit growth domestically and double-digit growth internationally, driven by continued success in the Infant and BabyGear product lines.

 

American Girl Brands gross sales increased 9% in the third quarter of 2004 to $61.4 million, reflecting continued strength in The American Girls Collection®, Bitty Baby® and the recently launched Hopscotch Hill School

 

21


Table of Contents

brands. The growth was primarily generated by the opening of the American Girl Place® retail store in New York City in November 2003, partially offset by sales declines in the catalog and Internet channel. Gross profit, as a percentage of net sales, was 47.8% in the third quarter of 2004, compared to 49.3% in the third quarter of 2003. The decline in gross profit, as a percentage of net sales, resulted from sales of lower margin products, including the impact of sales mix, cost of value enhancement initiatives, change in the classification of close out sales, as well as higher external cost pressures. Mattel plans to continue to invest in value enhancement initiatives and expects the external cost pressures to continue. Mattel is actively pursuing cost saving and pricing actions to offset or minimize these increased costs. If the current trend in sales mix continues, gross profit may be negatively impacted.

 

Advertising and promotion expense was $192.1 million, or 11.5% of net sales in the third quarter of 2004, consistent with the third quarter of 2003. Mattel expects advertising spending levels for 2004 to be fairly consistent with 2003 to support its plan to invest in the business to drive long-term performance.

 

Other selling and administrative expenses were $243.7 million, or 14.7% of net sales, in the third quarter of 2004, compared to
$263.3 million, or 15.5% of net sales, in the third quarter of 2003. Other selling and administrative expenses decreased $19.6 million, or 80 basis points, in the third quarter of 2004, primarily due to lower incentive compensation accruals and decreased spending on continuous improvement initiatives, which were partially offset by higher overhead costs associated with the American Girl Place® retail store in New York City that opened in November 2003 and the impact of changes in currency exchange rates on overhead costs in international markets.

 

Non-Operating Items

 

Interest expense decreased from $21.2 million in the third quarter of 2003 to $20.8 million in the third quarter of 2004 reflecting higher average short-term borrowings that were more than offset by the benefit of lower average interest rates. Other non-operating (income), net was $5.9 million in 2004 and was primarily comprised of gains on the sale of marketable securities. In 2003, other non-operating (income), net was $3.8 million, which included a $7.8 million gain from an insurance recovery related to the shareholder lawsuit and a $6.9 million gain from the sale of marketable securities, partially offset by a foreign currency transaction loss of
$10.7 million.

 

As of September 30, 2004, the pre-tax unrealized holding gains on marketable equity securities held by Mattel were $29.2 million ($18.4 million after-tax). Prospectively, management expects to periodically sell additional marketable securities.

 

Business Segment Results

 

Mattel’s reportable segments are separately managed business units and are divided on a geographic basis between domestic and international. The domestic segment is further divided into Mattel Brands US, Fisher-Price Brands US and American Girl Brands.

 

22


Table of Contents

Domestic Segment

 

Mattel Brands US gross sales decreased 18% in the third quarter of 2004 compared to the third quarter of 2003. Within this segment, Barbie® gross sales declined 26% while Other Girls Brands sales declined by double-digits driven by lower fall shipments of Polly Pocket!. The Wheels category experienced a decrease in gross sales in the third quarter of 2004 as a result of declines in sales of Hot Wheels® and Matchbox® brands, partially offset by an increase in sales of Tyco® R/C products. Gross sales in the Entertainment category experienced double-digit growth, largely due to increased sales of Yu-Gi-Oh! and Megaman, and strong sales of games and puzzles, including sales of JuiceBox, Mattel’s new personal media player. Management believes that the overall decrease in the Mattel Brands US segment sales is the result of continued reduction in inventory of Mattel products held by retailers and continued competitive challenges. Mattel Brands US segment income decreased 27% to $134.2 million in the third quarter of 2004, primarily due to lower sales volume and a decline in gross profit caused primarily by sales of lower margin products, including the impact of value enhancement initiatives, and sales mix.

 

Fisher-Price Brands US gross sales increased 1% in the third quarter of 2004 compared to the third quarter of 2003, reflecting an increase in sales of Fisher-Price® Friends and Core Fisher-Price® products, partially offset by a decrease in sales of Power Wheels®. Fisher-Price Brands US segment income increased from $89.7 million in the third quarter of 2003 to $95.3 million in the third quarter of 2004, driven by lower selling and administrative expenses and increased sales volume.

 

American Girl Brands gross sales increased 9% in the third quarter of 2004 compared to 2003, driven primarily by the opening of the American Girl Place® retail store in New York City in November 2003, partially offset by sales declines in the catalog and Internet channel. American Girl Brands segment income decreased slightly from $2.3 million in the third quarter of 2003 to $2.1 million in the third quarter of 2004, caused by higher overhead costs associated with its American Girl Place® retail store in New York City.

 

International Segment

 

The following table provides a summary of percentage changes in gross sales within the International segment for the three-months ended September 30, 2004 versus the three-months ended September 30, 2003:

 

Non-US Regions:


   % Change in
Gross Sales


  

Impact of Change
in Currency

(in % pts)


 

Europe

   7    8  

Latin America

   6    (3 )

Canada

   5    4  

Asia Pacific

   8    4  
    
  

Total International

   6    4  
    
  

 

International gross sales increased 6% in the third quarter of 2004 compared to the third quarter of 2003, including a benefit from changes in currency exchange rates of 4 percentage points. International gross sales of Barbie® were flat, including a benefit of
5 percentage points from changes in currency exchange rates. Strong growth in Hot Wheels® and Tyco® R/C products drove double-digit increases in gross sales in the Wheels category, which was

 

23


Table of Contents

partially offset by a decrease in sales of Matchbox® products. Fisher-Price Brands gross sales increased 23%, including a 6 percentage point benefit from changes in currency exchange rates, reflecting strong sales of Fisher-Price® Friends and Core Fisher-Price® products. International segment income decreased 6% in the third quarter of 2004, largely due to a decrease in gross profit as a result of a sales mix shift to lower margin products, including the higher cost of value enhancement initiatives and pricing adjustments on certain products in Europe to remain competitive given the strength of the Euro versus the US dollar, and external cost pressures.

