Mattel, Inc. (MAT) Q3 2020 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by and welcome to the Mattel Inc. Third Quarter 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today's conference is being recorded. [Operator Instructions]. It is now my pleasure to introduce VP, Investor Relations, David Zbojniewicz.

Thank you, operator, and good afternoon, everyone. Joining me today are Ynon Kreiz, Mattel's Chairman and Chief Executive Officer; Richard Dickson, Mattel's President and Chief Operating Officer; and Anthony DiSilvestro, Mattel's Chief Financial Officer. As you know. This afternoon we reported Mattel's 2020 third quarter financial results. We will begin today's call with the Ynon and Anthony providing commentary on our results, after which we will provide some time for Ynon, Richard and Anthony to take your questions. To help supplement our discussion today, we have provided you with a slide presentation. Our discussion, slide presentation and earnings release reference non-GAAP financial measures including gross sales, adjusted gross profit and adjusted gross margin, adjusted other selling and administrative expenses, adjusted operating income and loss, adjusted earnings and loss per share, earnings before interest, taxes, depreciation and amortization or EBITDA, adjusted EBITDA, free cash flow and constant currency. Please note that the gross sales figures referenced on this call will be stated in constant currency. In addition, please note that our accompanying slide presentation can be viewed in sync with today's call when you access it through the Investors section of our corporate website corporate.mattel.com. The information required by Regulation G regarding non-GAAP financial measures is included in our earnings release and slide presentation, and both documents are also available in the Investors section of our corporate website. Before we begin, I'd like to remind you that certain statements made during the call may include forward-looking statements related to the future performance of our business, brands, categories and product lines. These statements are based on currently available information and assumptions and they are subject to a number of significant risks and uncertainties that could cause our actual results to differ from those projected in the forward-looking statements including risks and uncertainties associated with the COVID-19 pandemic. We describe some of these uncertainties in the Risk Factors section of our 2019 Annual Report on Form 10-K, our Q2 2020 quarterly report on Form 10-Q, our earnings release and the presentation accompanying this call and other filings we make with the SEC from time to time, as well as in other public statements. Mattel does not update forward-looking statements and expressly disclaims any obligation to do so except as required by law. Now, I'd like to turn the call over to Ynon.

