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Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-Q

 


 

(Mark One)

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended March 31, 2005

 

¨ 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 Blvd.

El Segundo, CA 90245-5012

(Address of principal executive offices)

 

(310) 252-2000

(Registrant’s telephone number)

 

 

(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 April 29, 2005:

 

411,632,802 shares

 



Table of Contents

MATTEL, INC. AND SUBSIDIARIES

 

          Page

PART I.    FINANCIAL INFORMATION
Item 1.    Financial Statements.     
     Consolidated Balance Sheets    3
     Consolidated Statements of Income    4
     Consolidated Statements of Cash Flows    5
     Notes to Consolidated Financial Information    6-17
Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations.    18-34
Item 3.    Quantitative and Qualitative Disclosures About Market Risk.    34
Item 4.    Controls and Procedures.    35
PART II.    OTHER INFORMATION
Item 1.    Legal Proceedings.    36-37
Item 2.    Unregistered Sales of Equity Securities and Use of Proceeds.    37-38
Item 5.    Other Information.    38
Item 6.    Exhibits.    38
     Signatures    39

 

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Table of Contents

PART I – FINANCIAL INFORMATION

 

Item 1. Financial Statements.

 

MATTEL, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

 

(In thousands, except share data)


  

March 31,

2005

(Unaudited)


   

March 31,

2004

(Unaudited)


   

Dec. 31,

2004


 

ASSETS

                        

Current Assets

                        

Cash and equivalents

   $ 778,703     $ 787,967     $ 1,156,835  

Accounts receivable, net

     571,295       546,929       759,033  

Inventories

     472,579       402,555       418,633  

Prepaid expenses and other current assets

     246,923       255,646       302,649  
    


 


 


Total current assets

     2,069,500       1,993,097       2,637,150  
    


 


 


Property, plant and equipment, net

     562,507       615,094       586,526  

Goodwill

     731,816       726,594       735,680  

Other noncurrent assets

     790,407       770,469       797,136  
    


 


 


Total Assets

   $ 4,154,230     $ 4,105,254     $ 4,756,492  
    


 


 


LIABILITIES AND STOCKHOLDERS’ EQUITY

                        

Current Liabilities

                        

Short-term borrowings

   $ 19,899     $ 69,694     $ 28,995  

Current portion of long-term debt

     188,880       50,963       189,130  

Accounts payable

     231,653       208,560       349,159  

Accrued liabilities

     437,501       517,369       880,038  

Income taxes payable

     235,955       223,325       279,849  
    


 


 


Total current liabilities

     1,113,888       1,069,911       1,727,171  
    


 


 


Long-Term Liabilities

                        

Long-term debt

     400,000       588,880       400,000  

Other

     239,414       238,136       243,509  
    


 


 


Total long-term liabilities

     639,414       827,016       643,509  
    


 


 


Stockholders’ Equity

                        

Common stock $1.00 par value, 1.0 billion shares authorized;
441.4 million shares issued

     441,369       441,369       441,369  

Additional paid-in capital

     1,591,010       1,601,068       1,594,332  

Treasury stock at cost; 24.5 million shares, 13.1 million shares and
26.0 million shares, respectively

     (446,117 )     (251,981 )     (473,349 )

Retained earnings

     1,099,795       716,420       1,093,288  

Accumulated other comprehensive loss

     (285,129 )     (298,549 )     (269,828 )
    


 


 


Total stockholders’ equity

     2,400,928       2,208,327       2,385,812  
    


 


 


Total Liabilities and Stockholders’ Equity

   $ 4,154,230     $ 4,105,254     $ 4,756,492  
    


 


 


 

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

 

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Table of Contents

MATTEL, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

 

     For the Three Months Ended

 

(Unaudited; in thousands, except per share amounts)


  

March 31,

2005


   

March 31,

2004


 

Net Sales

   $ 783,120     $ 780,944  

Cost of sales

     439,060       429,267  
    


 


Gross Profit

     344,060       351,677  

Advertising and promotion expenses

     87,709       87,418  

Other selling and administrative expenses

     250,822       251,549  
    


 


Operating Income

     5,529       12,710  

Interest expense

     17,547       15,221  

Interest (income)

     (12,085 )     (4,896 )

Other non-operating (income), net

     (8,881 )     (10,019 )
    


 


Income Before Income Taxes

     8,948       12,404  

Provision for income taxes

     2,441       3,411  
    


 


Net Income

   $ 6,507     $ 8,993  
    


 


Net Income Per Common Share – Basic

   $ 0.02     $ 0.02  
    


 


Weighted average number of common shares

     416,096       428,169  
    


 


Net Income Per Common Share – Diluted

   $ 0.02     $ 0.02  
    


 


Weighted average number of common and common equivalent shares

     421,105       432,239  
    


 


 

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

 

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MATTEL, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

     For the Three Months Ended

 

(Unaudited; in thousands)


  

March 31,

2005


   

March 31,

2004


 

Cash Flows From Operating Activities:

                

Net income

   $ 6,507     $ 8,993  

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

                

Gain on sale of investments

     (11,445 )     (10,263 )

Net gain on sale of other property, plant and equipment

     (160 )     (874 )

Depreciation

     42,840       44,457  

Amortization

     1,315       1,932  

Deferred income taxes

     (8,229 )     1,294  

Increase (decrease) from changes in assets and liabilities:

                

Accounts receivable

     180,106       (1,434 )

Inventories

     (59,871 )     (24,914 )

Prepaid expenses and other current assets

     48,846       53,382  

Accounts payable, accrued liabilities and income taxes payable

     (573,662 )     (439,736 )

Deferred compensation and other retirement plans

     (3,543 )     (1,228 )

Other, net

     2,363       (4,821 )
    


 


Net cash flows used for operating activities

     (374,933 )     (373,212 )
    


 


Cash Flows From Investing Activities:

                

Purchases of tools, dies and molds

     (15,226 )     (20,598 )

Purchases of other property, plant and equipment

     (9,371 )     (14,913 )

Payment for businesses acquired

     (995 )     (9,692 )

Proceeds from sale of investments

     18,157       12,730  

Proceeds from sale of other property, plant and equipment

     931       1,189  
    


 


Net cash flows used for investing activities

     (6,504 )     (31,284 )
    


 


Cash Flows From Financing Activities:

                

Short-term borrowings, net

     (9,135 )     49,314  

Purchase of treasury stock

     —         (9,273 )

Proceeds from exercise of stock options

     23,899       3,403  

Other, net

     (2,337 )     (1,602 )
    


 


Net cash flows from financing activities

     12,427       41,842  
    


 


Effect of Currency Exchange Rate Changes on Cash

     (9,122 )     (2,060 )
    


 


Decrease in Cash and Equivalents

     (378,132 )     (364,714 )

Cash and Equivalents at Beginning of Period

     1,156,835       1,152,681  
    


 


Cash and Equivalents at End of Period

   $ 778,703     $ 787,967  
    


 


Supplemental Cash Flow Information:

                

Cash paid during the period for:

                

Income taxes

   $ 50,467     $ 34,138  

Interest

     16,019       13,320  

Non-cash investing and financing activities:

                

Liability for equipment acquired

   $ 443     $ —    

Asset writedowns

     378       —    

Liability for acquisitions

     —         1,024  

 

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

 

5


Table of Contents

MATTEL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL INFORMATION

(Unaudited)

 

1. Basis of Presentation

 

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, all 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. 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 2004 Annual Report on Form 10-K.

 

2. Accounts Receivable

 

Accounts receivable are shown net of allowances for doubtful accounts of $30.9 million (March 31, 2005), $28.1 million (March 31, 2004), and $32.8 million (December 31, 2004).

