JAKKS Pacific, Inc. — Q2 2011 Form 10-Q
Reporting period: Three and six months ended June 30, 2011; filed August 1, 2011. JAKKS designs, markets and distributes toys and children’s consumer products. Results are unaudited, and the company cautions that interim and seasonal results may not predict full-year performance. Amounts below are in millions unless otherwise noted.
Financial performance
| Metric | Q2 2011 | Q2 2010 | First half 2011 | First half 2010 |
|---|---|---|---|---|
| Net sales | $131.9 | $123.3 | $204.3 | $200.6 |
| Gross profit / margin | $45.1 / 34.2% | $43.2 / 35.1% | $69.4 / 34.0% | $68.5 / 34.1% |
| Operating income (loss) | $2.0 | $1.3 | $(12.8) | $(12.4) |
| Net income (loss) | $4.2 | $3.0 | $(6.3) | $(2.2) |
| Diluted EPS | $0.16 | $0.11 | $(0.23) | $(0.08) |
| Operating cash flow | Not presented by quarter | $(14.6) | $24.0 |
Q2 sales increased 7.0% year over year. Traditional Toys and Electronics sales rose 6.6% to $67.7 million; Role Play, Novelty and Seasonal Toys sales rose 7.5% to $64.2 million. First-half sales were up 1.8%; the Traditional segment grew 3.6%, while Role Play, Novelty and Seasonal was essentially flat. The filing attributes Q2 sales growth mainly to selected licensed and branded toys and Halloween products.
Q2 operating income improved by $0.7 million, while first-half operating loss widened by $0.4 million. First-half gross margin edged down to 34.0%, including higher royalty costs in Traditional Toys and Electronics, partly offset by lower costs and royalties in Role Play, Novelty and Seasonal. SG&A was $43.1 million in Q2 and $82.2 million in the first half; the first-half total rose $1.3 million, with higher product development, advisory and advertising costs partly offset by lower compensation expense.
Q2 net income included a $6.0 million payment from the terminated THQ video-game joint venture, recognized as income. The agreement provides for two further $4.0 million payments, due in 2012 and 2013, which JAKKS says it will recognize when received. This payment is important context for interpreting reported profitability: Q2 operating income was $2.0 million, versus net income of $4.2 million.
Cash, liquidity and debt
- Cash and cash equivalents were $246.8 million at June 30, 2011, down $31.5 million from year-end 2010. Working capital was $372.8 million, versus $387.3 million at December 31, 2010; current assets were $488.5 million and current liabilities $115.7 million.
- First-half operating activities used $14.6 million, compared with $24.0 million provided a year earlier. The filing cites inventory and prepaid-expense spending; inventory increased to $55.3 million from $43.2 million at year-end. Investing activities used $12.1 million, including $8.6 million for property, equipment, molds and tooling and acquisition earn-outs. Financing activities used $4.8 million, primarily reflecting share repurchases.
- Convertible senior notes had $100.0 million principal outstanding, carry 4.50% interest and mature November 1, 2014. Their balance-sheet carrying amount, net, was $90.8 million. Holders may require cash repurchase after specified fundamental changes.
- Management said available cash and expected operating cash flows should cover working-capital and capital-expenditure needs for at least 12 months. The company reported no off-balance-sheet arrangements.
Outlook, changes and risks
- No quantified revenue, earnings or margin guidance is provided. Management emphasizes toy-industry seasonality: sales generally peak in the third and fourth quarters, and working-capital needs are typically highest then. Orders are cancelable until shipment, limiting the usefulness of backlog as a sales indicator.
- Future minimum guarantees under product and character licenses totaled $101.2 million, excluding $48.1 million in advances already paid; $51.9 million was due within 12 months. License royalties generally range from 1% to 14% of net sales. Minimum royalties may be payable even if sales are insufficient.
- Three customers accounted for 48.4% of first-half net sales; the three largest represented approximately 47.3% of net receivables at June 30. The filing identifies customer concentration, retailer credit and order reductions as risks. Sales to Wal-Mart, Toys “R” Us and Target represented 48.4% of first-half sales.
- Other disclosed risks include changing consumer tastes and short product life cycles, competition for licenses and retail shelf space, reliance on third-party manufacturers principally in China, supply and transportation disruptions, foreign-currency exposure, product-safety and intellectual-property claims, and possible impairment of goodwill or intangibles.
- The first-half tax benefit was $4.3 million and included a $1.5 million discrete benefit from tax-reserve reductions and state tax refunds. The comparable 2010 period included a $4.9 million discrete tax benefit, affecting year-over-year comparisons. Ordinary-course legal proceedings were not expected by management to have a material effect.
- The board’s $30.0 million repurchase authorization had $19.3 million remaining at June 30. JAKKS repurchased and retired shares totaling approximately $5.1 million during the first quarter of 2011.
Most important facts for investors to verify
- How much Q2 earnings depended on the one-time-in-period $6.0 million THQ settlement payment, and the timing and collectability of the remaining $8.0 million.
- Whether seasonal second-half sales and cash generation are sufficient to address the first-half operating cash outflow and higher inventory.
- The sales, margin and royalty trends by segment, particularly the impact of product mix and licensed-product costs.
- The company’s ability to meet $51.9 million of near-term license minimum guarantees and manage customer and supplier concentration.
- Liquidity available for the 2014 notes, including the potential cash-repurchase obligation if a specified fundamental change occurs.
- Tax-reserve developments and the extent to which discrete tax items affect comparisons with future periods.