It's been a long road for toy maker Mattel (NASDAQ:MAT). The trouble began several years ago, as demand for the company's flagship Barbie faltered and it lost the coveted Disney Princesses and Frozen doll business to archrival Hasbro. The coup de grace came with the demise of Toys R Us, the last remaining big-box toy-centric retailer, which hit Mattel's financials worst of all. Some thought this might be the end of the House That Barbie Built, and anticipated that it would be swallowed up by Hasbro.

After enduring quarter after quarter of disappointment, Mattel investors went into the company's third quarter holding out little hope for signs of improvement. They were in for a surprise when Mattel posted an unexpected profit and operating income that grew year over year for the first time in eight consecutive quarters.

A selection of Barbie dolls dressed in outfits created by fashion designer Christian Siriano.

The Barbie Siriano Collection, featuring Barbies in dresses created by fashion designer Christian Siriano. Image source: Barbie.

A glimmer of hope?

Metric

Q3 2018

Q3 2017

Change (YOY)

Net sales

$1.44 billion

$1.56 billion

(8%)

Operating income

$129.9 million

$86.2 million

41%

Net income

$6.3 million

($603.9 million)

N/A

Earnings per share

$0.02

($1.75)

N/A

Data source: Mattel's Third-Quarter Financial Release. YOY=year over year.

For the third quarter, Mattel reported net sales of $1.4 billion, down 8% year over year and 6% in constant currency, and missing analysts' consensus estimates of $1.5 billion. However, the company's cost-cutting initiatives appeared to bear fruit, as operating income grew to $129.9 million, up 41% year over year. Adjusted operating income of $153 million resulted in adjusted earnings per share (EPS) of $0.18, double the $0.09 earned in the year-ago quarter, and falling just shy of the $0.20 expected by analysts. Gross margin also improved, clocking in at 42.6%, up from 41.5% in the year-ago quarter.

Sales in North America -- Mattel's biggest market -- grew by 4% year over year, marking the highest sales growth in the region since the fourth quarter of 2015. The surprising uptick was the result of a strong contribution by Barbie, partially offset by the impact of Toys R Us. 

Things weren't as bright internationally, as sales declined 18% and 14% in constant currency, compared with the prior-year quarter, the result of weak sales of Fisher-Price, Thomas & Friends, and Cars 3 (which premiered last year), partially offset by sales of products related to the hit movie Jurassic World: Fallen Kingdom. The company saw a 3% impact from slowing sales in China.

Overall, gross sales of Barbie grew by 14% year over year and 17% in constant currency. Hot Wheels weren't so hot, down 6% and 3% in constant currency compared with the prior-year quarter. Sales faced tough comps from the same period last year, which benefited from the theatrical release of Star Wars: The Last Jedi and an exclusive promotional deal with Toys R Us. Reported sales of Fisher-Price and Thomas & Friends slumped 12%, and 10% in constant currency terms, while sales of American Girl plummeted 31% on both a reported and constant currency basis.

Mattel boasted that it had recaptured the position of No. 1 toy company globally in each of the previous four months through September, according to market research firm NPD. The company also recaptured the title in the U.S. and Latin America year to date through September.

The organization is also on track to achieve a $650 million targeted run rate of cost savings by the end of 2019. Mattel achieved $120 million in savings during the third quarter and expects to cross the $500 million mark by the end of 2018.

"We are on track with the execution of our strategy and have made meaningful progress toward restoring profitability, as we transform Mattel into an IP-driven, high-performing toy company," said Ynon Kreiz, Chairman and CEO of Mattel.

Two girls laughing, holding American Girl dolls wearing outfits that match a woman in the background.

Image source: Mattel.

What the important holiday season may hold

Mattel is still playing its cards close to the vest and didn't provide quarterly guidance for the upcoming holiday quarter in its earnings release. To help provide some insight into what the broader market is expecting, analysts' consensus estimates for the fourth quarter are calling for revenue of $1.62 billion, up about 1% year over year, and EPS of $0.02, up significantly from the loss of $0.82 per share in the prior-year quarter.

This quarter's surprise profit may bode well for the company's fourth quarter, as it sets the stage for even greater profits if it can boost revenue. For now, however, Mattel has made important strides toward an eventual recovery.

Danny Vena owns shares of Hasbro, Mattel, and Walt Disney and has the following options: long January 2019 $85 calls on Walt Disney and long January 2020 $50 calls on Hasbro. The Motley Fool owns shares of and recommends Hasbro and Walt Disney. The Motley Fool has a disclosure policy.