 

3. Inventories

 

Inventories include the following:

 

(In thousands)


   March 31, 2005

     March 31, 2004

     Dec. 31, 2004

Raw materials and work in process

   $ 48,559      $ 44,189      $ 35,546

Finished goods

     424,020        358,366        383,087
    

    

    

     $ 472,579      $ 402,555      $ 418,633
    

    

    

 

4. Property, Plant and Equipment

 

Property, plant and equipment, net include the following:

 

(In thousands)


     March 31, 2005

     March 31, 2004

     Dec. 31, 2004

 

Land

     $ 29,168      $ 35,489      $ 29,282  

Buildings

       252,090        261,912        252,627  

Machinery and equipment

       708,041        686,119        710,122  

Tools, dies and molds

       586,650        527,945        585,181  

Capitalized leases

       23,271        23,271        23,271  

Leasehold improvements

       106,482        102,667        106,113  
      


  


  


         1,705,702        1,637,403        1,706,596  

Less: accumulated depreciation

       (1,143,195 )      (1,022,309 )      (1,120,070 )
      


  


  


       $ 562,507      $ 615,094      $ 586,526  
      


  


  


 

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5. Goodwill

 

Goodwill is allocated to various 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 three-months ended March 31, 2005, 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, 2004

    

Impact of

Currency

Exchange Rate

Changes


     March 31, 2005

Mattel Brands US Girls division

     $ 37,566      $ (527 )    $ 37,039

Mattel Brands US Boys division

       54,411        (41 )      54,370

Fisher-Price Brands US

       217,152        (105 )      217,047

American Girl Brands

       207,571        —          207,571

International

       218,980        (3,191 )      215,789
      

    


  

       $ 735,680      $ (3,864 )    $ 731,816
      

    


  

 

6. Other Noncurrent Assets

 

Other noncurrent assets include the following:

 

(In thousands)


     March 31, 2005

     March 31, 2004

     Dec. 31, 2004

Deferred income taxes

     $ 585,520      $ 511,322      $ 572,374

Identifiable intangibles, net

       22,153        25,277        22,926

Other

       182,734        233,870        201,836
      

    

    

       $ 790,407      $ 770,469      $ 797,136
      

    

    

 

7. Long-term Debt

 

Long-term debt consists of the following:

 

(In thousands)


     March 31, 2005

     March 31, 2004

     Dec. 31, 2004

 

6 1/8% senior notes due July 2005

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

Medium-term notes due 2006 to 2013

       400,000        450,000        400,000  

10.15% mortgage note due Dec. 2005

       38,880        39,843        39,130  
      


  


  


         588,880        639,843        589,130  

Less: current portion

       (188,880 )      (50,963 )      (189,130 )
      


  


  


       $ 400,000      $ 588,880      $ 400,000  
      


  


  


 

In 2004, Mattel repaid $50.0 million of medium-term notes upon maturity.

 

7


Table of Contents
8. Comprehensive Income

 

The changes in the components of comprehensive income (loss), net of tax, are as follows:

 

     For the Three Months Ended

 

(In thousands)


  

March 31,

2005


    

March 31,

2004


 

Net income

   $ 6,507      $ 8,993  

Currency translation adjustments

     (20,028 )      (2,453 )

Net unrealized gain on securities:

                 

Unrealized holding (losses) gains

     (2,070 )      447  

Less: reclassification adjustment for realized (gains) included in net income

     (5,745 )      (5,991 )
    


  


       (7,815 )      (5,544 )
    


  


Net unrealized gain (loss) on derivative instruments:

                 

Unrealized holding gains (losses)

     16,504        (9,866 )

Less: reclassification adjustment for realized losses included in net income

     3,962        6,321  
    


  


       12,542        (3,545 )
    


  


     $ (8,794 )    $ (2,549 )
    


  


 

The components of accumulated other comprehensive loss are as follows:

 

(In thousands)


   March 31, 2005

     March 31, 2004

     Dec. 31, 2004

 

Currency translation adjustments

   $ (219,820 )    $ (238,625 )    $ (199,792 )

Minimum pension liability adjustments

     (61,472 )      (60,042 )      (61,472 )

Net unrealized gain on securities

     8,627        27,257        16,442  

Net unrealized (loss) on derivative instruments

     (12,464 )      (27,139 )      (25,006 )
    


  


  


     $ (285,129 )    $ (298,549 )    $ (269,828 )
    


  


  


 

Currency Translation Adjustments

 

Mattel’s reporting currency is the US dollar. The translation of its net investment in subsidiaries with non-US dollar functional currencies subjects Mattel to currency exchange rate fluctuations in its results of operations and financial position. Assets and liabilities of subsidiaries with non-US dollar functional currencies 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 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 three-months ended March 31, 2005, currency translation adjustments resulted in a net loss of $20.0 million, with losses from the weakening of the Euro, British pound sterling, Venezuelan bolivar, and Chilean peso against the US dollar. For the three-months ended March 31, 2004, currency translation adjustments resulted in a net loss of $2.5 million, with losses from the weakening of the Euro against the US dollar being partially offset by strengthening of the British pound sterling against the US dollar.

 

Marketable Securities

 

As of March 31, 2005, Mattel had no marketable securities for which cost exceeded the fair market value of the securities. Unrealized pre-tax gains of $13.7 million ($8.6 million net of tax), $43.3 million ($27.3 million net of tax) and $26.1 million ($16.4 million net of tax) as of March 31, 2005 and 2004 and December 31, 2004, respectively, have been deferred in accumulated other comprehensive loss related to these securities.

 

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During the first quarters of 2005 and 2004, Mattel sold marketable securities for proceeds totaling $15.6 million and $14.5 million, respectively. Gains on sales of these securities totaling $9.1 million and $9.5 million, net of transaction costs, were recorded in other non-operating (income), net in the consolidated statements of income for the three-months ended March 31, 2005 and 2004, respectively.

 

9. Income Taxes

 

On October 22, 2004, the American Jobs Creation Act (the “Jobs Act”) was signed into law. Among its various provisions, the Jobs Act creates a temporary incentive for US corporations to repatriate accumulated income earned abroad by providing an 85% dividends received deduction for certain qualifying dividends. On December 21, 2004, the Financial Accounting Standards Board (“FASB”) issued Staff Position 109-2 (“FSP 109-2”), Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004. FSP 109-2 allows companies additional time beyond the financial reporting period in which the Jobs Act was enacted to evaluate the effect of the Jobs Act on a company’s plan for reinvestment or repatriation of unremitted foreign earnings for the purposes of applying SFAS No. 109, Accounting For Income Taxes. As of March 31, 2005, management had not completed its assessment of whether, or to what extent, Mattel may repatriate foreign earnings under the Jobs Act. Therefore, the statement of income for the three-months ended March 31, 2005, does not include any provision for income taxes on the cumulative balance of its unremitted foreign earnings.

 

Management’s plan for reinvestment and repatriation of foreign earnings under the Jobs Act was completed and approved by Robert A. Eckert, Mattel’s chief executive officer, on April 14, 2005. Mattel expects to repatriate up to approximately $2.4 billion in foreign earnings, and the corresponding tax liability is estimated to be approximately $180 million as calculated under existing law. The statement of income for the three-months ending June 30, 2005, will include a provision for income taxes on the total amount of earnings expected to be repatriated, which will occur throughout 2005. The computation of the estimated tax liability does not include the potential favorable effects of the Tax Technical Corrections Act of 2004 (the “Technical Corrections Bill”), which was introduced to the US Congress on November 22, 2004. If enacted in its current form, the Technical Corrections Bill would reduce Mattel’s computation of the estimated tax liability associated with the repatriation of foreign earnings under the Jobs Act. In addition, the estimated tax liability may be further impacted by any additional law change in the form of further guidance from the US Internal Revenue Service (“IRS”). Mattel would reflect the impact of the Technical Corrections Bill and any additional IRS guidance in the financial reporting period in which any such change in law is enacted or effective.