Thank you for joining Mattel's third quarter 2020 earnings call. I hope that you and your families are staying healthy and safe. This was a very strong quarter for Mattel. We saw a major upswing in top line and a significant increase in profitability. We continue to make meaningful progress towards becoming an IP driven high performing toy company. Here are some of the key highlights for the third quarter. Gross and net sales grew strongly versus prior year. Gross sales were $1.8 billion, up 10% as reported and up 11% in constant currency. Net sales were $1.6 billion, also up 10% as reported and up 11% in constant currency. Adjusted gross margin was 51%, a substantial improvement of 410 basis points. This was the ninth consecutive quarter in which we improved adjusted gross margin on a year-over-year basis. Adjusted operating income grew strongly to $401 million, up 131%, and adjusted EBITDA improved significantly to $470 million, an increase of 90%. The toy industry as a whole grew meaningfully and continues to demonstrate its resilience in challenging economic times. The industry is yet again proving to be a strategic category for retailers as parents continue to prioritize spend on their children and look for high-quality products at affordable price points. Mattel's growth outpaced the industry as we gained share in key markets around the world and achieved growth in each of our 4 regions. Our POS momentum remained strong throughout the quarter with total company POS up double digits and outpacing sales. POS momentum has continued into October. A key highlight for the quarter was our growth in E-commerce while we continue to see sales outpace other channels, even as more stores reopened. E-commerce grew by approximately 50% versus prior year, and it now represents approximately 30% of our global POS as we expanded our listings and continued to drive performance in this important channel. Our supply chain is fully operational as we chase the extraordinary growth in consumer demand for our products. Looking at our third quarter gross sales in constant currency by category. Our strong performance was driven by growth in our Dolls category, Action Figures Building Sets, Games and Other category and Vehicles. This was partially offset by Infant, Toddler and Preschool. Doll category gross sales grew by 24% year-over-year, driven primarily by Barbie and the newly launched Cave Club doll line. Barbie continued to perform exceptionally well and grew by a remarkable 30%. Gross sales increased across almost every segment driven by a combination of great product, new innovation cultural relevance and highly effective demand creation. POS growth rate in our Doll category outpaced shipments. Barbie POS was up more than 50%, which speaks to the strength and ongoing momentum of the franchise. Per NPD in the third quarter Mattel was the number one doll manufacturer in the US, Europe and Latin America and gained share in all three regions. In the US, Barbie was the number one toy property for 12 of 13 weeks in the quarter and finished the period as the number one toy property overall, not just in dolls. American Girl also improved substantially. Gross sales were down a mere 2% or $1 million compared to a decline of 16% in the first half. This encouraging performance was in spite of COVID-19 related retail disruptions, including a large drop in overall tourist traffic to our flagship stores as well as the permanent closure of four of our retail stores this year. American Girl direct to consumer sales however doubled and almost fully compensated for the reduction in the retail business with growth in new customer activations, average order value and conversion rates. For the quarter, direct to consumer represented more than 50% of sales. Our Vehicles category gross sales were up 8% year-over-year, driven by the strong performance of hot Wheels and matchbox. Hot Wheels grew 9%, with broad-based growth across segments including Monster Trucks and Super Mario Kart. Hot Wheels also benefited from improved impulse purchases as retail stores reopened and foot traffic increased. POS growth in our Vehicles category was twice the rate of sales growth. Hot Wheels POS was up double digits, reflecting the significant demand for this brand. Hot Wheels gained share in the third quarter in the US and remains the number one vehicles brand per NPD. Our Infant, Toddler and Preschool category gross sales were down 5% year-over-year due to a decline in Fisher-Price Friends as we continue to exit under-performing licenses and a decline in Fisher-Price and Thomas & Friends. Fisher-Price core was down only 1% which was a meaningful improvement compared to a 19% decline in the first half. These encouraging results were driven by growth in the Infant and Toddler segments offset by the Toy Story 4 comparison in our Imaginext line. Category POS was up low-single digits and continues to outpace shipping. Fisher-Price remains the number one Infant, Toddler, Preschool manufacturer in the US per NPD. Gross sales for Action Figures, Building Sets, Games and Other our challenger categories together grew 14% year-over-year, driven by Games and Plush. Games achieved its seventh consecutive quarter of year-over-year growth. Uno continued to perform exceptionally well, remaining the number one item in the games and puzzles category in the US per NPD. Games POS remains strong and was up double digits in the quarter. Our plush category continued to show strength with this year's launch of Star Wars, The Child. In the US, The Child was the number one selling item in the Plush category in the third quarter and year-to-date per NPD. Building sets were down slightly, a significant improvement compared to the first half. We are encouraged by the double-digit POS growth in the quarter. As expected, Action Figures declined due to a Toy Story 4 year-over-year comparison. The decline was partially offset by Jurassic World which was up in the third quarter and year-to-date, in spite of