 

Results of Operations - First Nine Months

 

Consolidated Results

 

Net sales in the first nine months of 2004 were $3.25 billion, a 1% increase compared to $3.22 billion in the first nine months of 2003, including a benefit from changes in currency exchange rates of 2 percentage points. Net income for the first nine months of 2004 was $288.4 million, or $0.68 per diluted share, as compared to net income of $323.7 million, or $0.73 per diluted share, in the first nine months of 2003. A decline in gross profit, as a percentage of net sales, due to sales of lower margin products, including the impact of sales mix, change in classification of close out sales, as well as ongoing external cost pressures were the primary drivers for lower profitability in the first nine months of 2004. Also contributing to the decline in profitability for the first nine months was a
pre-tax charge of $15.2 million, primarily related to the elimination of approximately 285 positions as a result of headcount reductions at certain domestic and international locations, and integration of the Matchbox® and Tyco® R/C business located in New Jersey into its Hot Wheels® business in California to take advantage of synergies in the Wheels business. These increased costs were partially offset by gains on the sale of investments, net favorable legal settlements and a positive benefit from changes in currency exchange rates. For the first nine months of 2003, profitability was negatively impacted by pre-tax charges totaling $25.9 million related to the financial realignment plan. Mattel also recognized pre-tax income of $7.9 million ($5.0 million after-tax) in the first nine months of 2003, representing an adjustment to a reserve accrued in 1999 associated with the closure of a manufacturing facility in Beaverton, Oregon. The combined effect of these items was a net after-tax charge of $13.2 million.

 

Shares repurchased during the last twelve months under Mattel’s share repurchase program caused a positive benefit to Mattel’s earnings per share in the first nine months of 2004 by reducing the number of common shares outstanding.

 

24


Table of Contents

The following table provides a summary of the consolidated results for the first nine months of 2004 and 2003:

 

     For the Nine Months Ended

 
     Sept. 30, 2004

    Sept. 30, 2003

 

(In millions, except percentage information)


   Amounts

   

% of

Net Sales


    Amounts

   

% of

Net Sales


 

Net sales

   $ 3,252.4     100.0 %   $ 3,219.0     100.0 %
    


 

 


 

Gross profit

   $ 1,514.7     46.6 %   $ 1,564.4     48.6 %

Advertising and promotion expenses

     363.9     11.2       361.2     11.2  

Other selling and administrative expenses

     734.0     22.6       716.7     22.3  

Restructuring and other charges

     —       0.0       4.4     0.1  
    


 

 


 

Operating income

     416.8     12.8       482.1     15.0  

Interest expense

     52.4     1.6       56.8     1.8  

Interest (income)

     (14.2 )   (0.5 )     (14.7 )   (0.5 )

Other non-operating (income), net

     (17.4 )   (0.5 )     (6.8 )   (0.2 )
    


 

 


 

Income before income taxes

   $ 396.0     12.2 %   $ 446.8     13.9 %
    


 

 


 

 

Worldwide gross sales for the first nine months of 2004 increased 1% compared to the first nine months of 2003, including a
3 percentage point benefit from changes in currency exchange rates. Gross sales in the US decreased 5% and accounted for 58% of consolidated gross sales in 2004 compared to 61% in 2003. Gross sales for the first nine months of 2004 in international markets increased 10% compared to 2003, including a 6 percentage point benefit from changes in currency exchange rates.

 

During the fourth quarter of 2003, Mattel changed the way certain close out sales are classified in its consolidated statement of operations. Close out sales are sales of certain products that are no longer included in current product lines. Effective October 1, 2003, close out sales previously classified as a reduction of cost of sales are now classified as net sales in Mattel’s consolidated statements of operations. This change in classification has no impact on gross profit, operating income, net income, income per common share, or any element of the consolidated balance sheets or consolidated statements of cash flows for any date or period presented. For the first nine months of 2003, close out sales, which were classified as a reduction of cost of sales, were $38.1 million, resulting in a
1 percentage point benefit to net sales for the first nine months of 2004 when compared to the first nine months of 2003.

 

Worldwide gross sales of Mattel Brands in the first nine months of 2004 decreased 4% to $2.11 billion, including a 3 percentage point benefit from changes in currency exchange rates. Domestic gross sales decreased 13% and international gross sales increased 6%, including a benefit from changes in currency exchange rates of 6 percentage points. Worldwide gross sales of Barbie® decreased 11% from 2003, including a benefit from changes in currency exchange rates of 3 percentage points. Domestic gross sales of Barbie® decreased 21% and international gross sales of Barbie® decreased 2%, including a 6 percentage point benefit from changes in currency exchange rates. Worldwide gross sales in the Wheels category increased 3% compared to 2003, including a 2 percentage point benefit from changes in currency exchange rates. Worldwide gross sales of the Hot Wheels® product line increased compared to 2003, driven by international growth resulting from new product introductions. Worldwide gross sales in the Entertainment category increased by double-digits, mainly attributable to strong sales of Yu-Gi-Oh!, Harry Potter and games and puzzles.

 

25


Table of Contents

Worldwide gross sales of Fisher-Price Brands in the first nine months of 2004 compared to the first nine months of 2003 increased 8% to $1.26 billion, including a benefit of 2 percentage points from changes in currency exchange rates. Domestic gross sales increased 3%, while international sales grew 22%, including a 7 percentage point benefit from changes in currency exchange rates. The increase in the sales over 2003 was driven by higher sales of Fisher-Price® Friends and continued success in Core Fisher-Price®, primarily in the Infant and BabyGear lines.

 

Gross sales of American Girl Brands increased 14% in the first nine months of 2004 over the first nine months of 2003 to
$164.7 million, due primarily to the opening of the American Girl Place® retail store in New York City in November 2003, partially offset by sales declines in the catalog and Internet channel.

 

Gross profit, as a percentage of net sales, was 46.6% in the first nine months of 2004, compared to 48.6% in the first nine months of 2003. The decrease in gross profit, as a percentage of net sales, resulted from sales of lower margin products, including the impact of sales mix, change in classification of close out sales, and ongoing external cost pressures. This decline was partially offset by a benefit from changes in currency exchange rates and savings generated from continuous improvement programs. Mattel plans to continue to invest in value enhancement initiatives and expects the external cost pressures to continue. Mattel is actively pursuing cost saving and pricing actions to offset or minimize these increased costs. In the first nine months of 2003, savings from the financial realignment plan and supply chain initiatives caused a benefit to gross profit, as a percentage of net sales. Cost of sales in the first nine months of 2003 includes a charge of $4.1 million for the financial realignment plan, primarily related to the consolidation of two of Mattel’s manufacturing facilities in Mexico.

 

Advertising and promotion expense was 11.2% of net sales in the first nine months of both 2004 and 2003. Mattel expects advertising spending levels for 2004 to be fairly consistent with 2003 to support its plan to invest in the business to drive long-term performance.

