JAKKS Pacific, Inc. — Q3 2017 Form 10-Q
Business and period: Children’s toy and consumer-products company reporting the unaudited quarter and nine months ended September 30, 2017. Results are seasonal, with sales generally strongest in the third and fourth quarters. Amounts below are in U.S. dollars; financial statement figures are converted from thousands to millions.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Net sales | $262.4M | $302.8M | $476.5M | $539.6M |
| Gross profit | $61.8M | $94.9M | $125.5M | $170.9M |
| Gross margin | 23.5% | 31.4% | 26.3% | 31.7% |
| Operating income (loss) | ($7.7M) | $34.4M | ($37.6M) | $19.5M |
| Net income (loss) | ($17.6M) | $30.5M | ($52.5M) | $9.0M |
| Net income (loss) attributable to JAKKS | ($17.6M) | $30.6M | ($52.7M) | $8.8M |
| Basic and diluted EPS | ($0.77) | $1.91 basic; $0.82 diluted | ($2.53) | $0.53 basic; $0.36 diluted |
Q3 sales fell about 13% year over year and nine-month sales fell about 12%. The largest segment, U.S. and Canada, declined 18.3% in Q3 and 15.8% for the nine-month period. International sales also declined; Halloween sales increased modestly. Gross margin contracted substantially, reflecting minimum-guarantee shortfalls, inventory impairment and lower-margin sales, among other factors. SG&A declined in dollars, but rose as a share of sales; bad-debt write-offs partly offset lower marketing expense.
Cash, debt and liquidity
- Cash and cash equivalents were $45.4M at September 30, 2017, plus $3.4M restricted cash; combined cash, cash equivalents and restricted cash were $48.8M, versus $86.1M at December 31, 2016.
- Operating activities used $6.2M in the first nine months, compared with $20.7M used in the prior-year period. Investing activities used $10.4M, primarily for molds and tooling; financing activities used $24.3M.
- Working capital was $182.0M, down from $236.6M at year-end 2016. Accounts receivable was $224.1M and inventory $80.1M. The allowance for doubtful accounts increased to $13.3M from $2.9M at year-end; the company recorded $11.0M of doubtful-account provision during the nine months.
- Convertible notes had a net carrying amount of $153.3M at quarter-end; revolver borrowings were $2.0M. The $75M revolving facility matures March 27, 2019. The company reported compliance with its financial covenants. Letters of credit exceeded borrowing-base availability by $3.4M, which was funded as restricted cash.
- Management stated that cash, expected operating cash flows and credit-facility availability should be sufficient for working capital and capital expenditure needs for at least the next 12 months, while noting that seasonal needs or significant growth could require additional financing.
- Future licensing minimum guarantees were $48.0M, excluding $15.4M in advances already paid; $34.5M was due over the following 12 months.
Material changes, commentary and risks
- Q3 included $13.5M of goodwill and intangible-asset impairment: $8.3M goodwill, $2.9M DreamPlay technology rights and $2.3M trademarks and trade names. The company also wrote off its $7.0M investment in DreamPlay, LLC. These charges followed a conclusion that the technology had not established a commercially viable market and that certain reporting-unit fair values had declined below carrying values.
- Toys “R” Us filed for Chapter 11 protection in the U.S. and related proceedings in Canada during September. JAKKS said the uncertainty affected quarterly sales but it could not quantify the impact; it resumed shipments for the 2017 holiday season and continued monitoring exposure. The three largest customers represented 47.9% of Q3 sales and 42.6% of receivables at quarter-end.
- During 2017, JAKKS exchanged and retired $51.1M principal amount of 2018 notes for cash and shares. A separate agreement to extend approximately $21.5M of 4.25% notes to November 1, 2020, reduce the rate to 3.25% and revise the conversion rate closed on November 7, after quarter-end. The filing classified approximately $21.5M as long-term and the remaining approximately $21.2M as current at September 30.
- JAKKS issued 3.66M shares to a Hong Kong affiliate of its China joint-venture partner for $19.3M in cash; shares outstanding were 26.99M at November 9, 2017. The increased share count is relevant when assessing per-share results and dilution.
- Management cited declining sales of several licensed product lines and minimum-guarantee shortfalls. Toy-industry seasonality and cancelable orders make forecasting difficult; reported quarterly results may not indicate full-year performance. The company identified customer credit risk, inventory-demand estimation, license commitments, foreign exchange and interest rates as relevant exposures.
- No specific earnings or revenue guidance was provided in the filing. Management’s liquidity statement is an outlook, not a guarantee. Ordinary-course litigation was not expected by management to have a material effect; the filing reported no material change to previously disclosed risk factors. Disclosure controls were assessed as effective.
Most important facts for investors to verify
- Whether seasonal fourth-quarter sales and collections recover from the year-to-date declines and whether gross margins stabilize.
- Receivables collectability, the adequacy of the sharply increased doubtful-account allowance, and continued exposure to Toys “R” Us and other large customers.
- Liquidity and borrowing availability, including restricted cash, borrowing-base limits, covenant compliance and the timing of licensing guarantees.
- Execution and terms of the November 7 note modification, remaining note maturities, and any resulting cash or share dilution.
- Whether further impairment charges, licensed-product minimum-guarantee shortfalls or weak demand affect future results.