being two years after the release of the movie as it continues to establish itself as an evergreen property. We also successfully introduced the Masters of the Universe collective toy line with more to come in anticipation of the franchises relaunched next year. In the US, we gained share in the Action Figures category in the third quarter per NPD. Given the strength of our brands, we have accelerated our direct to consumer offering of collective product to targeted segments of our consumers. We continue to leverage our capabilities in E-commerce and are looking to grow share and outpace the overall industry growth. Looking at gross sales by region in constant currency. We achieved growth in each of our four regions, despite COVID-19 disruptions and local restrictions that impacted some locations. By the end of the third quarter, about 2% of all retail outlets that sell our products representing about 1% of our revenue base remain closed. While retailers were restocking the shelves, we still exited the third quarter with lower retail inventories year-over-year. Looking at regional gross sales performance in constant currency for the quarter. North America was up 13%, driven by broad-based strength across almost all categories. POS was up more than 20%. Mattel was the number one manufacturer in the third quarter in the US and gained share throughout the quarter per NPD. EMEA was up 16%, driven by strong performance across all of our major markets and the continued shift to E-commerce. POS also accelerated and slightly outpaced sales growth. In Europe, Mattel grew at twice the rate of the industry and gained share throughout the quarter per NPD. Asia Pacific was up 3%, driven by solid growth in Australia. POS was flat in the quarter compared to a double-digit decline in the first half as several markets continued to experience restrictions in store recoveries. Latin America was up 3%, driven by an improving retail market with still reopenings and increased foot traffic. POS was up low-single digits and in line with sales. Our work over the past two years to develop a flexible and results-oriented organization continues to serve us well. While we faced significant disruptions in the first half of the year and some COVID-19 challenges still remained during the third quarter, we've demonstrated our strong execution capabilities and the power of our brands. We have clearly made significant progress in our short to mid-term strategy to restore profitability and regain top line growth, and at the same time, we continued to advance our mid-to long-term strategy to capture the full value of our IP. We recently announced a new film project based on Thomas & Friends. The film will be co-produced and directed by Marc Forster, the acclaimed filmmaker and Director of James Bond Quantum of Solace, Christopher Robin and Finding Neverland among others. We also recently greenlit 104 episodes and two specials for the Thomas & Friends television series. These shows will premiere in fall of 2021. Additionally, we announced season 13 of Fireman Sam and greenlit season 3 of Polly Pocket. Both shows would be distributed globally through broadcast television and streaming services. Production on our two Masters of the Universe animated series is ongoing and we look forward to releasing them on Netflix next year. The successful introduction of the product line this year, combined with this animated series will lay the groundwork for the holistic relaunch of this iconic franchise. We continue to advance our digital gaming strategy with the launch of our Hot Wheels integration into World of Tanks on console and the upcoming launch of Hot Wheels Open World on Roblox. We also continue to see growing engagement in our existing digital games, including UNO, Phase 10, Scrabble, Barbie Dreamhouse, Hot Wheels, and more. Looking beyond the third quarter, based on the POS momentum we are seeing, the low retail inventories and the early start of the holiday shopping season, we expect gross sales to grow in the fourth quarter. We are working closely with our retail partners on the challenge of meeting the extraordinary growth in consumer demand heading into the holiday season. Looking to the full year. With continued operational savings and margin expansion, we expect to see strong EBITDA growth. With that said, in spite of the positive outlook, we are mindful of the COVID-19 volatility and other macroeconomic uncertainties which could negatively impact performance. In closing, the third quarter represents a strong upswing compared to the first half as we were able to regain top line growth and exceed industry performance. We saw growth in every region in constant currency and broadly across our portfolio. Our supply chain continued to perform very well and worked in close partnership with our brand teams and commercial organization. We achieved significant improvement in all key profitability metrics, including gross margin, operating income, EBITDA and free cash flow. There is strong demand for our product with POS outpacing shipments and we expect continued growth through the rest of the year. We are also making significant progress on our strategy to capture the full value of our IP with 10 film projects already announced and numerous television projects in development or production with more to come. We continue to demonstrate meaningful progress towards becoming an IP driven high performing toy company. I could not be more proud of the work of the entire Mattel team. Every single employee deserves full credit for their commitment and contribution towards putting us back on a profitable growth trajectory. We remain focused on executing our strategy and the creation of long-term shareholder value. And now, Anthony DiSilvestro will cover the financials in more detail. As you know, this is Anthony's first earnings call as CFO. He has already made a real impact since joining the Company in June. I'm sure you will all enjoy working with him. Anthony, over to you.