 

Other selling and administrative expenses were $734.0 million, or 22.6% of net sales, in the first nine months of 2004, compared to $716.7 million, or 22.3% of net sales, in the first nine months of 2003. Other selling and administrative expenses increased in the first nine months of 2004, primarily due to the following:

 

  A $15.2 million charge for severance related to the elimination of approximately 285 positions resulting from headcount reductions at certain domestic and international locations and relocation of the Matchbox® and Tyco® R/C Brands from New Jersey to California to take advantage of synergies in the Wheels business;

 

  Higher overhead costs associated with the American Girl Place® retail store in New York City that opened in November 2003;

 

  The negative effect of changes in currency exchange rates on overhead expenses incurred in international markets, primarily Europe; and

 

  Higher external cost pressures.

 

The overall increase in other selling and administrative expenses was partially mitigated by lower incentive compensation accruals, reduced spending on continuous improvement initiatives, and net favorable legal settlements. Other selling and administrative expenses in the first nine months of 2003 includes an $8.6 million financial realignment plan charge, largely related to streamlining back office functions and the termination of a licensing arrangement.

 

26


Table of Contents

Non-Operating Items

 

Interest expense decreased from $56.8 million in the first nine months of 2003 to $52.4 million in the first nine months of 2004. Lower average long-term debt in the first nine months of 2004, as a result of the repayment of $180.0 million in long-term debt during 2003, partially offset by higher average short-term borrowings in the first nine months of 2004, were the primary causes of the decrease. Other non-operating (income), net was $17.4 million in 2004 and was primarily comprised of gains on sales of marketable securities during the first and third quarters of 2004. In 2003, other non-operating (income), net was $6.8 million, which included a $7.8 million gain from an insurance recovery related to the shareholder lawsuit and a $6.9 million gain from the sale of marketable securities, partially offset by foreign currency transaction losses of $9.5 million.

 

Business Segment Results

 

Domestic Segment

 

Mattel Brands US gross sales decreased 13% in the first nine months of 2004 compared to the first nine months of 2003. Within this segment, gross sales of Barbie® declined 21%. Management believes that Mattel Brands US segment sales continue to be negatively impacted by continued reduction in inventory of Mattel products held by retailers and continued competitive challenges. Mattel Brands US segment income decreased 28% to $207.8 million in the first nine months of 2004, primarily due to lower sales volume and a decline in gross profit resulting from increased sales of lower margin products, including the impact of sales mix and value enhancement initiatives, external cost pressures and increased royalty costs.

 

Fisher-Price Brands US gross sales increased 3% in the first nine months of 2004 compared to 2003, reflecting an increase in sales of Fisher-Price® Friends and Core Fisher-Price® products, mainly Infant and BabyGear. Fisher-Price Brands US segment income decreased from $104.6 million in the first nine months of 2003 to $99.2 million in the first nine months of 2004, primarily due to increased sales of lower margin products, including the impact of sales mix, and higher product costs, including transportation and royalty expenses.

 

American Girl Brands gross sales increased 14% in the first nine months of 2004 compared to 2003, primarily as a result of the higher sales volume generated by the opening of the American Girl Place® retail store in New York City in November 2003. American Girl Brands segment loss decreased from $2.2 million in the first nine months of 2003 to $0.8 million in the first nine months of 2004, driven by higher sales volume and improved gross profit, partially offset by higher overhead costs associated with its American Girl Place® retail store in New York City.

 

27


Table of Contents

International Segment

 

The following table provides a summary of percentage changes in gross sales within the International segment for the nine-months ended September 30, 2004 versus the nine-months ended September 30, 2003:

 

Non-US Regions:


   % Change in
Gross Sales


  

Impact of Change
in Currency

(in % pts)


 

Europe

   6    9  

Latin America

   15    (2 )

Canada

   6    5  

Asia Pacific

   29    7  
    
  

Total International

   10    6  
    
  

 

International segment gross sales increased 10% in the first nine months of 2004 compared to the first nine months of 2003, which included a benefit from changes in currency exchange rates of 6 percentage points. Gross sales of Barbie® decreased 2%, including a benefit from changes in currency exchange rates of 6 percentage points. Gross sales in the Wheels category grew by double-digits in the first nine months of 2004 compared to the first nine months of 2003, mainly due to growth in Hot Wheels® products. Gross sales in the Entertainment category also increased by double-digits in the first nine months of 2004 compared to the first nine months of 2003, primarily due to strong sales of Warner Bros. properties, including Batman and Harry Potter, and increased sales of
Yu-Gi-Oh! and games and puzzles. Fisher-Price Brands gross sales increased 22%, including a benefit from changes in currency exchange rates of 7 percentage points, due to strong growth in Core Fisher-Price® products and Fisher-Price® Friends. International segment income decreased 14% in the first nine months of 2004 compared to the first nine months of 2003 as a result of a sales mix shift to lower margin products, including the higher cost of value enhancement initiatives and pricing adjustments on certain products in Europe to remain competitive given the strength of the Euro versus the US dollar, and external cost pressures.

 

Financial Realignment Plan

 

In 2003, Mattel completed its financial realignment plan, originally announced during the third quarter of 2000, designed to improve gross margin; selling and administrative expenses; operating income; and cash flows. Since its inception, Mattel recorded a total
pre-tax charge of $250.0 million, or approximately $171 million after-tax, of which approximately $123 million represented cash expenditures and $48 million represented noncash writedowns.

 

Mattel exceeded the targeted initial cumulative pre-tax cost savings of approximately $200 million, achieving cumulative pre-tax cost savings of approximately $221 million, of which approximately $55 million, $87 million and $79 million were realized in 2001, 2002 and 2003, respectively.

 

28


Table of Contents

A summary of the components of the financial realignment plan is as follows:

 

     For the Year Ended

    

(In millions)


   2000

   2001

   2002

   2003

   Total

Gross profit

   $ 78.6    $ 28.2    $ 10.4    $ 4.1    $ 121.3

Advertising and promotion expenses

     4.8      0.3      —        —        5.1

Other selling and administrative expenses

     13.4      6.0      13.3      8.6      41.3

Restructuring and other charges

     22.9      15.7      24.6      12.7      75.9

Other non-operating expense, net

     5.5      —        —        0.9      6.4
    

  

  

  

  

Pre-tax charges

   $ 125.2    $ 50.2    $ 48.3    $ 26.3    $ 250.0
    

  

  

  

  

Approximate after-tax charges

   $ 84    $ 35    $ 32    $ 20    $ 171
    

  

  

  

  

 

For the three- and nine-months ended September 30, 2003, Mattel recorded net restructuring (income) charges totaling $(7.6) million and $4.4 million, respectively, in its consolidated statements of operations, representing $0.3 million and $25.9 million, respectively, of restructuring charges related to the financial realignment plan that were partially offset by income of $7.9 million, representing an adjustment to a reserve accrued in 1999 associated with the closure of a manufacturing facility in Beaverton, Oregon.