 

10. Foreign Currency Transaction Gains and Losses

 

Currency exchange rate fluctuations may impact Mattel’s results of operations and cash flows. Mattel’s currency transaction exposures include gains and losses realized on unhedged inventory purchases and unhedged receivable and payable balances that are denominated in a currency other than the applicable functional

 

9


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currency. Gains and losses on unhedged inventory purchases and other transactions associated with operating activities are recorded in the components of operating income in the consolidated statement of income. Gains and losses on unhedged intercompany loans and advances are recorded as a component of other non-operating (income), net in the consolidated statement of income in the period in which the currency exchange rate changes. 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.

 

Currency transaction (gains)/losses included in the consolidated statements of income are as follows:

 

     For the Three Months Ended

 

(In thousands)


  

March 31,

2005


    

March 31,

2004


 

Operating income

   $ (5,819 )    $ (12,658 )

Other non-operating (income), net

     1,485        (1 )
    


  


Net transaction (gains)

   $ (4,334 )    $ (12,659 )
    


  


 

11. Other Selling and Administrative Expenses

 

Other selling and administrative expenses include the following:

 

     For the Three Months Ended

(In thousands)


  

March 31,

2005


    

March 31,

2004


Research and development

   $ 41,204      $ 39,873

Identifiable intangible amortization

     577        476

 

12. Earnings Per Share

 

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

 

Diluted net income per common share is computed by dividing reported 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 repurchases at average market prices, as applicable. Nonqualified stock options totaling 9.4 million and 25.2 million were excluded from the calculation of diluted net income per common share for the first quarter of 2005 and 2004, respectively, because they were anti-dilutive.

 

13. Employee Benefit Plans

 

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 2004 Annual Report on Form 10-K.

 

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A summary of the components of Mattel’s net periodic benefit cost for the quarters ended March 31 is as follows:

 

    

Defined Benefit Pension

Plans


    Postretirement Benefit Plans

(In thousands)


   2005

    2004

    2005

   2004

Service cost

   $ 2,331     $ 1,889     $ 32    $ 71

Interest cost

     5,417       5,443       803      886

Expected return on plan assets

     (5,668 )     (5,459 )     —        —  

Amortization of:

                             

Prior service cost

     (149 )     (132 )     —        —  

Net actuarial loss

     2,339       1,965       384      386
    


 


 

  

     $ 4,270     $ 3,706     $ 1,219    $ 1,343
    


 


 

  

 

During the first quarter of 2005, Mattel made cash contributions totaling approximately $5 million to its defined benefit pension and postretirement benefit plans. Mattel expects to make cash contributions totaling approximately $15 million to its defined benefit pension and postretirement benefit plans for the year ending December 31, 2005, including $12 million to cover benefit payments of its unfunded plans.

 

The Medicare Prescription Drug Improvement and Modernization Act of 2003 (the “Medicare Act”) was signed into law on December 8, 2003. On May 19, 2004, the FASB issued Staff Position 106-2 (“FSP 106-2”), Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003, which provides guidance as to how employers who sponsor post-65 prescription drug benefits should recognize the impact of the Medicare 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 reduced its accumulated postretirement benefit obligation by $7.6 million in recognition of the actuarial impact of the subsidy on benefits attributed to prior service. Mattel’s net periodic benefit cost for fiscal year 2004 was reduced by $1.0 million in the areas of interest cost ($0.5 million) and amortization of net actuarial loss ($0.5 million). On January 21, 2005, the Centers for Medicare and Medicaid Services released final regulations implementing the Medicare Act. Mattel is currently reviewing the final regulations and does not believe that they will have a material impact on its results of operations or financial position for the year ending December 31, 2005.

 

14. Stock-Based Compensation

 

Mattel has various stock compensation plans, which are more fully described in Note 7 to the Consolidated Financial Statements in its 2004 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 compensation 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.

 

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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 determined 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 net income per common share would have been adjusted as follows:

 

     For the Three Months Ended

 

(In millions, except per share amounts)


   March 31,
2005


     March 31,
2004


 
Net income                  

As reported

   $ 6.5      $ 9.0  

Pro forma compensation cost, net of tax

     (6.7 )      (6.5 )
    


  


Pro forma net income (loss)

   $ (0.2 )    $ 2.5  
    


  


Income per share                  

Basic

                 

As reported

   $ 0.02      $ 0.02  

Pro forma compensation cost, net of tax

     (0.02 )      (0.01 )
    


  


Pro forma net income (loss) per common share – basic

   $ —        $ 0.01  
    


  


Diluted

                 

As reported

   $ 0.02      $ 0.02  

Pro forma compensation cost, net of tax

     (0.02 )      (0.01 )
    


  


Pro forma net income (loss) per common share- diluted

   $ —        $ 0.01  
    


  


 

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

 

15. Contingencies

 

Litigation Related to The Learning Company, Inc. (“Learning Company”)

 

Following Mattel’s announcement in October 1999 of the expected results of its Learning Company division for the third quarter of 1999, various Mattel stockholders filed purported class action complaints naming Mattel and certain of its present and former officers and directors as defendants.

 

These shareholder complaints were consolidated into two lead cases, one under §10(b) of the Securities Exchange Act of 1934 (the “Exchange Act”), and the other under §14(a) of the Exchange Act. In November 2002, the United States District Court for the Central District of California permitted the actions to proceed as class actions.

 

Several stockholders filed related derivative complaints purportedly on behalf of Mattel. Some of the derivative suits were consolidated into one lawsuit in Los Angeles County Superior Court in California, which was dismissed for the plaintiff’s failure to make pre-suit demand on the board of directors. An appeal from that

 

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decision was dismissed in July 2003 by stipulation of the parties. Another derivative suit was filed in the Delaware Court of Chancery, and was dismissed without prejudice in August 2002 in deference to the then-ongoing California derivative case. A third derivative suit, filed in federal court in the Central District of California, was dismissed in July 2002, and re-filed in November 2002 as part of the settlement described below.

 

In November 2002, the parties to the federal cases negotiated and thereafter memorialized in a final settlement agreement a settlement of all the federal lawsuits in exchange for payment of $122.0 million and Mattel’s agreement to adopt certain corporate governance procedures. The court granted final approval to the settlement in September 2003, and judgments were entered accordingly. On October 9, 2003, a group of persons purporting to be members of the §14(a) class filed a notice of appeal, challenging the manner in which the $122.0 million was allocated between the §10(b) class and the §14(a) class. On April 4, 2005, the United States Court of Appeals for the Ninth Circuit heard the appeal but has not yet rendered a decision.

 

Litigation Related to LeapFrog Enterprises, Inc.

 

Fisher-Price, Inc. (“Fisher-Price”), a subsidiary of Mattel, was sued for patent infringement by LeapFrog Enterprises, Inc. in a lawsuit filed in October 2003 in the United States District Court for the District of Delaware, and in September 2004, Mattel was joined to the lawsuit as a defendant. The lawsuit alleges that Fisher-Price’s PowerTouch system infringes a LeapFrog patent relating to an electronic learning device for teaching phonics. On April 7, 2005, the trial court issued a ruling regarding the construction of the words of the patent claim at issue. The case is set to be tried before a jury beginning on May 16, 2005. The plaintiff in this lawsuit is asserting a total damages claim of up to approximately $90 million, which could possibly be trebled if the infringement were found to be willful, and an injunction preventing the further sale of the PowerTouch system. Mattel and its subsidiary Fisher-Price believe the action is without merit and intend to continue to defend themselves vigorously.

 

Litigation Related to Carter Bryant and MGA Entertainment, Inc.

 

In April 2004, Mattel filed a lawsuit in Los Angeles County Superior Court against Carter Bryant (“Bryant”), a former Mattel design employee. The suit alleges that Bryant aided and assisted a Mattel competitor, MGA Entertainment, Inc. (“MGA”), during the time he was employed by Mattel, in violation of his contractual and other duties to Mattel. In September 2004, Bryant asserted counterclaims against Mattel, including counterclaims in which Bryant seeks, as a putative class action representative, to invalidate Mattel’s Confidential Information and Propriety Inventions Agreements with its employees. Mattel has moved to dismiss Bryant’s counterclaims, which motion remains pending.