Thanks, Ynon. We had an outstanding quarter, with results exceeding our expectations following a first half that was impacted by store closures and restrictions due to COVID-19. We are very pleased with the continuing improvements in gross margin, a key driver of our overall financial performance as we continue to benefit from our cost savings programs. Our cost savings programs in aggregate delivered $37 million of savings in the quarter, bringing the year-to-date total $149 million. Cumulatively, we remain on track to exceed $1 billion of savings exiting 2020. Today, we will be providing 2020 guidance reflecting our year-to-date performance and positive outlook for the fourth quarter, including the all-important holiday season. I will now review our detailed results. In the third quarter, we generated gross sales of $1.818 billion and net sales of $1.632 billion, both increasing by 10% as reported and 11% in constant currency versus prior year. On an adjusted basis, we generated $401 million of operating income, increasing by 131% year-over-year. This substantial increase reflects gains across the P&L, including higher sales, gross margin expansion reductions in advertising, in part due to timing and lower SG&A. Adjusted EPS in the quarter was $0.95, 265% higher than the prior year. Adjusted EBITDA was up substantially, improving by $222 million or 90% to $470 million. This was driven by gains in operating income, partly offset by lower depreciation as we’ve reduced our capital spending over the past few years. Bridging our third quarter gross sales performance by reporting segment. North America increased by 13% in constant currency versus prior year. The increase was fueled by double-digit POS growth which outpaced the industry as our teams together with our retail and online Partners executed extremely well. International increased by 10% in constant currency versus prior year. This was driven by 16% growth in EMEA benefiting from accelerated E-commerce growth, while Latin America and Asia-Pacific each delivered 3% growth, a significant improvement from the first half as retail doors continued to reopen. American Girl gross sales declined 2% in the quarter as we continue to make progress on our strategy to rationalize our retail footprint and transition more of the business to DTC. As Ynon mentioned, the continued high growth of E-commerce was a key contributor globally. Total Company gross sales in constant currency increased 11%. Gross sales as reported increased 10%, including a one point negative impact from foreign currency translation, primarily due to the weakening of the Brazilian real and Mexican peso. We achieved continued improvement in gross margin. Compared to 2019, our third quarter adjusted gross margin increased by 410 basis points to 51%. This is the ninth consecutive quarter in which we improved adjusted gross margin on a year-over-year basis. Our cost savings programs contributed 150 basis points of adjusted gross margin expansion. We continue to achieve savings from our ongoing Capital Light program by rationalizing our manufacturing footprint and having successfully reduced our SKU count by over 30%. This 150 basis point gross margin expansion consisted of $14 million of savings from the Structural Simplification program, which we completed at the end of last year and $11 million of savings under the multi-year Capital Light program. Gross margin also benefited by 130 basis points from reduced royalties, reflecting lower sales of licensed products. Mix and other contributed 110 basis points driven primarily by the benefit of category mix, reflecting the above-average growth of Dolls and Games. And we experienced product cost deflation, adding 20 basis points to gross margin, driven by lower material prices, partly offset by increased conversion costs. On a year-to-date basis, adjusted gross margin was 47.8% compared to 42.9% for the same period last year as we make further progress on our goal to restore profitability. Moving down to P&L. Advertising expenses for the quarter totaled $103 million, a decline of 40% compared to 2019. As anticipated, the year-over-year decrease in Advertising was primarily due to lower spending in the quarter, reflecting a shift in timing to the fourth quarter as we plan to increase support for our products during the all-important holiday shopping season. We continue to proactively manage our SG&A expenses and have taken additional actions in 2020. Adjusted SG&A for the quarter was $329 million compared to $351 million in the prior-year quarter, a decline of 6%. The decrease in SG&A was primarily driven by the benefits of the Structural Simplification program and additional cost savings actions taken in 2020. We also had very strong bottom line performance in the quarter. Adjusted operating income grew from $174 million to $401 million, an increase of $227 million or 131% compared to the prior-year quarter. The increase in adjusted operating income was primarily driven by sales growth, gross margin expansion, lower advertising in part due to timing and lower SG&A. Adjusted EBITDA was also up significantly, reflecting the gains in operating income. Adjusted EBITDA increased by $222 million or 90% to $470 million. Generating free cash flow is a key focus area for us. In the 9-month year-to-date period, cash from operations improved by $80 million from a use of $514 million in 2019 to a use of $434 million in 2020 as a lower net loss was partly offset by higher seasonal working capital requirements. For the year-to-date period, depreciation and amortization decreased by $36 million from $186 million in 2019 to $150 million in the current year, as we’ve reduced capital spending levels over the years. Capital expenditures for the nine months increased from $76 million to $90 million. We expect our full-year capital expenditures to be in the range of $125 million to $150 million, which remains well below historical levels. Free cash flow improved by $65 million from a use of $589 million last year to $524 million in the current year. We believe it is important to begin communicating free cash flow on a trailing four-quarter basis given the highly seasonal nature of our business. On that basis, we generated positive free cash flow of $130 million over the last four quarters compared to $74 million a year ago, an increase of $56 million. The improvement in free cash flow was driven by increased cash from operations, partly offset by an increase in capital expenditures. Turning to the balance sheet, accounts receivable increased by $35 million to $1.326 billion due to the increase in gross sales. While the dollar value increased, day's sales outstanding declined by five days and in the quarter at 73 days as we tightly managed receivables. Owned inventory decreased by $38 million to $664 million. The reduction is primarily due to the increased demand for our products. We ended the quarter with a cash balance of $452 million, including $400 million of short-term borrowings. This compares to a cash balance of $218 million a year ago with $230 million of short-term borrowings. The increase of $64 million in our cash balance, excluding short-term borrowings, is primarily driven by our trailing four-quarter positive free cash flow. With no debt maturities until March 2023 and the availability of a $1.6 billion credit facility, liquidity is expected to be sufficient to effectively execute our strategy. Given our EBITDA growth trajectory, we expect our leverage ratio to continue to decline and we intend to use excess free cash flow to reduce debt. With one quarter to go in the year and more visibility than we had in the early part of the COVID-19 disruption, we are providing sales and earnings guidance for 2020. We expect full year gross sales in constant currency to be between flat to and 1%, as our projected strong second half performance offsets the 13% decline in the first half. We anticipate our gross sales as reported to be negatively impacted by one to two percentage points due to currency translation. Our guidance for the full year gross sales in constant currency reflects mid-single-digit expected growth in the fourth quarter. As Ynon said, we are working closely with our retail Partners on the challenge of meeting consumer demand heading into the holiday season. In addition, we are mindful of the COVID-19 volatility and other macroeconomic uncertainties which could negatively impact performance. Moving to profitability. We are increasing our guidance for adjusted gross margin which we provided on our second quarter call. We now expect our adjusted gross margin to increase by 350 to 400 basis points to about 48.5% to 49% for the full year compared to last year’s 44.9%. The improved gross margin outlook reflects better than expected manufacturing performance, lower than anticipated cost inflation and the benefit of favorable volume and mix. Advertising expense is expected to be near the midpoint of our previously communicated range of 11% to 13% of net sales. On adjusted SG&A for the full year, we expect to generate the $90 million of net SG&A cost savings previously discussed but expect it to be partly offset by above-target, incentive compensation in currency translation reflecting a US dollar weaker than our initial expectations. Adjusted EBITDA savings from structural simplification are still expected to be $92 million, and we remain on track to deliver savings of $50 million under our Capital Light program. Based on our year-to-date performance and outlook for the balance of the year. We expect full-year adjusted EBITDA in the range of $625 million to $650 million compared to $453 million in 2019. The strong forecasted growth in adjusted EBITDA reflects our ongoing progress to restore profitability and is driven by the benefit of our cost savings programs, improved supply chain performance leveraging the benefit of our 30% SKU reduction, additional actions taken in 2020 to reduce SG&A, favorable product mix and overall better execution across our organization. Mattel has delivered an outstanding quarter. In spite of the pandemic, we have continued to make meaningful progress towards our strategy to restore profitability and regain top line growth. We believe we are well positioned to maintain this momentum. I’m very much looking forward to partnering with Ynon and the entire team as we continue to transform Mattel into an IP driven high performing toy company. I will now hand it over to the operator for the Q&A.