 

For the three- and nine-months ended September 30, 2003, Mattel recorded $0.3 million and $12.3 million, respectively, of pre-tax restructuring charges in connection with the financial realignment plan, primarily related to consolidation of its US Girls and US Boys-Entertainment segments into one segment, renamed Mattel Brands US, the restructuring of its Corolle doll business in France, and the consolidation of two manufacturing facilities in Mexico.

 

Since inception, restructuring charges totaling $75.9 million were recorded as part of the financial realignment plan. These charges were largely related to the elimination of positions at Mattel’s US-based headquarters locations in El Segundo, Fisher-Price and American Girl, implementation of the North American Strategy, closure of certain international offices, and consolidation of facilities.

 

Liquidity and Capital Resources

 

Mattel’s primary sources of liquidity for the first nine months of 2004 were cash on hand at the beginning of the year and short-term borrowings. Cash flows from operations 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 realized 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 an inability to meet its debt covenant requirements, which include maintaining consolidated debt-to-capital and interest coverage ratios, 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.

 

29


Table of Contents

Capital and Investment Framework

 

To guide future capital deployment decisions, with a goal of maximizing shareholder value, Mattel’s board of directors in 2003 established the following capital and investment framework:

 

  To maintain approximately $800 million to $1 billion in year-end cash available to fund a substantial portion of seasonal working capital;

 

  To maintain a year-end debt-to-capital ratio of about 25%;

 

  To invest approximately $180 million to $200 million in capital expenditures annually to maintain and grow the business;

 

  To make strategic acquisitions consistent with Mattel’s vision of providing “the world’s premier toy brands – today and tomorrow”; and

 

  To return excess funds to shareholders through dividends and share repurchases.

 

Over the long-term, assuming cash flows from operating activities remain strong, Mattel plans to use its free cash flows to invest in strategic acquisitions and to return funds to shareholders through cash dividends and, depending on market conditions, share repurchases. However, the ability to implement successfully the capital deployment plan is directly dependent on Mattel’s ability to generate strong cash flows from operating activities. There is no assurance that Mattel will continue to generate strong cash flows from operating activities or achieve its targeted goals from investing activities.

 

Operating Activities

 

Cash flows used for operating activities decreased by $5.0 million to $549.1 million in the first nine months of 2004 compared to $554.1 million in the first nine months of 2003, largely due to lower use of cash for working capital, partially offset by decreased income from operations. The working capital improvement was primarily attributable to the decrease in the amount of incentive compensation payments made in the first quarter of 2004 compared to the first quarter of 2003. Working capital in 2003 increased due to payments made for year end 2002 accruals related to incentive compensation and the shareholder litigation settlement.

 

Investing Activities

 

During the first nine months of 2004, Mattel used cash flows of $84.1 million, primarily to invest in tooling to support existing and new products and its long-term information technology strategy. In 2004, capital expenditures were partially offset by proceeds from the sale of marketable securities. Cash flows used for investing activities improved $56.2 million from 2003 due to spending in 2003 associated with the American Girl Place® retail store in New York City and the expansion of certain North American manufacturing facilities as part of the financial realignment plan, and reduced spending in 2004 on information technology.

 

Financing Activities

 

Cash flows used for financing activities in the first nine months of 2004 increased $7.6 million to $185.4 million, primarily due to the purchase of 14.7 million shares of treasury stock at a cost of $255.1 million and repayment of medium-term notes upon maturity, partially offset by increased short-term borrowings. During the fourth quarter of 2004, Mattel intends to repay $40.0 million in medium-term notes upon maturity.

 

30


Table of Contents

Seasonal Financing

 

Mattel’s financing of seasonal working capital typically grows throughout the first nine months of the year and peaks in the third or fourth quarter, when inventories are at their highest levels in anticipation of expected second-half sales volume and when accounts receivable are at their highest levels due to increased sales volume, consistent with the industry taken as a whole. Mattel expects to finance its seasonal working capital requirements for the next twelve months by using existing and internally generated cash, issuing commercial paper, selling certain trade receivables, and using various short-term bank lines of credit. In the first quarter of 2004, Mattel amended and restated its domestic unsecured committed revolving credit facility. The size of the facility was increased to $1.30 billion, and the expiration date of the facility was extended to March 2007. The other terms and conditions of the amended and restated facility are substantially similar to those contained in the previous facility. Interest is charged at various rates selected by Mattel, ranging from market commercial paper rates to the bank reference rate. The unsecured committed revolving credit facility contains a variety of covenants, including financial covenants that require Mattel to maintain certain consolidated debt-to-capital and interest coverage ratios. Specifically, Mattel is required to meet these financial covenant ratios at the end of each fiscal quarter and fiscal year, using the formulae specified in the credit agreement to calculate the ratios. Mattel was in compliance with such covenants at the end of the third quarter of 2004. As of September 30, 2004, Mattel’s consolidated debt-to-capital ratio, as calculated per the terms of the credit agreement, was 0.29 to 1 (compared to a maximum allowed of 0.60 to 1) and Mattel’s interest coverage ratio was 12.47 to 1 (compared to a minimum allowed of 3.50 to 1). The unsecured committed revolving credit facility is a material agreement and failure to comply with the financial covenant ratios may result in an event of default under the terms of the facility. If Mattel defaulted under the terms of the unsecured committed revolving credit facility, its ability to meet its seasonal financing requirements could be adversely affected.

 

To finance seasonal working capital requirements of certain foreign subsidiaries, Mattel avails itself of individual short-term credit lines with a number of banks. Mattel expects to extend these credit lines through the remainder of 2004.

 

Mattel believes the cash on hand at the beginning of 2004, amounts available under its domestic unsecured committed revolving credit facility, its uncommitted money market facility, and its foreign credit lines will be adequate to meet its seasonal financing requirements in 2004.

 

Mattel sells certain domestic and foreign trade receivables as one of its means for financing its seasonal working capital requirements. Mattel has a $300.0 million domestic receivables sales facility that is a sub-facility of Mattel’s domestic unsecured committed revolving credit facility. The outstanding amount of receivables sold under the domestic receivables facility may not exceed
$300.0 million at any given time, and the amount available to be borrowed under the credit facility is reduced to the extent of any such outstanding receivables sold. Under the domestic receivables facility, certain trade receivables are sold to a group of banks, which currently include, among others, Bank of America, N.A. as administrative agent, Citicorp USA, Inc. and Barclays Bank PLC, as co-syndication agents, and Societe Generale and BNP Paribas, as co-documentation agents. Pursuant to the domestic receivables facility, Mattel Sales Corp. and Fisher-Price, Inc. (which are wholly-owned subsidiaries of Mattel) can

 

31


Table of Contents

sell eligible trade receivables from Wal-Mart and Target to Mattel Factoring, Inc. (“Mattel Factoring”), a Delaware corporation and wholly-owned, consolidated subsidiary of Mattel. Mattel Factoring is a special purpose entity whose activities are limited to purchasing and selling receivables under this facility. Pursuant to the terms of the domestic receivables facility and simultaneous with each receivables purchase, Mattel Factoring sells those receivables to the bank group. Mattel records the transaction, reflecting cash proceeds and sale of accounts receivable on its consolidated balance sheet, at the time of the sale of the receivables to the bank group.