 

In December 2004, MGA intervened as a party-defendant in Mattel’s action against Bryant, asserting that its rights to the “Bratz” property are at stake in the litigation. Mattel’s suit has been removed to the United States District Court for the Central District of California, where it is currently pending.

 

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Separately, in November 2004, Bryant filed an action against Mattel in the United States District Court for the Central District of California. The action seeks a judicial declaration that Bryant’s purported conveyance of rights in “Bratz” was proper and that he did not misappropriate Mattel property in creating “Bratz.” Mattel has filed a motion to dismiss, which remains pending.

 

In April 2005, MGA filed suit against Mattel in the United States District Court for the Central District of California. MGA’s action alleges claims of trade dress infringement, trade dress dilution, false designation of origin, unfair competition and unjust enrichment. The suit alleges, among other things, that certain products, themes, packaging and/or television commercials in various Mattel product lines have infringed upon products, themes, packaging and/or television commercials for various MGA product lines, including “Bratz.” The complaint also asserts that various alleged Mattel acts with respect to unidentified retailers, distributors and licensees have damaged MGA and that various alleged acts by industry organizations, purportedly induced by Mattel, have damaged MGA.

 

MGA’s suit alleges that MGA has been damaged in an amount “believed to reach or exceed tens of millions of dollars” and further seeks punitive damages, disgorgement of Mattel’s profits and injunctive relief. Mattel believes the claims by Bryant and MGA are without merit and intends to vigorously defend against them.

 

16. Segment Information

 

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 Disney Classics (collectively “Other Girls Brands”), Hot Wheels®, Matchbox® and Tyco® R/C vehicles and playsets (collectively “Wheels”) and Harry Potter, Yu-Gi-Oh!, Batman, Justice League, MegaMan and games and puzzles (collectively “Entertainment”).

 

Fisher-Price Brands — including Fisher-Price®, Little People®, Rescue Heroes®, BabyGear and View-Master® (collectively “Core Fisher-Price®”), Sesame Street®, Barney, Dora the Explorer, Winnie the Pooh, InteracTV and See ’N Say® (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

 

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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 (as defined in SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information) 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 income. The corporate and other category includes costs not allocated to individual segments, including charges related to 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

 

(In thousands)


  

March 31,

2005


   

March 31,

2004


 

Revenues

                

Domestic:

                

Mattel Brands US

   $ 237,937     $ 262,649  

Fisher-Price Brands US

     169,218       182,819  

American Girl Brands

     67,630       54,127  
    


 


Total Domestic

     474,785       499,595  

International

     375,467       353,972  
    


 


Gross sales

     850,252       853,567  

Sales adjustments

     (67,132 )     (72,623 )
    


 


Net sales

   $ 783,120     $ 780,944  
    


 


Segment Income (Loss)

                

Domestic:

                

Mattel Brands US

   $ 16,393     $ 40,372  

Fisher-Price Brands US

     (1,692 )     905  

American Girl Brands

     7,787       (285 )
    


 


Total Domestic

     22,488       40,992  

International

     9,701       6,787  
    


 


       32,189       47,779  

Corporate and other expense (a)

     (26,660 )     (35,069 )
    


 


Operating income

     5,529       12,710  

Interest expense

     17,547       15,221  

Interest (income)

     (12,085 )     (4,896 )

Other non-operating (income), net

     (8,881 )     (10,019 )
    


 


Income before income taxes

   $ 8,948     $ 12,404  
    


 



(a) For the quarter ended March 31, 2004, corporate and other includes a $10.8 million charge related to severance.

 

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(In thousands)


   March 31, 2005

   March 31, 2004

   Dec. 31, 2004

Assets

                    

Domestic:

                    

Mattel Brands US

   $ 267,260    $ 263,324    $ 319,351

Fisher-Price Brands US

     177,958      193,375      177,508

American Girl Brands

     52,679      64,579      48,128
    

  

  

Total Domestic

     497,897      521,278      544,987

International

     474,468      391,551      588,144
    

  

  

       972,365      912,829      1,133,131

Corporate and other

     71,509      36,655      44,535
    

  

  

Accounts receivable and inventories

   $ 1,043,874    $ 949,484    $ 1,177,666
    

  

  

 

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

 

(In thousands)


  

March 31,

2005


   

March 31,

2004


 
Worldwide Revenues                 

Mattel Brands

   $ 514,389     $ 532,101  

Fisher-Price Brands

     264,384       263,998  

American Girl Brands

     67,630       54,127  

Other

     3,849       3,341  
    


 


Gross sales

     850,252       853,567  

Sales adjustments

     (67,132 )     (72,623 )
    


 


Net sales

   $ 783,120     $ 780,944  
    


 


 

17. New Accounting Pronouncements

 

In December 2004, the FASB issued SFAS No. 123 (revised 2004) (“SFAS No. 123(R)”), Share-Based Payment, which replaced SFAS No. 123 and superseded APB Opinion No. 25. SFAS No. 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values. The pro forma disclosures previously permitted under SFAS No. 123 will no longer be an alternative to financial statement recognition. Under SFAS No. 123(R), Mattel must determine the appropriate fair value method to be used for valuing share-based payments, the amortization method of compensation cost and the transition method to be used at the date of adoption. The transition methods include prospective and retroactive adoption options. Under the retroactive option, prior periods may be restated either as of the beginning of the year of adoption or for all periods presented. The prospective method requires that compensation cost be recorded for all unvested stock options and nonvested stock at the beginning of the first quarter of adoption of SFAS No. 123(R), whereas the retroactive method requires recording compensation cost for all unvested stock options and nonvested stock beginning with the first period restated.

 

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In April 2005, the Securities Exchange Commission amended Rule S-X to delay the effective date for compliance with SFAS No. 123(R). Based on the amended rule, Mattel is required to adopt SFAS No. 123(R) on January 1, 2006. Mattel is evaluating the requirements of SFAS No. 123(R) and expects that the adoption of SFAS No. 123(R) will have a material adverse effect on its results of operations and earnings per share. Mattel has not yet determined the method of adoption of SFAS No. 123(R), or whether the amounts recorded in the consolidated statements of income in future periods will be similar to the current pro forma disclosures under SFAS No. 123.

 

In November 2004, the FASB issued SFAS No. 151, Inventory Costs – An Amendment of ARB No. 43, Chapter 4. SFAS No. 151 amends the guidance in Chapter 4, “Inventory Pricing,” of Accounting Research Bulletin (“ARB”) No. 43, Restatement and Revision of Accounting Research Bulletins, to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (“spoilage”). Among other provisions, the statement requires that items such as idle facility expense, excessive spoilage, double freight, and rehandling costs be recognized as current-period charges regardless of whether they meet the criterion of “so abnormal” as stated in ARB No. 43. Additionally, SFAS No. 151 requires that the allocation of fixed production overhead to the costs of conversion be based on the normal capacity of the production facilities. SFAS No. 151 is effective for fiscal years beginning after June 15, 2005. Mattel is currently evaluating the effect that the adoption of SFAS No. 151 will have on its results of operations and financial position, but does not expect it to have a material impact.

 

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

 

MATTEL, INC. AND SUBSIDIARIES

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 Disney Classics (collectively “Other Girls Brands”), Hot Wheels®, Matchbox® and Tyco® R/C vehicles and playsets (collectively “Wheels”) and Harry Potter, Yu-Gi-Oh!, Batman, Justice League, MegaMan and games and puzzles (collectively “Entertainment”).