Thank you. [Operator Instructions] And our first question comes from the line of Michael Ng with Goldman Sachs.

Great, thank you very much for the question and congratulations on the great quarter. I just have two questions. First, there were a few theatrical shifts in the quarter, Minions got pushed out for instance, and didn't really show up in your results in all. But I was wondering if you could talk about the impact of theatrical shifts and discuss some of the key partner brand initiatives that you have for this year and next. And then I just have a quick follow up.

Yes, hi, Michael. Thank you. The -- as you noted, theatrical releases have been shifted away from this year to next. This while had some the impact on us overall didn't change the very strong performance we expect to have in the second half of the year and see growth in the fourth quarter. With that said, we do expect performance to be positively impacted next year with the additional releases theatrically and there is actually a pretty strong slate of movies that we expect such as Minions, Spirit, Jurassic World 3, Fast and Furious, Top Gun, all at this point expected to show next year. So this in addition to our own strong portfolio of brands and product bodes well for us in 2021

Great, thank you. And I just had a follow up question on the guidance. Can you talk about some of the assumptions in the 4Q growth outlook of mid-single digits, particularly given the 10% growth in 3Q? Did 3Q benefit from an outsized amount of retail inventory restocking? Is there anything in particular you would call out? Thank you very much.

Just to say that we are seeing a significant upswing in revenues with our top line now forecasted to be to be up high single digits in the second half versus a double-digit decline in the first half. We do expect an improved second half, but we did not anticipate such a strong upswing in such a short time when we entered peak production and planned our inventory. POS remains strong and there is continuing demand for our product. And while our supply chain is fully operational, we are chasing extraordinary growth in demand. We gave you guidance and we do expect to meet our gross sales guidance, but we cannot be certain we will fully meet the surge in consumer demand. We continue to work closely with our retail Partners on the challenge of meeting the strong demand heading into the holiday season.

Just add to that, we did -- do see the restocking of retailer inventories. This is the typical seasonal build that we see in the third quarter, but we did end the quarter below last year's levels. And when you consider the strong POS or weeks of supply are also down at the end of the third quarter.

Yes, good, good add. Thank you.

Thank you. Your next question comes from the line of Garrick Johnson with BMO Capital Markets.

Okay, thank you. Sounds like supply is good, but can we go into more detail there? We've been hearing about difficulties getting continuous for exist -- for instance. So how is that supply chain? How are your factories in Asia? And then also how are your retailers? There may be some retailer bottlenecks that we've been hearing about as well. So if you'd go through all that. Thank you.

Yes. Our supply chain is fully operational, and as I said, we, at this point, chased the extraordinary growth in consumer demand for our product. And we work closely with our retail Partners on the challenge of meeting the demand heading into the season. This is not impacted by COVID. This is literally all about surge, surge in demand. As far as retail closure, as we noted in the preferred remarks, at this point 2% of stores that sell our product are closed, representing about 1% of our revenue base. In North America and Europe, the retail is 100% open LATAM is about 2% closed and Asia Pacific about 7% closed

Okay. But none of your retail partners having any problem flowing goods, they're all pretty clean?

Yes, the retail partners are doing a great job, really chasing as well demand we've done -- together we worked hard to fulfill the demand. They are doing an excellent job in offering a multi-channel offering omnichannel solutions for shoppers and we expect that this will remain an important category for them, a strategic category for them, heading into the holiday season.

Yes. And my last one, some big Barbie playsets were really good sellers over the summer, Board & Buster's offering kids activities while they're at home. Do you believe this has pulled some sales from fourth quarter when those products would have traditionally been sold? So yes, especially on those Barbie Dreamhouses, there were lot of those sold I think in July. Thank you.

Yes, we do not believe there was pulled forward as it relates to shipment or consumer demand. The -- in the third quarter, some restocking did occur but retail inventories are still down in absolute dollars and bouncing definitely in weeks of supply. So as it relates to consumer demand, our own internal shopper research shows that the vast majority of parents plan to spend the same or more on holiday tote purchases throughout the fourth quarter.

Thank you. And our next question comes from the line of Arpine Kocharyan with UBS.

Hi, thanks very much. Thank you for taking the question. Could you actually quantify where retail inventories are? I know you said in your prepared remarks that that number was down year-over-year as of end of the quarter and you -- if you have that number for North America as well as internationally that would be most helpful. And then I have a quick follow up. Thanks.