 

Mattel’s subsidiaries, Mattel International Holdings B.V., a Netherlands company, Mattel France S.A.S., a French company, and Mattel GmbH, a German company, have entered into a Euro 150 million European trade receivables facility, pursuant to which Mattel France S.A.S. and Mattel GmbH may sell trade receivables to a bank, Societe Generale Bank Nederland N.V. The receivables sales are accounted for as a sale. As with the domestic receivables facility, each sale of accounts receivable is recorded on Mattel’s consolidated balance sheet at the time of such sale. No Mattel subsidiary is used as a special purpose entity in connection with these transactions. Under the European receivables facility, the outstanding amount of receivables sold may not exceed Euro 60 million from February 1 through July 31 of each year and may not exceed Euro 150 million at all other times. Pursuant to a letter agreement between Societe Generale Bank Nederland N.V. and Mattel International Holdings B.V., Mattel France S.A.S. and Mattel GmbH dated July 12, 2004, and effective June 25, 2004, the commitment termination date for the European receivables facility was extended to June 24, 2005.

 

The outstanding amounts of accounts receivable that have been sold under these facilities and other factoring arrangements, net of collections from customers, have been excluded from Mattel’s consolidated balance sheets and are summarized as follows:

 

(In millions)


   Sept. 30,
2004


   Sept. 30,
2003


   Dec. 31,
2003


Receivables sold pursuant to the:

                    

Domestic receivables facility

   $ 189.3    $ 192.4    $ 279.5

European receivables facility

     138.4      144.3      94.5

Other factoring arrangements

     40.2      44.9      82.0
    

  

  

     $ 367.9    $ 381.6    $ 456.0
    

  

  

 

Financial Position

 

Mattel’s cash and short-term investments decreased $70.3 million to $331.1 million at September 30, 2004, compared to
$401.4 million at September 30, 2003, primarily due to the purchase of treasury stock, payment of dividends and capital expenditures, partially offset by short-term borrowings and sales of investments. Compared to year end 2003, cash and short-term investments decreased $821.5 million, primarily due to cash flows used for operating activities, purchase of treasury stock and capital expenditures. Accounts receivable, net increased $676.6 million to $1.22 billion at September 30, 2004 compared to $543.9 million at year end 2003, primarily due to the seasonality of Mattel’s business. Inventories increased $277.8 million to $666.5 million at September 30, 2004 compared to $388.7 million at year end 2003 caused by the seasonal inventory buildup to support sales in the last three months of the year.

 

32


Table of Contents

Current portion of long-term debt increased $178.8 million to $191.0 million at September 30, 2004 compared to $12.2 million at September 30, 2003, primarily due to reclassification of $150.0 million of 6- 1/8% senior notes maturing in the third quarter of 2005 and $40.0 million of medium-term notes maturing in the fourth quarter of 2004 from long-term debt to current portion of long-term debt, partially offset by the repayment of $10.0 million of medium-term notes in the second quarter of 2004. Compared to year end 2003, current portion of long-term debt increased $138.7 million due to the aforementioned reclassification of $150.0 million of
6- 1/8% senior notes. Accrued liabilities decreased $187.0 million since year end 2003, mainly due to lower receivables collections due to bank related to the European receivables facility and reduced incentive compensation accruals, partially offset by higher advertising accruals. Compared to September 30, 2003, accrued liabilities decreased $107.3 million as a result of lower derivative payables for hedged inventory transactions and accruals for treasury stock purchases, incentive compensation and freight.

 

A summary of Mattel’s capitalization is as follows:

 

(In millions, except percentage information)


   Sept. 30, 2004

    Sept. 30, 2003

    Dec. 31, 2003

 

Medium-term notes

   $ 400.0    14 %   $ 440.0    14 %   $ 400.0    13 %

Senior notes

     —      —         150.0    5       150.0    5  

Other long-term debt obligations

     38.4    1       39.4    1       39.1    1  
    

  

 

  

 

  

Total long-term debt

     438.4    15       629.4    20       589.1    19  

Other long-term liabilities

     244.5    8       206.9    6       237.9    8  

Stockholders’ equity

     2,248.0    77       2,334.4    74       2,216.2    73  
    

  

 

  

 

  

     $ 2,930.9    100 %   $ 3,170.7    100 %   $ 3,043.2    100 %
    

  

 

  

 

  

 

Total long-term debt decreased $191.0 million at September 30, 2004 compared to September 30, 2003, mainly due to the aforementioned reclassification of the $150.0 million of 6- 1/8% senior notes and $40.0 million of medium-term notes maturing in the next twelve months to current portion of long-term debt. Compared to year end 2003, total long-term debt decreased $150.7 million, primarily as a result of the reclassification of the 6- 1/8% senior notes to current portion of long-term debt. Mattel expects to satisfy its future long-term capital needs through the generation of corporate earnings and the issuance of long-term debt instruments.

 

Mattel’s debt-to-capital ratio, including short-term borrowings and current portion of long-term debt, increased from 22.4% at September 30, 2003 to 24.2% at September 30, 2004, largely due to the purchase of treasury stock and an increase in short-term borrowings. Mattel’s objective is to continue to maintain a year-end debt-to-capital ratio of approximately 25%.

 

New Accounting Pronouncements

 

In March 2004, the FASB published an Exposure Draft, Share-Based Payment, an Amendment of FASB Statements No. 123 and 95. The proposed change in accounting would replace existing requirements under SFAS No. 123 and APB Opinion No. 25. The proposed statement would require public companies to recognize the cost of employee services received in exchange for equity instruments, based on the grant-date fair value of those instruments, with limited exceptions. Mattel is currently determining what impact the proposed statement would have on its results of

 

33


Table of Contents

operations or financial position. In October 2004, the FASB determined that adoption of the proposed statement would be required for interim and annual periods beginning after June 15, 2005. In November 2003 and March 2004, the Emerging Issues Task Force (“EITF”) reached final consensus on EITF Issue No. 03-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments. The EITF requires a company to apply a three-step model to determine whether an impairment of an investment, within the scope of SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, is other-than-temporary. EITF Issue No. 03-1 was to be applied prospectively to all current and future investments, in interim or annual reporting periods beginning after June 15, 2004. However, in October 2004, the FASB issued FSP 03-1-1, which delayed the effective date for the recognition and measurement guidance of EITF Issue No. 03-1 until certain implementation issues are addressed and a final FSP providing implementation guidance is issued. Mattel believes the adoption of EITF Issue No. 03-1 will not have a material impact on its results of operations or financial position.