 

Fisher-Price Brands — including Fisher-Price®, Little People®, Rescue Heroes®, BabyGear and View-Master® (collectively “Core Fisher-Price®”), Sesame Street®, Barney, Dora the Explorer, Winnie the Pooh, InteracTV and See ’N Say® (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.

 

Management believes that the business environment for Mattel in 2005 will be similar to that of 2004. Mattel expects to continue facing challenges both domestically and internationally as retailers continue to rationalize stores and tightly manage inventory. Management also expects to encounter continued cost pressures in the areas of product costs, including oil-based resin, transportation costs, and employee-related costs.

 

Management has established two overarching goals for 2005. The first goal is to drive growth by continuing the invigoration of the Barbie® brand, while maintaining growth in all of its core brands by continuing to develop innovative toys. Mattel also intends to align more effectively with growing retail customers and to develop new channels to generate growth. The second goal is to gain further efficiencies in the supply chain by implementing new spend management and e-procurement policies, procedures and information systems; and rationalizing manufacturing and vendor sourcing.

 

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Results of Operations

 

Consolidated Results

 

Net sales for the first quarter of 2005 were $783.1 million, flat as compared to $780.9 million in 2004, including a benefit from changes in currency exchange rates of 2 percentage points. Net income for the first quarter of 2005 was $6.5 million, or $0.02 per diluted share, as compared to net income of $9.0 million, or $0.02 per diluted share, for 2004. Gross profit, as a percentage of net sales, declined from 45.0% in 2004 to 43.9% in 2005. External cost pressures in transportation and raw material costs reflecting the increased cost of oil, and higher royalty and obsolescence costs, mainly related to JuiceBox, were the primary causes of the decline in gross profit. These costs were partially offset by a modest price increase implemented in January and a benefit from changes in currency exchange rates. Profitability in the first quarter of 2004 was impacted by a $10.8 million charge for severance related to the elimination of approximately 260 positions resulting from headcount reductions at certain domestic and international locations.

 

The following table provides a summary of Mattel’s consolidated results for the first quarter of 2005 and 2004:

 

     For the Three Months Ended March 31,

             

(In millions, except percentage and basis point information)


   2005

    2004

   

Year/Year Change


 
     Amount

    % of Net
Sales


    Amount

    % of Net
Sales


    %

   

Basis Points

of Net Sales


 

Net sales

   $ 783.1     100.0 %   $ 780.9     100.0 %   —          
    


 

 


 

           

Gross profit

   $ 344.0     43.9 %   $ 351.7     45.0 %   -2 %   (110 )

Advertising and promotion expenses

     87.7     11.2       87.4     11.2     —       —    

Other selling and administrative expenses

     250.8     32.0       251.6     32.2     —       (20 )
    


 

 


 

           

Operating income

     5.5     0.7       12.7     1.6     -57 %   (90 )

Interest expense

     17.6     2.2       15.2     1.9     15 %   30  

Interest (income)

     (12.1 )   -1.5       (4.9 )   -0.6     147 %   (90 )

Other non-operating (income), net

     (8.9 )   -1.1       (10.0 )   -1.3     -11 %   (20 )
    


 

 


 

           

Income before income taxes

   $ 8.9     1.1 %   $ 12.4     1.6 %   -28 %   (50 )
    


 

 


 

           

 

Sales

 

Net sales for the first quarter of 2005 remained flat at $783.1 million, including a benefit from changes in currency exchange rates of 2 percentage points. Gross sales within the US decreased 5% as compared to 2004 and accounted for 56% of consolidated gross sales in 2005 compared to 59% in 2004. In 2005, gross sales in international markets increased 6% compared to 2004, including a benefit from changes in currency exchange rates of 4 percentage points.

 

Worldwide gross sales of Mattel Brands decreased 3% in the first quarter of 2005 to $514.4 million, including a 2 percentage point benefit from changes in currency exchange rates. Domestic gross sales decreased 9% and international gross sales increased 3%, including a 4 percentage point benefit from changes in currency exchange rates. Worldwide gross sales for Barbie® declined 15% from 2004, including a 2 percentage point benefit from changes in currency exchange rates. Domestic gross sales of Barbie® declined 25%, while international gross sales

 

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of Barbie® declined 7%, including a 4 percentage point benefit from changes in currency exchange rates. Worldwide gross sales of Other Girls Brands increased 10%, including a 2 percentage point benefit from changes in currency exchange rates. The sales growth for Other Girls Brands was driven by new product introductions, including Winx Club, Pound Puppies® and Doggie Daycare, as well as strong sales of Disney Princesses, partially offset by declines in sales of Polly Pocket! compared to the first quarter of 2004. Worldwide gross sales in the Wheels category declined 5%, including a 2 percentage point benefit from changes in currency exchange rates. Worldwide gross sales of the Hot Wheels® product line declined 2%, including a 2 percentage point benefit from changes in currency exchange rates, driven by double-digit sales growth in international markets, which was more than offset by a decrease in domestic sales. Worldwide gross sales of Matchbox® declined, along with sales of Tyco® R/C brands. Worldwide gross sales in the Entertainment category increased 18%, including a 3 percentage point benefit from changes in currency exchange rates. Growth in the Entertainment category was primarily driven by continued strength in male-action entertainment properties, including Robots, Batman and MegaMan, partially offset by sales declines in Yu-Gi-Oh!.

 

Worldwide gross sales of Fisher-Price Brands were flat at $264.4 million in the first quarter of 2005 as compared to $264.0 million in 2004, including a benefit of 1 percentage point from changes in currency exchange rates. Worldwide sales of Core Fisher-Price® were flat, with international sales up double-digits and domestic sales down despite particularly strong performance at retail. Worldwide gross sales of Fisher-Price® Friends grew in the double-digits, driven by continued strength in Dora the Explorer.

 

American Girl Brands gross sales increased 25% in the first quarter of 2005 to $67.6 million as compared to $54.1 million in the first quarter of 2004, reflecting increased sales from the January 2005 launch of the new American Girl Today® doll, Marisol, and continued growth generated by the American Girl Place® retail stores.

 

Gross Profit

 

Gross profit, as a percentage of net sales, was 43.9% in the first quarter of 2005, compared to 45.0% in the first quarter of 2004. External cost pressures in transportation and raw material costs, reflecting the increased cost of oil, and higher royalty and obsolescence costs, mainly related to JuiceBox, were the primary causes of the decrease in gross profit. These costs were partially offset by a modest price increase implemented in January and a benefit from changes in currency exchange rates. Mattel expects the cost pressures to continue through 2005, and this may adversely affect Mattel’s gross profit.

 

Advertising and Promotion Expenses

 

Advertising and promotion expenses remained flat at 11.2% of net sales in the first quarter of 2005 and 2004. Mattel expects advertising spending levels for 2005 to be fairly consistent with 2004 to support its plan to invest in the business to drive long-term performance.

 

Other Selling and Administrative Expenses

 

Other selling and administrative expenses were $250.8 million, or 32.0% of net sales, in the first quarter of 2005 compared to $251.6 million, or 32.2% of net sales, in the first quarter of 2004. Other selling and administrative

 

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expenses benefited from lower severance charges in the first quarter of 2005 as compared to 2004. However, this benefit was partially offset by higher employee-related costs, the negative effect of changes in currency exchange rates (primarily the Euro), and the timing of charitable contributions.

 

Non-Operating Items

 

Interest expense increased from $15.2 million in the first quarter of 2004 to $17.6 million in the first quarter of 2005, largely due to higher average seasonal borrowings and higher average short-term borrowing rates, partially offset by lower long-term debt as a result of repaying $50.0 million of medium-term notes during 2004. Other non-operating (income), net was $8.9 million in the first quarter of 2005 compared to $10.0 million in the first quarter of 2004 and was mainly comprised of gains from the sale of marketable securities.

 

As of March 31, 2005, the pre-tax unrealized gains of marketable securities held by Mattel were $13.7 million ($8.6 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.