Yes, we don't have the specific number, but let me give you some additional context on retailer inventories. And going back to the beginning of 2020, we came into the year with retailer inventories higher than the prior year. And then as we talked about at the end of Q2, we talked about retailer inventories being down versus the prior year. And then as I said earlier, there was the seasonal build in the third quarter of retailer inventories but at the end of the quarter we're still down a little bit versus the prior year. Not as much as we were at the end of the second quarter, but when you consider weeks of supply, given the high growth of POS, the weeks of supply are down rather significantly.

Okay, that's very helpful. Thank you. And then, Ynon, you mentioned October retail momentum has held up. Should we assume you continue to see double-digit increase in POS into October?

We gave you guidance for the quarter and what I can say in addition to that is the POS momentum is strong. It remained strong throughout the quarter with total Company POS up double-digit as we said, outpacing sales. The good news is that there is strong demand for the product and at this point, it remains ahead of sales. All of this we believe will be -- will point to a strong season for us.

Thank you very much.

Thank you. And our next question comes from the line of Tami Zakaria with JP Morgan.

Hi, thank you so much for taking my question. So very impressive quarter, congrats to the team. I just have two quick questions One is, historically if you look at the fourth quarter sales versus the third quarter, usually the fourth quarter is bigger in dollar amount versus the third quarter but it seems like you're guiding the fourth quarter to be similar to the third quarter this time around. So is that conservatism or there is something specific that's driving that outlook for the fourth quarter?

Yes, hi, Tami. Thank you for the question. As I said, this is not about change in demand. The demand is still strong. At this point, it's about being able to fulfill the demand. This is why we say we are chasing the -- this extraordinary surge that we see in demand. When you consider that we went from a double-digit decline in the first half to a double-digit growth in the third quarter and a high single-digit growth overall in the second half, at this point it's all about being able to fulfill this very strong extraordinary growth in demand.

Got it, got it, that's super helpful. And then another quick one is, for the Thomas & Friends movie that you just announced, are you planning to co-produce that movie? Meaning if there is upside to the movie revenues, will you be sharing in that economics, or it's just going to be more like a product-driven revenue?

Well, we haven't disclosed the terms of the distribution of the movie, in other words, the commercial arrangements about the movie. This is a development deal with Marc Forster. The -- we have different types of relationships and agreements with different studios, and directionally we always expect to have economic upside in our movies. This is not -- none of our movies are purely about a licensing deal. We do get paid, but we also retain upside in the economic success of our projects.

Got it, that's super helpful. Thank you so much and best of luck for the quarter.

Thank you. Thank you.

Thank you. And our next question comes from the line of Steph Wissink with Jefferies.

Thank you. Good day, everyone. We would like to isolate two areas if we could. The first is on A&P. Think you mentioned that your expectations for the year are right around the midpoint of that 11% to 13% range, which would imply a pretty significant step up in Q4. So our question is, have you already committed to that amount or is that kind of banking the value in case you need it? Particularly, just want to reconcile that with your comments on demand outstripping supply. And then really quickly just on E-com, because that seemed to really stand out, both for American Girl and for the total Company being almost a third of your business now. If you talk a little bit about what a higher percentage of E-comm penetration might mean to the timing of revenues, the scope of your advertising and promotions, anything that we should be thinking about in terms of that channel shift. Thank you.

Yes, I'll start with the advertising question and give you a little bit of context. If you go back to the beginning of the year, we did say we expect the shift of advertising to the back half and that's turning out to be more of a shift between Q3 to Q4 as well. Don't want to get into too much specifics for competitive reasons, but let me say that some of that shift is due to year on year timing and some of it is the result of aligning our spend with consumer shopping behavior. As you point out, we also said for 2020, we expect to be near the midpoint of the 11% to 13% of net sales range. And as you do the math, you will see that's a pretty significant increase in our fourth quarter spending as we support our products during the holiday shopping season when consumers are making those purchase decisions and I would also say that most of that spend is largely committed at this point. Yes and Steph, I take the E-comm question. So as we said in the prepared remarks,

We are seeing very strong growth for us in E-commerce and online retail, more than 50% growth now representing 30% of our global POS. In the case of American Girl, B2C more than doubled and now represents more than 50% of sales. So clearly a very important part of the business. As it relates to our economics, what we are seeing is a high propensity of online shopping among consumers. And at the same time, traditional retailers are doing really good work in evolving in that direction, offering more solutions for shoppers. So this is really about being at the front of the curve of responding to change in consumer behavior and being able to meet demand wherever consumers are. We haven't broken out the economics, change in margin and things of that nature, but I would say that as the future becomes more about online shopping and online retail, our ability to be at the front of it is going to be very important for our growth. It is part of our strategy, as you know, it's always been on that one page that we have, what did change is the timing of it. We are accelerating the execution of this part of the strategy given the importance of this channel.

Thank you.

Thank you. Your next question comes from the line of Linda Weiser with DA Davidson.

Thanks. Hi, I'm trying to do the math on the EBITDA and what would be implied for the fourth quarter. It looks like your implied guidance is just slightly lower than where the street is. So I was wondering if there is any way you can quantify the increase in incentive comp or what the year-over-year increase in incentive comp would be or if there is any other factors that are affecting the SG&A in fourth quarter? Thanks.