 

Non-GAAP Financial Measure

 

In this Quarterly Report on Form 10-Q, Mattel includes a non-GAAP financial measure, gross sales, which it uses to analyze its continuing operations and to monitor, assess and identify meaningful trends in its operating and financial performance. Net sales, as reported in the consolidated statements of operations, include the impact of sales adjustments, such as trade discounts and other allowances. Gross sales represent sales to customers, excluding the impact of sales adjustments. Consistent with its segment reporting, Mattel presents changes in gross sales as a metric for comparing its aggregate, business unit and geographic results to highlight significant trends in Mattel’s business. Changes in gross sales are discussed because, while Mattel records the detail of such sales adjustments in its financial accounting systems at the time of sale, such sales adjustments are generally not associated with individual products, making net sales less meaningful. A reconciliation of gross sales to the most directly comparable GAAP financial measure, net sales, is as follows:

 

     For the Three Months Ended

    For the Nine Months Ended

 

(In thousands)


   Sept. 30, 2004

    Sept. 30, 2003

    Sept. 30, 2004

    Sept. 30, 2003

 

Revenues

                                

Domestic:

                                

Mattel Brands US

   $ 503,874     $ 614,038     $ 991,063     $ 1,135,459  

Fisher-Price Brands US

     480,607       476,418       879,300       857,017  

American Girl Brands

     61,393       56,254       164,662       144,246  
    


 


 


 


Total Domestic

     1,045,874       1,146,710       2,035,025       2,136,722  

International

     759,687       714,603       1,503,452       1,370,308  
    


 


 


 


Gross sales

     1,805,561       1,861,313       3,538,477       3,507,030  

Sales adjustments

     (138,100 )     (156,639 )     (286,070 )     (288,079 )
    


 


 


 


Net sales

   $ 1,667,461     $ 1,704,674     $ 3,252,407     $ 3,218,951  
    


 


 


 


 

Factors That May Affect Future Results

(Cautionary Statement Under the Private Securities Litigation Reform Act of 1995)

 

Certain written and oral statements made or incorporated by reference from time to time by Mattel or its representatives in this Quarterly Report on Form 10-Q, other filings or reports filed with the Securities and Exchange Commission (“SEC”), press releases, conferences, or otherwise, are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 and may include, but are not limited to, statements

 

34


Table of Contents

about: sales and inventory levels; brand and customer management programs; increased competition; initiatives to promote revenue growth; globalization initiatives; restructuring and financial realignment plans; special charges and other non-recurring charges; initiatives aimed at anticipated cost savings; operating efficiencies, including those associated with supply chain and information technology initiatives; capital and investment framework (including statements about free cash flow, seasonal working capital,
debt-to-capital ratios, capital expenditures, strategic acquisitions, dividends and share repurchases); cost increases; increased advertising and promotion spending; and profitability. Mattel is including this Cautionary Statement to make applicable and take advantage of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 for any such forward-looking statements. Forward-looking statements include any statement that may predict, forecast, indicate, or imply future results, performance, or achievements. Forward-looking statements can be identified by the use of terminology such as “believe,” “anticipate,” “expect,” “estimate,” “may,” “will,” “should,” “project,” “continue,” “plans,” “aims,” “intends,” “likely,” or other similar words or phrases. Except for historical matters, the matters discussed in this Quarterly Report on Form 10-Q and other statements or filings made by Mattel from time-to-time may be forward-looking statements. Management cautions you that forward-looking statements involve risks and uncertainties that may cause actual results to differ materially from the forward-looking statements. In addition to the important factors detailed herein and from time to time in other reports filed by Mattel with the SEC, including Forms 8-K, 10-Q and 10-K, the following important factors could cause actual results to differ materially from past results or those suggested by any forward-looking statements.

 

Competition and New Product Introductions

 

Mattel’s business and operating results depend largely upon the appeal of its toy products. Consumer preferences, particularly among end users of Mattel’s products – children - are continuously changing. The toy industry experiences significant, sudden shifts in demand caused by “hit” toys and trends, which are often unpredictable. In recent years there have been trends towards shorter life cycles for individual toy products, the phenomenon of children outgrowing toys at younger ages and an increasing use of high technology in toys. In addition, Mattel competes with many other companies, both large and small, which means that Mattel’s market position is always at risk. Mattel’s ability to maintain its current market share, and increase its market share or establish market share in new product categories, will depend on Mattel’s ability to satisfy consumer preferences, enhance existing products, develop and introduce new products, and achieve market acceptance of such products. For example, in 2004, Mattel has introduced a new “worlds of” concept for the Barbie® product line. This concept is unproven and may not succeed. 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 results of operations may be adversely affected.

 

Seasonality, Managing Production and Predictability of Orders

 

Mattel’s business is subject to risks associated with the underproduction of popular toys and the overproduction of toys that do not match consumer demand. Sales of toy products at retail are seasonal, with a majority of retail sales occurring during the period of September through December. As a result, Mattel’s annual operating results will depend, in large part, on sales during the relatively brief traditional holiday season. Retailers are attempting to manage their inventories better, requiring Mattel to ship products closer to the time the retailers expect to sell the

 

35


Table of Contents

products to consumers. This in turn results in shorter lead times for production. Management believes that the increase in “last minute” shopping during the holiday season and the popularity of gift cards (which often result in purchases after the holiday season) may negatively impact customer re-orders during the holiday season. Shipping disruptions limiting the availability of ships or containers in Asia during peak demand times may affect Mattel’s ability to deliver its products in time to meet retailer demand. These factors may decrease sales or 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.

 

Uncertain and Adverse General Economic Conditions

 

Current conditions in the domestic and global economies have a certain level of uncertainty. As a result, 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 markets 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, the prevailing economic uncertainties render estimates of future income and expenditures even more difficult than usual to make. Adverse changes may occur as a result of soft global economies, rising oil prices, wavering consumer confidence, or other factors affecting economic conditions generally. Such changes may negatively affect the sales of Mattel’s products, increase exposure to losses from bad debts, or increase costs associated with manufacturing and distributing these products.