 

Domestic Segment

 

Mattel Brands US gross sales decreased 9% in the first quarter of 2005 compared to the first quarter of 2004. Within this segment, Barbie® gross sales declined 25% and sales of Other Girls Brands increased 12% as a result of several new brand introductions, including Winx Club, Doggie Daycare, and Pound Puppies®. Gross sales in the Wheels category decreased double-digits as a result of sales declines across all product lines. Gross sales in the Entertainment category increased double-digits reflecting strength in male-action entertainment properties, including Batman and Robots, partially offset by a decline in sales of Yu-Gi-Oh!. Mattel Brands US segment income decreased 59% to $16.4 million in the first quarter of 2005, primarily due to lower sales volume and a decline in gross profit caused by external cost pressures, and higher royalty and obsolescence costs, mainly related to JuiceBox.

 

Fisher-Price Brands US gross sales decreased 7% in the first quarter of 2005 compared to the first quarter of 2004, mainly due to a decrease in sales of Core Fisher-Price® products, reflecting declines in sales of infant and preschool products, partially offset by an increase in sales of BabyGear products. Fisher-Price Brands US segment income decreased from income of $0.9 million in the first quarter of 2004 to a loss of $1.7 million in the first quarter of 2005, primarily due to decreased sales volume and higher investment in product development.

 

American Girl Brands gross sales increased 25% in the first quarter of 2005 compared to the first quarter of 2004, reflecting increased sales from the January 2005 launch of the new American Girl Today® doll, Marisol, and continued growth generated by the American Girl Place® retail stores. The American Girl Brands segment income increased from a loss of $0.3 million in the first quarter of 2004 to income of $7.8 million in the first quarter of 2005, primarily due to increased sales volume.

 

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International Segment

 

The following table provides a summary of percentage changes in gross sales within the International segment for the first quarter of 2005 versus 2004:

 

Non-US Regions:


  

% Change in

Gross Sales


    

Impact of Change

in Currency

(in % pts)


Europe

   4      4

Latin America

   28      3

Canada

   (18 )    4

Asia Pacific

   12      2
    

  

Total International

   6      4
    

  

 

International gross sales increased 6% in the first quarter of 2005 compared to the first quarter of 2004, including a benefit from changes in currency exchange rates of 4 percentage points. Gross sales of Barbie® decreased 7%, including a 4 percentage point benefit from changes in currency exchange rates. Gross sales of Other Girls Brands increased 8%, including a benefit from changes in currency exchange rates of 5 percentage points, due to several new product introductions, including Winx Club, Doggie Daycare, and Pound Puppies®. Gross sales increased in the Wheels category, reflecting growth in Hot Wheels®, partially offset by declines in sales of Matchbox® and Tyco® R/ C vehicles. Gross sales also increased in the Entertainment category driven by increases in sales of male-action figures, including Robots, Batman and MegaMan. Fisher-Price Brands gross sales increased double-digits, including strong sales of Core Fisher-Price® products and Fisher-Price® Friends, mainly due to Dora the Explorer. International segment income increased 43% in the first quarter of 2005 due to increased sales volume, partially offset by an increase in external cost pressures.

 

Income Taxes

 

On October 22, 2004, the American Jobs Creation Act (the “Jobs Act”) was signed into law. Among its various provisions, the Jobs Act creates a temporary incentive for US corporations to repatriate accumulated income earned abroad by providing an 85% dividends received deduction for certain qualifying dividends. On December 21, 2004, the Financial Accounting Standards Board (“FASB”) issued Staff Position 109-2 (“FSP 109-2”), Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004. FSP 109-2 allows companies additional time beyond the financial reporting period in which the Jobs Act was enacted to evaluate the effect of the Jobs Act on a company’s plan for reinvestment or repatriation of unremitted foreign earnings for the purposes of applying Statement of Financial Accounting Standards (“SFAS”) No. 109, Accounting For Income Taxes. As of March 31, 2005, management had not completed its assessment of whether, or to what extent, Mattel may repatriate foreign earnings under the Jobs Act. Therefore, the statement of income for the three-months ended March 31, 2005, does not include any provision for income taxes on the cumulative balance of its unremitted foreign earnings.

 

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Management’s plan for reinvestment and repatriation of foreign earnings under the Jobs Act was completed and approved by Robert A. Eckert, Mattel’s chief executive officer, on April 14, 2005. Mattel expects to repatriate up to approximately $2.4 billion in foreign earnings, and the corresponding tax liability is estimated to be approximately $180 million as calculated under existing law. The statement of income for the three-months ending June 30, 2005, will include a provision for income taxes on the total amount of earnings expected to be repatriated, which will occur throughout 2005. The computation of the estimated tax liability does not include the potential favorable effects of the Tax Technical Corrections Act of 2004 (the “Technical Corrections Bill”), which was introduced to the US Congress on November 22, 2004. If enacted in its current form, the Technical Corrections Bill would reduce Mattel’s computation of the estimated tax liability associated with the repatriation of foreign earnings under the Jobs Act. In addition, the estimated tax liability may be further impacted by any additional law change in the form of further guidance from the US Internal Revenue Service (“IRS”). Mattel would reflect the impact of the Technical Corrections Bill and any additional IRS guidance in the financial reporting period in which any such change in law is enacted or effective.

 

Liquidity and Capital Resources

 

Mattel’s primary sources of liquidity for the first quarter of 2005 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 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.

 

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.

 

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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 successfully implement 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 remained relatively flat at $374.9 million in the first quarter of 2005 compared to $373.2 million in the first quarter of 2004. Cash flows used for operating activities in 2005 were driven primarily by net income and depreciation and amortization, offset by the use of cash for working capital needs.

 

Investing Activities

 

Cash flows used for investing activities in the first quarter of 2005 decreased $24.8 million to $6.5 million compared to $31.3 million in the first quarter of 2004. The decrease in cash flows used for investing activities in 2005 was mainly due to the timing of capital expenditures year-over-year, partially offset by higher proceeds from the sale of investments in 2005.

 

Financing Activities

 

Cash flows from financing activities in the first quarter of 2005 and 2004 were $12.4 million and $41.8 million respectively. The $29.4 million decrease in cash flows from financing activities in 2005 was primarily due to the repayment of short-term borrowings, partially offset by proceeds from the exercise of stock options. Mattel intends to repay its $150.0 million of 6 1/8% senior notes in July 2005 and a $38.9 million mortgage note in December 2005 upon maturity.

 

Seasonal Financing

 

Mattel’s financing of seasonal working capital typically grows throughout the first half 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 maintains and periodically amends or replaces a domestic unsecured committed revolving credit facility with a commercial bank group that is used as the primary source of financing for the seasonal working capital requirements of its domestic subsidiaries. The agreement in effect was amended and restated in March 2005 and the expiration date of the facility was extended to March 23, 2010. All other terms and conditions of the amended facility are substantially similar to the previous facility, including the consolidated debt-to-capital and interest coverage ratios. Interest is charged at various rates selected by Mattel, ranging from market commercial paper rates to the bank reference rate. The domestic 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

 

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ratios. Mattel was in compliance with such covenants at the end of the first quarter of 2005. As of March 31, 2005, Mattel’s consolidated debt-to-capital ratio, as calculated per the terms of the credit agreement, was 0.22 to 1 (compared to a maximum allowed of 0.60 to 1) and Mattel’s interest coverage ratio was 11.90 to 1 (compared to a minimum allowed of 3.50 to 1). The domestic 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 domestic 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 utilizes individual short-term credit lines with a number of banks. Mattel expects to extend these credit lines throughout 2005.

 

Mattel believes its cash on hand at the beginning of 2005, 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 2005.

 

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 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. 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 trade 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.