Yes, I'll take that. You've got your math right. On a full-year basis, we're going from $453 million to $625 million to $650 million on adjusted EBITDA and that implies that a smaller growth in the fourth quarter. I would tell you the biggest change is actually in the advertising line. When you go through the math, I just talked about the midpoint of 11% to 13% against where we are year-to-date implies a very significant increase in advertising, and that shift right between the first three quarters and the last explains most of that delta in terms of growth in EBITDA compared to the prior year. Specifically around SG&A, as we said in our remarks, we do expect to generate the $90 million of net SG&A savings that we talked about before. But sitting here today, our expectations and guidance for the full year is above our original expectations. So we're accruing to above target incentive compensation, don't want to quantify that yet. It's all based on forecasts and estimates, so it's a little bit premature for us to do that. But again, the biggest factor is that shift in advertising.

And Linda, let me just add that the EBITDA guidance that we gave is as you know, $50 million more or higher than the guidance we gave before the disruption which we pulled. So coming back and upgrading that number by $50 million after such a strong -- such negatives first half tells you a story of a strong, very strong performance in the second half overall.

Thank you very much.

Thank you. Your next question comes from the line of William Reuter with Bank of America.

Hi, thanks for taking the question. In your -- one of your first slides of the presentation, you talk about the industry as a whole growing meaningfully and Mattel growing ahead of that. It's based on your internal numbers. What do you think that the toy industry did grow at? And I'm wondering as a whole, the industry growth. What do you attribute this to and I guess how much of it may be related to COVID in some way?

Yes, look, the industry as a whole did grow meaningfully and continued to demonstrate its resilience even in challenging economic times. We see that parents continue to prioritize spend on their children and look for high-quality products at affordable price points. The industry is a strategic category for retailers. It drives foot traffic, even though there is not a lot of foot traffic in stores, but it definitely increases engagement and an important category for them. The retail partners themselves have done a really good job adapting to the new current environment and we expect them to continue to drive shopping among consumers, especially as we head into the season. While we believe some of the growth that we see in the industry, is because of COVID, it's important to note that the toy industry has been growing historically and was projected to grow before COVID. We always point to euro monitor research the forecast growth of 4.9% on a global basis through 2024. This is actually expected to be driven by the Dolls category, which is meant to grow at about 10% per year, which is a good thing for Mattel. And I would note that within these dynamics, we expect to continue to outpace the industry growth and continue to perform above industry averages.

That was a very wholesome answer and helpful. Just one more question. Given your credit metrics have improved so much, do you have a leverage target at this point? Or are you thinking about -- hoping or trying to achieve an investment grade credit rating?

Yes. So a couple of things on that front. First, we are very pleased with our free cash flow performance. We've talked about the last four quarters being a positive $130 million, and our intent is to pay down debt going forward to improve our leverage ratio. If you combine that with the adjusted EBITDA performance and the trajectory we expect, our leverage will continue to decline and improve over time. And we are targeting and an investment grade rating. I don't -- can't give you a date for that but directionally that's where we're headed. If you look at some of the metrics on a trailing four-quarter basis, we ended the third quarter debt to adjusted EBITDA at 5.3 times and that compares to 6.9 times same period 12 months ago. So significant improvement and we expect that to continue to improve as we head towards investment grade.

Thank you and good luck for continued success.

Thanks, Bill.

Thank you. Your next question comes from the line of David Beckel with Berenberg Capital Markets.

Thanks so much for the question. I have two, if I could. The first one with regards to gross margin for next year. I was curious to what extent should we expect certain areas of outperformance this year from things like royalties and mix to reverse next year? And then I have a quick follow up. Thanks.

Yes. So not prepared to give guidance for 2021 at this point, but needless to say, we're very pleased with the performance on gross margin and the fact that we're going to be up 350 to 400 basis points this year to a range of about 48.5% to 49%. If you go back in time, 2017, that gross margin was just around 38%, so significant improvement. And that's really the result of all the great work the Company has done around cost savings both Structural Simplification and the Capital Light program. Now the Capital Light program is a multi-year program addressing our plant footprint, reducing SKUs by over 30%, other productivity measures. We do expect that to continue to contribute into 2021, I don't have a number for you yet. And we will also look for other opportunities and efficiencies to further improve our gross margin.

Great, that's helpful. Thanks. And second question is around E-commerce and specifically direct to consumer. You called out Masters of the Universe and collector sets as a partial driver of sales this year. I was wondering if you could expand on that and just shed some light on to the extent to which that forms or is the broader E-commerce and direct to consumer strategy that you expect to roll out in the future?

David, it's too early to talk about that, to provide specific detail. But as I mentioned before, online retail and E-commerce and B2C especially is an important part of our strategy and we'll be able to share with you more down the road as we make further progress.

Fair enough, thanks.