 

Customer Concentration and Pricing

 

A small number of customers account for a large share of Mattel’s net sales. For 2003, Mattel’s three largest customers, Wal-Mart, Toys “R” Us and Target, in the aggregate accounted for approximately 47% of net sales, and its ten largest customers in the aggregate accounted for approximately 59% of net sales. 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 significantly reduce purchases for any reason. 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. In 2003, several large customers engaged in price cutting of toy products during the holiday season, which, if it continues, could have a long-term impact on Mattel’s gross profit, profitability and consumers’ perception of the brand equity of Mattel’s products.

 

Competition from Private Label Toys

 

In recent years, consumer goods companies generally, including those in the toy business, 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 that are customers of Mattel sell private-label toys designed, manufactured and branded by the retailers themselves. Such toys may be sold at prices lower than comparable toys sold by Mattel, and may result in lower purchases of Mattel-branded products by such retailers. In some cases,

 

36


Table of Contents

retailers who sell such private label toys are larger than Mattel and may have substantially more resources than Mattel.

 

Rationalization of Mass Market Retail Channel and Bankruptcy of Key Customers

 

Many of Mattel’s key customers are mass market retailers. The mass market retail channel in the US has experienced significant shifts in market share among competitors in recent years, causing some large retailers to experience liquidity problems. In the last three years, four large customers of Mattel filed for bankruptcy. In addition, Mattel’s sales to customers are typically made on credit without collateral. 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, which could increase Mattel’s exposure to losses from bad debts. In addition, if these or other customers were to cease doing business as a result of bankruptcy, it could have a material adverse effect on Mattel’s business, financial condition and results of operations.

 

Adequate Supplies; Cost Increases

 

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 raw materials and components. Although Mattel works closely with suppliers to avoid these types of shortages, there can be no assurances that Mattel will not encounter these problems in the future. A reduction or interruption in supplies or a significant increase in the price of one or more supplies, such as fuel and resin (which is an oil-based product) expenses, could have a material adverse effect on Mattel’s business. Cost increases as a result of shortages of materials or rising wage and service expenses, including expenses related to employee health plans and insurance policies, could increase the cost of Mattel’s products and result in lower sales.

 

Litigation and Disputes

 

Mattel is involved in a number of litigation matters. An unfavorable resolution of pending litigation could have a material adverse effect on Mattel’s financial condition. Litigation may result in substantial costs and expenses and significantly divert the attention of Mattel’s management regardless of the outcome. There can be no assurance that Mattel will be able to achieve a favorable settlement of pending litigation or obtain a favorable resolution of litigation if it is not settled. In addition, current and future litigation, governmental proceedings, labor disputes or environmental matters could lead to increased costs or interruptions of normal business operations of Mattel.

 

Recalls

 

Mattel is subject to regulation by the Consumer Product Safety Commission and similar state and international regulatory authorities, and its products could be subject to involuntary recalls and other actions by such authorities. Concerns about product safety may lead Mattel to voluntarily recall selected products. Mattel has experienced, and in the future may experience, defects or errors in products after their production and sale to customers. Such defects or errors could result in the rejection of Mattel’s products by customers, damage to its reputation, lost sales, diverted development resources and increased customer service and support costs, any of which could harm Mattel’s business. Individuals could sustain injuries from Mattel’s products, and Mattel may be subject to claims or lawsuits resulting from such injuries. There is a risk that these claims or liabilities may exceed, or fall outside the scope of, Mattel’s

 

37


Table of Contents

insurance coverage. Moreover, Mattel may be unable to obtain adequate liability insurance in the future. Recalls,
post-manufacture repairs of Mattel products, absence or cost of insurance and administrative costs associated with recalls could harm Mattel’s reputation, increase costs or reduce sales.

 

Protection of Intellectual Property Rights

 

The value of Mattel’s business depends to a large degree on its ability to protect its intellectual property, including its trademarks, trade names, copyrights, patents and trade secrets in the US and around the world. Any failure by Mattel to protect its proprietary intellectual property and information, including any successful challenge to Mattel’s ownership of its intellectual property or material infringements of such property, could have a material adverse effect on Mattel’s business, financial condition and results of operations.

 

Political Developments, including Trade Relations, and the Threat or Occurrence of War or Terrorist Activities

 

Mattel’s business is worldwide in scope, including operations in 36 countries. 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 US 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 for China could result in a substantial increase in the import duty of toys manufactured in China and imported into the US. In addition, the occurrence of war or hostilities between countries or threat of terrorist activities, and the responses to and results of such activities, could materially impact Mattel, its personnel and facilities, its customers and suppliers, retail and financial markets and general economic conditions.

 

Manufacturing Risk; Severe Acute Respiratory Syndrome (“SARS”) and Other Diseases

 

Mattel owns and operates manufacturing facilities and utilizes third-party manufacturers throughout Asia, primarily in China, Indonesia, Malaysia and Thailand. 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 SARS have been significantly concentrated in Asia, particularly in Hong Kong, and in the Guangdong province of China, where many of Mattel’s plants and contractors 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 manufacturers or their suppliers contract SARS or other communicable diseases, or otherwise are unable to fulfill their responsibilities. Mattel has developed contingency plans designed to help mitigate the impact of disruptions in its manufacturing operations. Mattel’s 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

 

Mattel has significant operations, including its headquarters, near major earthquake faults in Southern California. Southern California has experienced earthquakes, wildfires and other natural disasters in recent years. A catastrophic event 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 business negatively, harming Mattel’s operating results.

 

38


Table of Contents

Changes in Currency Exchange Rates

 

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. Mattel seeks to mitigate the exposure of its results of operations to fluctuations in currency exchange rates by partially or fully hedging such exposure using foreign currency forward exchange and option contracts. Such 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 the government-fixed foreign currency exchange rates, including the Chinese yuan, could have a material adverse effect on Mattel’s business and results of operations.

 

Financing Matters

 

Increases in interest rates, both domestically and internationally, could negatively affect Mattel’s cost of financing both its operations and investments. Any reduction in Mattel’s credit ratings could increase the cost of obtaining financing. Additionally, Mattel’s ability to issue long-term debt and obtain seasonal financing could be adversely affected by factors such as an inability to meet its debt covenant requirements, which include maintaining consolidated debt-to-capital and interest coverage ratios. Mattel’s ability to conduct its operations could be negatively impacted should these or other adverse conditions affect its primary sources of liquidity.

 

Advertising and Promotion

 

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 such programs. If Mattel does not successfully market its products or if media or other advertising or promotional costs increase, these factors could have a material adverse effect on Mattel’s business, financial condition and results of operations.