 

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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)


   March 31, 2005

   March 31, 2004

   Dec. 31, 2004

Receivables sold pursuant to the:

                    

Domestic receivables facility

   $ 60.0    $ 59.1    $ 253.4

European receivables facility

     51.3      54.0      93.8

Other factoring arrangements

     4.5      —        99.1
    

  

  

     $ 115.8    $ 113.1    $ 446.3
    

  

  

 

Financial Position

 

Mattel’s cash and equivalents at March 31, 2005 decreased $378.1 million to $778.7 million compared to year end 2004, primarily due to cash flows used for operating and investing activities. Accounts receivable, net decreased $187.7 million to $571.3 million at March 31, 2005 compared to year end 2004 due to the seasonality of collections.

 

The current portion of long-term debt increased $137.9 million to $188.9 million at March 31, 2005 compared to $51.0 million at March 31, 2004, primarily due to the reclassification of $150.0 million of 6 1/8% senior notes maturing in the third quarter of 2005 and a $38.9 million mortgage note maturing in the fourth quarter of 2005 from long-term debt to current portion of long-term debt, partially offset by repayment of $50.0 million of medium-term notes in 2004. Accounts payable and accrued liabilities decreased $560.0 million since year end 2004 to $669.2 million at March 31, 2005, mainly due to the payment of year end 2004 accounts payable and various accrued liability balances, including receivables collections due to bank related to the European receivables facility, incentive compensation, advertising and royalties.

 

A summary of Mattel’s capitalization is as follows:

 

(In millions, except percentage information)


   March 31, 2005

    March 31, 2004

    Dec. 31, 2004

 

Medium-term notes

   $ 400.0    13 %   $ 400.0    13 %   $ 400.0    13 %

Senior notes

     —      —         150.0    5       —      —    

Other long-term debt obligations

     —      —         38.9    1       —      —    
    

  

 

  

 

  

Total long-term debt

     400.0    13       588.9    19       400.0    13  

Other long-term liabilities

     239.4    8       238.1    8       243.5    8  

Stockholders’ equity

     2,400.9    79       2,208.3    73       2,385.8    79  
    

  

 

  

 

  

     $ 3,040.3    100 %   $ 3,035.3    100 %   $ 3,029.3    100 %
    

  

 

  

 

  

 

Total long-term debt decreased $188.9 million at March 31, 2005 compared to March 31, 2004 due to the aforementioned reclassification of $150.0 million of 6 1/8% senior notes maturing in the third quarter of 2005 and the $38.9 million mortgage note maturing in the fourth quarter of 2005 from long-term debt to current portion of long-term debt. Mattel expects to satisfy its future long-term capital needs through the generation of corporate earnings and issuance of long-term debt instruments. Stockholders’ equity increased $192.6 million since March 31, 2004, primarily as a result of income from operations, partially offset by the purchase of treasury stock during 2004 and payment of the annual dividend on common stock in the fourth quarter of 2004.

 

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Mattel’s debt-to-capital ratio, including short-term borrowings and current portion of long-term debt, improved from 24.3% at March 31, 2004 to 20.2% at March 31, 2005, mainly due to cash flows generated from operating activities combined with the repayment of medium-term notes, partially offset by the purchase of treasury stock and the payment of the annual dividend on common stock. Mattel’s objective is to continue to maintain a year-end debt-to-capital ratio of approximately 25%.

 

Litigation

 

See Part II, Item 1 “Legal Proceedings.”

 

New Accounting Pronouncements

 

In December 2004, the FASB issued SFAS No. 123 (revised 2004) (“SFAS No. 123(R)”), Share-Based Payment, which replaced SFAS No. 123, Accounting for Stock-Based Compensation, and superseded Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees. SFAS No. 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values. The pro forma disclosures previously permitted under SFAS No. 123 will no longer be an alternative to financial statement recognition. Under SFAS No. 123(R), Mattel must determine the appropriate fair value method to be used for valuing share-based payments, the amortization method of compensation cost and the transition method to be used at the date of adoption. The transition methods include prospective and retroactive adoption options. Under the retroactive option, prior periods may be restated either as of the beginning of the year of adoption or for all periods presented. The prospective method requires that compensation cost be recorded for all unvested stock options and nonvested stock at the beginning of the first quarter of adoption of SFAS No. 123(R), whereas the retroactive method requires recording compensation cost for all unvested stock options and nonvested stock beginning with the first period restated.

 

In April 2005, the Securities Exchange Commission (“SEC”) amended Rule S-X to delay the effective date for compliance with SFAS No. 123(R). Based on the amended rule, Mattel is required to adopt SFAS No. 123(R) on January 1, 2006. Mattel is evaluating the requirements of SFAS No. 123(R) and expects that the adoption of SFAS No. 123(R) will have a material adverse effect on its results of operations and earnings per share. Mattel has not yet determined the method of adoption of SFAS No. 123(R), or whether the amounts recorded in the consolidated statements of income in future periods will be similar to the current pro forma disclosures under SFAS No. 123.

 

In November 2004, the FASB issued SFAS No. 151, Inventory Costs – An Amendment of ARB No. 43, Chapter 4. SFAS No. 151 amends the guidance in Chapter 4, “Inventory Pricing,” of Accounting Research Bulletin (“ARB”) No. 43, Restatement and Revision of Accounting Research Bulletins, to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (“spoilage”). Among other provisions, the statement requires that items such as idle facility expense, excessive spoilage, double freight, and rehandling costs be

 

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recognized as current-period charges regardless of whether they meet the criterion of “so abnormal” as stated in ARB No. 43. Additionally, SFAS No. 151 requires that the allocation of fixed production overhead to the costs of conversion be based on the normal capacity of the production facilities. SFAS No. 151 is effective for fiscal years beginning after June 15, 2005. Mattel is currently evaluating the effect that the adoption of SFAS No. 151 will have on its results of operations and financial position, but does not expect it to have a material impact.

 

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 income, 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, brand 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 (in millions):

 

     For the Three Months Ended

 

(In thousands)


  

March 31,

2005


    

March 31,

2004


 

Revenues

                 

Domestic:

                 

Mattel Brands US

   $ 237,937      $ 262,649  

Fisher-Price Brands US

     169,218        182,819  

American Girl Brands

     67,630        54,127  
    


  


Total Domestic

     474,785        499,595  

International

     375,467        353,972  
    


  


Gross sales

     850,252        853,567  

Sales adjustments

     (67,132 )      (72,623 )
    


  


Net sales

   $ 783,120      $ 780,944  
    


  


 

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 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 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

 

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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 category share, and increase its category share or establish category 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. 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 from 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 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.

 

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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. In 2004, Mattel’s three largest customers, Wal-Mart, Toys “R” Us and Target, in the aggregate, accounted for approximately 46% of net sales, and its ten largest customers, in the aggregate, accounted for approximately 56% 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.

 

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, 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. From 2001 through early 2004, 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, or significantly reduce the number of stores operated, it could have a material adverse effect on Mattel’s business, financial condition and results of operations.

 

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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 assurance 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, labor or rising wage and service costs, 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 interruption of the 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 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.

 

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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 42 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”) or 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 manufacturing facilities and third-party manufacturers 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 third-party 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 corporate headquarters, near major earthquake faults in Southern California. Southern California has experienced earthquakes, wildfires and other natural disasters in recent years. A catastrophic event where Mattel has important operations, such as an earthquake, tsunami, flood, typhoon, fire or other natural or manmade disaster, 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 results of operations.

 

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 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 government-fixed currency exchange rates, including the Chinese yuan, could have a material adverse effect on Mattel’s business and results of operations.

 

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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, catch new trends, create new brands and enter new categories, develop people, and improve productivity, simplify processes and maintain customer service levels, as well as new initiatives designed to drive sales growth and improve its supply chain. 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 income 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 costs, changes in Mattel’s 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 ratio, 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 merger partners or that, if identified, it will be able to acquire such targets on acceptable terms or agree to terms with merger partners. Additionally, there can be no

 

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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.

