JAKKS Pacific, Inc. — Q3 2012 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2012. Unaudited results; amounts below are in U.S. dollars, generally millions except per-share data.
Financial performance
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Net sales | $314.5 | $332.4 | $533.3 | $536.7 |
| Gross profit / margin | $96.7 / 30.8% | $105.7 / 31.8% | $167.2 / 31.3% | $175.0 / 32.6% |
| Operating income / margin | $37.3 / 11.9% | $50.1 / 15.1% | $18.0 / 3.4% | $37.3 / 6.9% |
| Net income | $30.4 | $34.8 | $14.7 | $28.5 |
| Diluted EPS | $1.10 | $1.10 | $0.59 | $0.97 |
Q3 sales declined 5.4% year over year and net income declined 12.6%; nine-month sales were nearly flat while operating income fell about 52% and net income about 49%. Q3 basic EPS rose to $1.38 from $1.32 despite lower net income, reflecting fewer weighted-average shares following the tender offer; diluted EPS was unchanged.
Q3 Traditional Toys and Electronics sales grew 4.9% to $171.2 million, while Role Play, Novelty and Seasonal sales fell 15.3% to $143.3 million. Management cited new product launches and acquired Moose Mountain sales as contributors to the former; lower sales of dress-up products, Halloween items and outdoor furniture weighed on the latter. Higher advertising and other SG&A costs, alongside lower gross margin, reduced operating profitability.
Cash flow, liquidity and debt
- Operating cash flow was a use of $19.3 million in the first nine months, versus a $2.6 million use in the comparable 2011 period. Increased receivables and inventory and lower sales-return reserves were key cash uses.
- Investing cash use was $62.8 million, including acquisitions, technology rights, the DreamPlay LLC investment and capital spending. Financing cash use was $34.5 million, principally the $80 million share repurchase and $7.4 million of dividends, partly offset by $53.4 million of credit-facility borrowings.
- Cash and equivalents were $140.8 million at September 30, down from $257.3 million at year-end 2011. Working capital was $257.5 million, versus $374.7 million. Accounts receivable increased to $242.6 million and inventory to $73.2 million.
- A new secured $75 million revolving facility had $53.4 million outstanding at 3.25%; it matures April 30, 2013. The company also had $100 million principal amount of 4.50% convertible notes due November 2014; their balance-sheet carrying amount, net, was $94.2 million.
- At September 30, the company failed two credit-facility covenants: rolling consolidated net profit was negative $5.4 million versus a minimum of $1, and leverage was 5.87x versus a maximum of 4.00x. It met the $100 million liquidity requirement, reporting $141.0 million. On November 7, the lender waived the two breaches and imposed additional reporting requirements and a $10 million limit on future acquisitions without lender consent. Future covenant breaches could trigger default and acceleration.
- Management said cash, operating cash flows and cash equivalents should be sufficient for working capital and capital needs for at least 12 months, while cautioning that future growth may require additional financing. $130.8 million of cash and short-term investments was held in Hong Kong and was subject to a 25% repatriation tax.
Material developments, outlook and risks
- The company repurchased and retired 4 million shares for $80 million, or $20 per share, in July. It also paid quarterly dividends of $0.10 per share.
- It acquired Maui in July for initial consideration of $37.6 million, with an earn-out of up to $18 million, and acquired UK-based JKID in September for $1.1 million upfront plus $5.5 million in deferred payments and a potential $4.4 million earn-out. Purchase-price allocations were not final.
- The company invested $8 million cash and issued warrants valued at $7 million for exclusive toy-technology rights connected with DreamPlay Toys; it separately invested $7 million for a 5% economic interest in DreamPlay LLC. DreamPlay product sales were expected to begin in Q2 2013.
- Future minimum license guarantees were $51.8 million, including $32.7 million due within 12 months. The toy business is seasonal, with sales and working-capital needs generally concentrated in the third and fourth quarters; customer orders are cancelable before shipment.
- No specific full-year earnings or sales guidance is stated in the supplied filing text. Key risks include covenant compliance and refinancing, customer and licensor concentration, product and license demand, acquisition integration, inventory forecasting, reliance on third-party manufacturers, and foreign currency and repatriation exposure. The three largest customers represented 43.5% of nine-month sales; Wal-Mart alone represented 17.8%.
- Management reported ordinary-course legal proceedings that it did not expect to have a material effect. It also warned that domestic deferred tax assets could be impaired if sufficient taxable income is not generated. Disclosure controls were assessed as effective.
Important facts for investors to verify
- Compliance with the amended Wells Fargo facility covenants, the terms of the November waiver, and the company’s refinancing or repayment plan before the April 2013 maturity.
- Cash availability and repatriation constraints, seasonal working-capital needs, and the ability to convert receivables and inventory into operating cash.
- Sales and margin trends by segment, especially continued weakness in Role Play, Novelty and Seasonal products and the effect of advertising and royalty costs.
- Final purchase-price allocations, earn-out liabilities and integration performance for Maui and JKID, plus the expected launch and economics of DreamPlay products.
- Customer concentration, $51.8 million of future minimum license guarantees, and the potential impact of product demand or license renewals.