 

Success of New Initiatives

 

Mattel has announced initiatives to improve the execution of its core business, globalize and extend Mattel’s brands, create new brands, develop people, and improve productivity and simplify processes, including a supply chain initiative, a long-term information technology strategy and new initiatives designed to drive growth in sales. Such initiatives involve complex decision making as well as extensive and intensive execution, and the success of such initiatives is not assured. Failure to successfully implement any of these initiatives could have a material adverse effect on Mattel’s business, financial condition and results of operations.

 

Changes in Laws and Regulations

 

Mattel operates in a highly regulated environment in the US and international markets. US 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. Such regulations may include accounting standards, taxation requirements (including changes in applicable tax rates, new tax laws and revised tax law interpretations), trade restrictions, regulations regarding financial matters, environmental regulations, advertising directed toward children, safety and other administrative and regulatory restrictions. Changes in laws or regulations may lead to increased

 

39


Table of Contents

costs, changes in Mattel’s consolidated effective tax rate, or the interruption of normal business operations that would negatively impact its financial condition and results of operations.

 

Acquisitions, Dispositions and Takeover Defenses

 

Mattel may engage in acquisitions, mergers or dispositions, which may affect the profit, revenues, profit margins, debt-to-capital ratios, 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 that, if identified, it will be able to acquire such targets on acceptable terms. Additionally, there can 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. In addition, Mattel has certain anti-takeover provisions in its by-laws that may make it more difficult for a third party to acquire Mattel without its consent, which may adversely affect Mattel’s stock price.

 

If any of the risks and uncertainties described in the cautionary factors listed above actually occurs, Mattel’s business, financial condition and results of operations could be materially and adversely affected. The factors listed above are not exhaustive. Other sections of this Quarterly Report on Form 10-Q 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 such 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 Quarterly Report on Form 10-Q 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.

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

 

Risk Management

 

Foreign currency exchange rate fluctuations may impact Mattel’s results of operations and cash flows. Inventory purchase transactions denominated in the Euro, British pound sterling, Mexican peso, Hong Kong dollar and Indonesian rupiah are the primary transactions that cause foreign currency transaction exposure for Mattel. Mattel seeks to mitigate its exposure to market risk by monitoring its foreign currency transaction exposure for the year and partially or fully hedging such exposure using foreign currency forward exchange and option contracts. Such contracts are primarily used to hedge Mattel’s purchase and sale of inventory, and other intercompany transactions denominated in foreign currencies. These contracts generally have maturity dates of up to 18 months. For those intercompany receivables and payables that are not hedged, the transaction gains or losses are recorded in the consolidated statement of operations in the period in which the exchange rate changes as part of operating income or other non-operating (income) expense, net based on the nature of the underlying transaction. However, for unhedged intercompany inventory transactions, the transaction gains or losses are recorded in the consolidated statement of

 

40


Table of Contents

operations in the period in which the inventory is sold to customers. In addition, Mattel manages its exposure through the selection of currencies used for international borrowings. Mattel does not trade in financial instruments for speculative purposes. Mattel’s financial position is also impacted by currency exchange rate fluctuations on translation of its net investment in foreign subsidiaries. Assets and liabilities of foreign subsidiaries are translated into US dollars at fiscal period-end exchange rates. Income, expense and cash flow items are translated at weighted average exchange rates prevailing during the fiscal period. The resulting currency translation adjustments are recorded as a component of accumulated other comprehensive loss within stockholders’ equity. Mattel’s primary foreign currency translation exposures are on its net investment in entities having functional currencies denominated in the Euro, British pound sterling, Mexican peso and Indonesian rupiah.

 

Item 4. Controls and Procedures.

 

As of September 30, 2004, Mattel’s disclosure controls and procedures were evaluated. Based on this evaluation, Robert A. Eckert, Mattel’s principal executive officer, and Kevin M. Farr, Mattel’s principal financial officer, concluded that these disclosure controls and procedures were effective as of September 30, 2004, in timely alerting them to material information relating to Mattel required to be included in Mattel’s periodic reports.

 

Mattel continues to implement a conversion to new and upgraded financial and human resources information technology systems that began in the fourth quarter of 2002. Mattel has evaluated the effect on its internal control over financial reporting of this conversion and determined that this conversion has not materially affected, and is not reasonably likely to materially affect, Mattel’s internal control over financial reporting. Mattel has not made any significant changes to its internal control over financial reporting or in other factors that could significantly affect these controls subsequent to September 30, 2004.

 

41


Table of Contents

PART II — OTHER INFORMATION

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

 

During the third quarter of 2004, Mattel did not repurchase any of its common stock.

 

ISSUER PURCHASES OF EQUITY SECURITIES

 

Period


   Total Number of
Shares (or Units)
Purchased


   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


July 1 – July 31

   —      —      —      $ 384,333

Aug. 1 – Aug. 31

   —      —      —      $ 384,333

Sept. 1 – Sept. 30

   —      —      —      $ 384,333
    
  
  
  

Total

   —      —      —      $ 384,333
    
  
  
  

 

In July 2003, Mattel’s board of directors approved a share repurchase program of up to $250.0 million. During 2003, Mattel repurchased 12.7 million shares at a cost of $244.4 million pursuant to this program. In November 2003, the board of directors approved an increase to the share repurchase program of an additional $250.0 million, bringing the total authorized repurchases to $500.0 million. In the first nine months of 2004, Mattel repurchased 14.7 million shares at a cost of $255.1 million pursuant to this program. Mattel’s share repurchase program has no expiration date.

 

Item 6. Exhibits.

 

Exhibits

    
11.0    Computation of Income (Loss) per Common and Common Equivalent Share
12.0    Computation of Ratio of Earnings to Fixed Charges and Ratio of Earnings to Combined Fixed Charges and Preferred Stock Dividends
31.0    Certification of Principal Executive Officer dated November 8, 2004 pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.1    Certification of Principal Financial Officer dated November 8, 2004 pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.0    Certification of Principal Executive Officer and Principal Financial Officer dated November 8, 2004 pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 20021
99.0    Fifth Amendment to Mattel, Inc. October 1, 2001 Restated Personal Investment Plan dated July 31, 2004
99.1    Sixth Amendment to Mattel, Inc. Hourly Employee Personal Investment Plan dated July 31, 2004
99.2    Letter Agreement Regarding Master Agreement for the Transfer of Receivables among Societe Generale Bank Nederland N.V., Mattel International Holdings B.V., Mattel France S.A.S. and Mattel GmbH

1 This exhibit should not be deemed to be “filed” for purposes of Section 18 of the Securities Exchange Act of 1934.

 

42


Table of Contents

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934 as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

       

MATTEL, INC.

       

(Registrant)

Date: As of November 8, 2004

 

By:

 

LOGO


       

Douglas E. Kerner

       

Senior Vice President and

Corporate Controller (Duly authorized officer

and chief accounting officer)

 

43