 

Foreign Currency Exchange Rate Risk

 

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 currency transaction exposure for Mattel. Mattel seeks to mitigate its exposure to market risk by monitoring its currency transaction exposure for the year and partially hedging such exposure using foreign currency forward exchange and option contracts primarily to hedge its 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 income 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. Transaction gains or losses on hedged intercompany inventory transactions are recorded in the consolidated statement of income 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 subsidiaries with non-US dollar functional currencies. Assets and liabilities of subsidiaries with non-US dollar functional currencies are translated into US dollars at fiscal year-end exchange rates. Income, expense and cash flow items are translated at weighted average exchange rates prevailing during the fiscal year. The resulting currency translation adjustments are recorded as a component of accumulated other comprehensive loss within stockholders’ equity. Mattel’s primary currency translation exposures are related to its net investment in entities having functional currencies denominated in the Euro, British pound sterling, Mexican peso and Indonesian rupiah.

 

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Item 4. Controls and Procedures.

 

Evaluation of Disclosure Controls and Procedures

 

As of March 31, 2005, 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 March 31, 2005, in timely alerting them to material information relating to Mattel required to be included in Mattel’s periodic reports.

 

Changes in Internal Control Over Financial Reporting

 

Mattel made no change to its internal control over financial reporting or in other factors that materially affected, or were reasonably likely to have materially affected, its internal control over financial reporting during the quarter ended March 31, 2005.

 

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PART II — OTHER INFORMATION

 

Item 1. Legal Proceedings.

 

Litigation Related to The Learning Company, Inc. (“Learning Company”)

 

Following Mattel’s announcement in October 1999 of the expected results of its Learning Company division for the third quarter of 1999, various Mattel stockholders filed purported class action complaints naming Mattel and certain of its present and former officers and directors as defendants.

 

These shareholder complaints were consolidated into two lead cases, one under §10(b) of the Securities Exchange Act of 1934 (the “Exchange Act”), and the other under §14(a) of the Exchange Act. In November 2002, the United States District Court for the Central District of California permitted the actions to proceed as class actions.

 

Several stockholders filed related derivative complaints purportedly on behalf of Mattel. Some of the derivative suits were consolidated into one lawsuit in Los Angeles County Superior Court in California, which was dismissed for the plaintiff’s failure to make pre-suit demand on the board of directors. An appeal from that decision was dismissed in July 2003 by stipulation of the parties. Another derivative suit was filed in the Delaware Court of Chancery, and was dismissed without prejudice in August 2002 in deference to the then-ongoing California derivative case. A third derivative suit, filed in federal court in the Central District of California, was dismissed in July 2002, and re-filed in November 2002 as part of the settlement described below.

 

In November 2002, the parties to the federal cases negotiated and thereafter memorialized in a final settlement agreement a settlement of all the federal lawsuits in exchange for payment of $122.0 million and Mattel’s agreement to adopt certain corporate governance procedures. The court granted final approval to the settlement in September 2003, and judgments were entered accordingly. On October 9, 2003, a group of persons purporting to be members of the §14(a) class filed a notice of appeal, challenging the manner in which the $122.0 million was allocated between the §10(b) class and the §14(a) class. On April 4, 2005, the United States Court of Appeals for the Ninth Circuit heard the appeal but has not yet rendered a decision.

 

Litigation Related to LeapFrog Enterprises, Inc.

 

Fisher-Price, Inc. (“Fisher-Price”), a subsidiary of Mattel, was sued for patent infringement by LeapFrog Enterprises, Inc. in a lawsuit filed in October 2003 in the United States District Court for the District of Delaware, and in September 2004, Mattel was joined to the lawsuit as a defendant. The lawsuit alleges that Fisher-Price’s PowerTouch system infringes a LeapFrog patent relating to an electronic learning device for teaching phonics. On April 7, 2005, the trial court issued a ruling regarding the construction of the words of the patent claim at issue. The case is set to be tried before a jury beginning on May 16, 2005. The plaintiff in this lawsuit is asserting a total damages claim of up to approximately $90 million, which could possibly be trebled if the infringement were found to be willful, and an injunction preventing the further sale of the PowerTouch system. Mattel and its subsidiary Fisher-Price believe the action is without merit and intend to continue to defend themselves vigorously.

 

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Litigation Related to Carter Bryant and MGA Entertainment, Inc.

 

In April 2004, Mattel filed a lawsuit in Los Angeles County Superior Court against Carter Bryant (“Bryant”), a former Mattel design employee. The suit alleges that Bryant aided and assisted a Mattel competitor, MGA Entertainment, Inc. (“MGA”), during the time he was employed by Mattel, in violation of his contractual and other duties to Mattel. In September 2004, Bryant asserted counterclaims against Mattel, including counterclaims in which Bryant seeks, as a putative class action representative, to invalidate Mattel’s Confidential Information and Propriety Inventions Agreements with its employees. Mattel has moved to dismiss Bryant’s counterclaims, which motion remains pending.

 

In December 2004, MGA intervened as a party-defendant in Mattel’s action against Bryant, asserting that its rights to the “Bratz” property are at stake in the litigation. Mattel’s suit has been removed to the United States District Court for the Central District of California, where it is currently pending.

 

Separately, in November 2004, Bryant filed an action against Mattel in the United States District Court for the Central District of California. The action seeks a judicial declaration that Bryant’s purported conveyance of rights in “Bratz” was proper and that he did not misappropriate Mattel property in creating “Bratz.” Mattel has filed a motion to dismiss, which remains pending.

 

In April 2005, MGA filed suit against Mattel in the United States District Court for the Central District of California. MGA’s action alleges claims of trade dress infringement, trade dress dilution, false designation of origin, unfair competition and unjust enrichment. The suit alleges, among other things, that certain products, themes, packaging and/or television commercials in various Mattel product lines have infringed upon products, themes, packaging and/or television commercials for various MGA product lines, including “Bratz.” The complaint also asserts that various alleged Mattel acts with respect to unidentified retailers, distributors and licensees have damaged MGA and that various alleged acts by industry organizations, purportedly induced by Mattel, have damaged MGA.

 

MGA’s suit alleges that MGA has been damaged in an amount “believed to reach or exceed tens of millions of dollars” and further seeks punitive damages, disgorgement of Mattel’s profits and injunctive relief. Mattel believes the claims by Bryant and MGA are without merit and intends to vigorously defend against them.

 

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

 

Recent Sales of Unregistered Securities

 

During the first quarter of 2005, Mattel did not sell any unregistered securities.

 

Issuer Purchases of Equity Securities

 

In 2003, Mattel’s board of directors initiated a share repurchase program. The amount authorized for repurchase is approved by the board of directors based on the guidelines outlined in Mattel’s capital and investment framework. From the inception of its share repurchase program through year end 2004, Mattel has repurchased 27.4 million shares of its common stock at a cost of $499.5 million.

 

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In March 2005, the board of directors approved the repurchase of $250.0 million of Mattel’s common stock, bringing the total available for share repurchase under the program to $250.5 million as of March 31, 2005. Repurchases will take place from time to time, depending on market conditions. Mattel’s share repurchase program has no expiration date.

 

During the first quarter of 2005, Mattel did not repurchase any of its common stock.

 

Item 5. Other Information.

 

None.

 

Item 6. Exhibits.

 

     
Exhibit No.

 

Exhibit Description


11.0*   Computation of Income per Common and Common Equivalent Share
31.0*   Certification of Principal Executive Officer dated May 4, 2005 pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.1*   Certification of Principal Financial Officer dated May 4, 2005 pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.0**   Certification of Principal Executive Officer and Principal Financial Officer dated May 4, 2005 pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 20021

 


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

 

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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 May 4, 2005

 

By:

 

LOGO


       

Douglas E. Kerner

       

Senior Vice President and

Corporate Controller (Duly authorized

officer and chief accounting officer)

 

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