Thank you. Your next question comes from the line of Felicia Hendrix with Barclays.

Hi, thank you. Good afternoon. So Ynon, you guys have had now a nice string of reporting upside in the quarters, and I do think everyone appreciates your conservatism. But it would be helpful to know what the biggest surprise was in terms of biggest delta I would say between your outlook and then what you reported. And I think you touched on it very early in this call in Michael's question, but maybe if you could help peel back those layers a little bit more. And then as you look to the end of the year, on the same lines, what do you think the biggest drivers of potential upside could be?

Thank you, Felicia. You've been following the Company and you know that we've done a lot over the last couple of years and many of the actions that we took before the pandemic to reshape and simplify our operations as part of our turnaround strategy are definitely working. Our brands and our products resonate very well with consumers and our partnership with retailers and driving demand is working very well. And when you ask about surprise, we did expect growth as we've said in the second quarter, we said that we expect growth. But clearly this surge and incredible momentum we have both top line and bottom line is very strong. The quality of the numbers, the fact that we grew in every region and broadly across the entire portfolio, seeing such strong growth in profitability, all of this is very strong. And as it happens, this was actually the highest quarterly growth for Mattel in the past 10 years of any quarter, not the third quarter, of any quarter. This was the highest growth for Mattel in any quarter in the last 10 years. And when you add that to the continuous improvement in gross margin nine quarters in a row where we continue to improve gross margin on a year-over-year basis with such strong momentum, all of that is -- speaks to the progress we are making. I can't see it here and tell you that it's exactly as we planned. It's fair to say it's ahead of our expectations and we're not slowing down. We keep up the momentum, we focus on execution, and it's great to see the results coming in.

Yes, I get all that. I guess what I'm just wondering is like, what -- because that you all -- you know before. So what I'm trying to say is like was it the restocking that was faster than expected, were there certain products that just had a stronger peak in retail? I mean, was there anything that was -- what was specifically different? Because I think what we're all trying to do is gauge fourth quarter and certainly there is some conservatism built in there as well.

I wouldn't say we're not -- I'm not trying to avoid the question. It's in a way a tale of two halves for the year. We did have a challenging first half, and obviously we've done -- we've seen a very strong momentum in the third quarter and expect that to continue in the fourth quarter. The performance was broad based. I literally can't sit and just point to one part of the Company. Dolls as a whole category grew 24%. Vehicles -- Hot Wheels was up 9%, even our Challenger categories were up 14%. Our growth in the US was 1.4 times the industry's growth rate. We were number one in the region in the third quarter. In Europe, we grew at twice the rate of the industry and gained share throughout the quarter per NPD. So you look at our categories, you look at our regions, the Company as a whole is performing very strongly and together with the momentum we are seeing in the market, partly driven by the -- by what retailers are doing themselves, very strong demand from consumers. All of this comes together to these numbers.

Yes, I would just add to that. As you look to the fourth quarter, there is a couple of factors at play. One is the continued POS growth, the other is our supply chain ability to supply and that's what Ynon was talking about in terms of we can't be certain that we could fully meet that surge. So that's the other factor as we look ahead in the near term.

Okay, thank you. And just very quickly on Fisher-Price, just do you expect to see more of a positive momentum in the fourth quarter? Right now you're lagging in North America, but just wondering that and how long it would take through to work or through some of the underperforming brands that you mentioned in the in the deck?

Yes, hi. It's Richard, Felicia. Yes…

Hi.

We've been very encouraged with the progress that we're making on Fisher-Price. We've been seeing consistent POS growth for the last two consecutive quarters. It's been driven by new innovation, great new compelling product, and Mattel led by Fisher-Price is still the number one leader in the Infant, Toddler, Preschool category, continuing to be this incredibly valued brand by parents and trust which is such an important attribute today more than ever. So you'll see a lot more progress on Fisher-Price. But we're really encouraged with the last two quarters of positive POS.

Great, thank you.

Thank you. That is all the time we have for Q&A. So with that, I will turn the call back over to Chairman and CEO Ynon Kreiz for closing remarks.

Thank you, operator, and thank you everyone for your questions. This was a very strong quarter for us. We continue to make meaningful progress towards becoming an IP driven high performing toy company. I would not say that the COVID disruption and volatility is over and that macroeconomic uncertainties do not remain, but seeing such strong growth in top line and even more so on the bottom line in the midst of a pandemic is another clear sign that our turnaround is working. We believe there is more to come. And as always, we remain focused on creating long-term shareholder value. We hope that you and your families are healthy and safe. And now, I will return the call back to Dave to provide the replay details. Thank you.

Thank you, Ynon. And thank you everyone for joining the call today. The replay of this call will be available via webcast and audio beginning at 8:30 PM Eastern Time today. The webcast link can be found on our Investors page or for an audio replay, please dial 404-537-3406. The passcode is 3348954. Thank you for participating in today's call.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating and you may now disconnect.