It's going to be a lean Christmas for Mattel Inc.
The El Segundo-based toymaker announced last week that a drop in orders from retailers will result in 1998 sales being $500 million short of earlier estimates. That will translate into a 33 percent earnings decline for the year compared with 1997.
The earnings disappointment was somewhat tempered by an announcement that Mattel will be acquiring educational software firm the Learning Co., in a deal worth $3.2 billion. With sales of about $850 million in 1998, The Learning Co. is the world's second-largest consumer software company after Microsoft Corp.
The acquisition is part of Mattel's attempt to broaden into the interactive toy market, which is experiencing the most rapid growth in the toy industry. Mattel said the deal will help the firm attain its goal of building a $1 billion software business.
"The Learning Co. acquisition makes sense," said Brian Eisenbarth, an analyst at Collins & Co. in San Francisco. "The software market has higher margins than traditional toys and the Learning Co. is a pretty dominant force in that area."
But the announcement was not enough to save Mattel's stock, which fell almost 40 percent in the days following last week's announcement. As of late last week it was near the $21 level. As recently as August, it was trading above $40.
Mattel blamed its weak fourth quarter on two factors: a drop in demand for holiday merchandise from major retailers like Toys 'R' Us; and a related decision by Mattel to delay the shipment of some its spring 1998 inventory.
"Although we had a strong Thanksgiving, up 23 percent for our top five accounts, retailers have determined that they would rather drastically reduce their inventory levels than capture incremental sales," Mattel Chairman Jill Barad said in a conference call with reporters and analysts last week. "This has negatively impacted our sales by approximately $350 million this year. Furthermore, due to a continuing shift in retailers to just-in-time inventory management, we have decided to (adjust) our business to a more just-in-time schedule."
The delay of 1999 products will result in a further $150 million reduction in 1998 sales, she said. As a result of that drop, 1998 revenues will be flat compared with last year and earnings are expected to decline steeply.
Last week's announcement marks the culmination of a tough year for the toy maker, which will end up having posted disappointing earnings in three out of the last four quarters.
For the third quarter ended Sept. 30, the company reported net income of $199.7 million, (68 cents per diluted share), compared with $223.7 million (76 cents) for the like period a year ago. Mattel reported an earnings gain only in the first quarter of the year, when it posted a slim profit of $12.7 million, compared with a $204.6 million loss for the like period a year earlier.
For 1997, Mattel posted net income of $274.7 million (95 cents), compared with $364.8 million ($1.26) in 1996.
Mattel is betting that its acquisition of the Learning Co. will be key in improving the numbers.
"We have begun the process of transforming Mattel from a toy company to a global children's products company," Barad said. "There can be no better catalyst for our transformation than the merger we are now announcing."
While analysts generally approved of the deal, they stressed that the merger was not a panacea for Mattel's problems.
"We may not have seen the worst of this story yet," said Jill Krutick, an analyst at Salomon Smith Barney. "We believe in the strategic initiatives of the company diversifying its distribution, expanding global product demand, and increasing its interactive presence. But the segue between making these initiatives translate into earnings power and the potential slowdown in traditional toy demand could be perilous."
The company still has a stable of highly marketable toys, such as Barbie and Hot Wheels. These well-known brands can be combined with the Learning Co.'s interactive software capabilities, allowing Mattel to tap new markets around the world.
"Mattel has been through a lot of ups and downs in the market in the past," Eisenbarth said. "They have some pretty good core products that are some of the most recognized in the world. Barbie is not going to go away any time soon."
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