JAKKS Pacific, Inc. — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018; filed May 10, 2018. JAKKS designs, markets and distributes toys and consumer products, including licensed products, across U.S. and Canada, International, and Halloween segments. The toy business is seasonal, with sales generally highest in the third and fourth quarters.
Financial performance
Amounts below are in millions except per-share data and margins.
| Metric | Q1 2018 | Q1 2017 |
|---|---|---|
| Net sales | $93.0 | $94.5 |
| Gross profit / margin | $23.0 / 24.7% | $30.0 / 31.8% |
| SG&A | $58.6 | $45.7 |
| Operating loss | $(35.7) | $(15.7) |
| Net loss attributable to JAKKS | $(36.2) | $(18.3) |
| Basic and diluted loss per share | $(1.57) | $(1.01) |
| Operating cash flow | $(11.4) | $9.9 |
- Sales declined 1.6%. U.S. and Canada sales were nearly flat at $70.5 million; International fell 13.1% to $17.3 million; Halloween rose 40.5% to $5.2 million.
- Gross margin fell 7.1 percentage points. Management cited product mix, higher direct product costs and royalty rates, and minimum royalty shortfalls associated with the Toys “R” Us liquidation.
- SG&A increased $12.9 million, primarily due to bad-debt expense tied to Toys “R” Us. The company recorded a $13.8 million provision for doubtful accounts in operating cash-flow reconciliation.
- Interest expense declined to $1.9 million from $2.9 million, mainly reflecting lower average debt balances. A $1.0 million fair-value loss on the 3.25% convertible notes also weighed on Q1 2018 results.
Balance sheet, debt and liquidity
- At March 31, cash and cash equivalents were $46.8 million, down from $65.0 million at year-end; working capital was $102.8 million versus $146.9 million. Total assets were $313.9 million and total stockholders’ equity was $60.0 million.
- Operating activities used $11.4 million; investing activities used $2.6 million, primarily for molds and tooling; financing activities used $5.1 million, including repayment of $5.0 million in credit-facility borrowings. Cash declined by $19.0 million during the quarter.
- There were no credit-facility borrowings outstanding at quarter-end, but $13.7 million of letters of credit were outstanding and excess availability was $10.0 million under the $75 million facility. The facility was in covenant compliance at March 31.
- Convertible-note principal included $21.2 million due August 2018, $113.0 million due June 2020, and $21.5 million of notes extended to November 2020. The balance sheet reported $155.8 million of convertible notes, net of issuance costs.
- The credit facility’s springing maturity provision could require repayment of the $21.2 million 2018 notes by June 15, 2018 unless they were refinanced or extended on qualifying terms. JAKKS was negotiating to amend its borrowing base to include certain foreign receivables and arranging a potential inventory-backed term loan; neither transaction was assured.
- Management stated that cash, projected operating cash flow and credit availability should fund working-capital needs, capital expenditures and 2018 debt repayment for the next 12 months, subject to mitigating plans. The filing warns that failure to complete financing or secure other capital could require cost, inventory or supplier-payment changes that could harm revenue and operations.
Material developments, outlook and risks
- Toys “R” Us exposure: TRU sought to wind down its U.S. operations and close 735 stores. JAKKS reported $35.1 million of worldwide gross receivables from TRU at March 31. After collecting $12.0 million from its insurer and $0.6 million from TRU in April, the remaining $22.5 million net receivable was fully reserved at quarter-end. TRU represented 29.4% of gross receivables at March 31.
- Customer concentration: Walmart, Target and TRU represented 54.5% of Q1 sales; the three largest customers accounted for 58.4% of gross receivables at March 31. Customer distress, returns or reduced orders could materially affect results and liquidity.
- Royalty commitments: Future minimum royalty guarantees totaled $107.0 million, excluding $14.3 million of advances already paid; $43.8 million was due within 12 months.
- Potential ownership transaction: Meisheng, then owning 18% of JAKKS, submitted a non-binding proposal to acquire additional shares for $2.95 per share and potentially increase its ownership and voting rights to 51%. The proposal was subject to due diligence and approvals; an independent-director special committee was evaluating it.
- Accounting and unusual items: JAKKS adopted ASC 606 using the modified retrospective method; management reported no effect on Q1 revenue or cost of sales. The company retested goodwill after events during the quarter and recorded no impairment. The quarter’s results include the Toys “R” Us-related receivable reserve and royalty shortfalls.
- No specific revenue, earnings or margin guidance was provided. Management cautioned that quarterly results are seasonal and may not indicate full-year performance. Other stated risks include licensed-product demand and renewals, competition, product forecasting, vendor dependence, international operations, and foreign-exchange exposure.
Important facts for investors to verify
- Whether the 2018 convertible notes were repaid, refinanced or extended by the applicable June 2018 deadline, and whether the credit facility maturity was extended.
- Whether the proposed credit-facility amendment and inventory-backed term loan closed, and how much usable borrowing capacity resulted.
- Subsequent collections, insurance recoveries or bankruptcy claims relating to the fully reserved $22.5 million TRU receivable.
- Progress on the Meisheng proposal and any resulting ownership, governance or financing changes.
- Actual sales, margins and cash flow through the seasonally important later quarters, including the effects of customer concentration and minimum royalty commitments.