JAKKS Pacific, Inc. — Q2 2014 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2014. The company designs, markets and distributes toys and consumer products through Traditional Toys and Electronics and Role Play, Novelty and Seasonal Toys. Financial amounts below are in U.S. dollars unless stated otherwise.
Financial performance and position
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Net sales | $124.2m | $106.2m | $206.7m | $184.3m |
| Gross profit / margin | $37.8m / 30.5% | $2.2m / 2.1% | $61.4m / 29.7% | $25.6m / 13.9% |
| Operating loss / margin | $(4.8)m / (3.8)% | $(44.3)m / (41.7)% | $(19.7)m / (9.5)% | $(68.1)m / (37.0)% |
| Net loss | $(9.1)m | $(46.9)m | $(25.4)m | $(74.4)m |
| Basic and diluted loss per share | $(0.43) | $(2.14) | $(1.17) | $(3.40) |
For the six months ended June 30, 2014, operating cash flow was negative $32.6m, investing cash flow negative $6.1m and financing cash flow positive $84.6m. Cash increased $45.6m from year-end to $162.7m. Capital spending on property and equipment was $6.9m.
At June 30, cash and cash equivalents were $162.7m; working capital was $198.4m, up from $136.3m at December 31, 2013. Receivables were $109.3m and inventory $65.1m. Total current liabilities were $201.6m. Long-term debt, including current portion, was $253.6m; the balance-sheet current portion was $38.6m. The GE revolving facility had no balance outstanding, with reported borrowing capacity of approximately $10.9m.
Material changes and operating drivers
- Q2 sales grew 16.9%; six-month sales grew 12.1%. Role Play, Novelty and Seasonal Toys drove growth, with sales up 29.5% in Q2 and 25.0% for the six-month period, supported by Frozen-related products and Halloween costumes; six-month results also benefited from Maui Toys.
- Traditional Toys and Electronics sales were nearly flat in Q2, up 1.9%, but down 2.2% for six months. Frozen dolls and accessories helped offset weaker Smurfs figures and playsets.
- Gross margin improved sharply year over year. Management attributed comparisons partly to prior-year closeout activity and write-downs of license minimum guarantees, as well as changes in product mix. SG&A fell $3.9m in Q2 and $12.7m for six months, including lower personnel, legal/professional and product-development costs; Q2 direct selling and advertising costs partly offset savings.
- Interest expense rose to $3.0m in Q2 and $5.2m for six months, largely reflecting the 2018 and 2020 convertible notes.
Outlook, liquidity, risks and unusual items
- Management expected cash on hand, operating cash flows and credit-facility availability to cover working capital and capital spending for at least the next 12 months. No numerical revenue or earnings guidance is provided in the filing.
- The business is seasonal: sales are generally highest in the third and fourth quarters, with working-capital needs also highest in those quarters. Orders are generally cancelable until shipment, making backlog an uncertain indicator.
- In June 2014, JAKKS issued $115m of 4.875% convertible notes due 2020. Proceeds included $24m used for a prepaid forward repurchase of approximately 3.1m shares and $39m intended to redeem the remaining 2014 notes at maturity. The company had $39m of 4.50% notes due November 1, 2014 and anticipated repayment using cash and/or its revolving facility. It also had $100m of 4.25% notes due 2018. The 2020 and 2018 notes are convertible into shares and include cash repurchase rights upon specified fundamental changes.
- The GE facility is secured, subject to borrowing-base availability and financial covenants; the company reported covenant compliance at June 30. A covenant breach could permit acceleration or termination of credit access. Availability was substantially below the facility’s $75m headline commitment.
- Future minimum license guarantees were $58.3m, including $39.2m due within 12 months, in addition to $22.6m of advances already paid. License minimums may burden results and cash if product sales disappoint.
- Customer concentration is material: the three largest customers represented 41.1% of six-month sales and approximately 60.2% of accounts receivable at June 30. The company also cited product and license acceptance, retail demand, third-party manufacturing, international sourcing and currency exposure as risks.
- Pending securities class and shareholder derivative actions include allegations concerning public forecasts and other company matters. JAKKS said it would defend the cases; outcomes and potential financial effects were uncertain. Other routine claims were not expected by management to have a material adverse effect.
- Cash held by foreign subsidiaries was $72.1m at June 30. The filing states that a full valuation allowance was maintained against U.S. deferred tax assets because realization was uncertain. Management was evaluating the effect and adoption method for the new revenue-recognition standard effective in 2017.
Important facts for investors to verify
- Whether seasonal third- and fourth-quarter demand sustains the sales and margin improvement, especially the contribution from Frozen and Halloween products.
- Cash conversion and working-capital trends, including the increase in inventory and receivables and the substantial customer concentration in receivables.
- Funding and repayment plans for the $39m notes due November 2014, and actual borrowing availability and covenant headroom under the GE facility.
- Expected sales, margins and cash requirements associated with the $58.3m of future license minimum guarantees.
- Developments in the class action and derivative litigation, and any resulting costs or disclosures.