JAKKS Pacific, Inc. — Q2 2018 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2018. The company designs, markets, and distributes toys and consumer products, including Halloween costumes, through U.S. and Canada, International, and Halloween segments. Amounts below are in millions of dollars unless stated otherwise.
Financial performance
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Net sales | $105.8 | $119.6 | $198.8 | $214.1 |
| Gross profit / margin | $27.9 / 26.4% | $33.7 / 28.2% | $50.9 / 25.6% | $63.7 / 29.8% |
| Operating loss | ($12.1) | ($14.1) | ($47.8) | ($29.8) |
| Net loss attributable to JAKKS | ($18.6) | ($16.7) | ($54.8) | ($35.1) |
| Loss per diluted share | ($0.80) | ($0.77) | ($2.37) | ($1.77) |
Q2 sales declined 11.5% year over year; first-half sales declined 7.1%. Q2 SG&A fell to $40.1 million from $47.8 million, but first-half SG&A rose to $98.7 million from $93.6 million, principally due to bad-debt expense associated with Toys “R” Us (TRU). The first-half operating loss included a $3.4 million noncash loss from remeasuring certain convertible notes at fair value; Q2 included $2.4 million of that charge.
- Cash flow: Operating activities used $8.7 million in the first half, versus $13.2 million provided in the prior-year period. Investing activities used $6.5 million, mainly for molds and tooling; financing activities provided $13.5 million. Cash, cash equivalents, and restricted cash totaled $63.0 million at June 30, versus $65.0 million at year-end.
- Liquidity: Working capital was $85.0 million, down from $146.9 million at December 31, 2017. Cash and cash equivalents were $36.8 million, with an additional $26.2 million restricted cash. Wells Fargo revolver borrowings were zero, with $21.8 million excess availability and $13.4 million of letters of credit outstanding.
- Debt: Convertible notes had a carrying value of $158.5 million at June 30. The company also had a $20.0 million secured GACP term loan, bearing LIBOR plus 9% (weighted-average rate about 11.1% in the period). The loan is secured, includes covenants and a $10.0 million minimum-liquidity requirement, and has an early maturity trigger tied to the Wells Fargo facility and 2020 notes. The Wells Fargo facility matures March 27, 2019, subject to its terms.
- Other balance-sheet items: Total assets were $348.9 million and total liabilities $308.6 million. Accounts receivable were $100.3 million net of a $23.3 million doubtful-account allowance; inventory was $62.2 million. Stockholders’ equity was $40.3 million.
Material changes and segment trends
- U.S. and Canada sales fell 15.3% in Q2 and 7.9% in the first half, primarily due to the TRU U.S. liquidation. The segment’s first-half operating loss widened to $29.4 million from $17.4 million.
- International sales rose 25.7% in Q2 and 5.1% in the first half, supported by Nintendo products and newer Incredibles 2 and Squish-Dee-Lish products. First-half operating loss widened to $9.7 million from $3.3 million, with higher royalties and product costs cited.
- Halloween sales fell 23.5% in Q2 and 17.1% in the first half; first-half operating loss was $8.7 million versus $9.2 million. Management cited lower unit sales and higher cost and royalty rates as a share of sales.
- TRU’s exposed receivable balance was $35.1 million. JAKKS received $12.0 million from its insurer and $1.9 million from TRU during Q2; the remaining $21.2 million was fully reserved at June 30. TRU represented 17.5% of gross receivables at quarter-end.
- Common shares outstanding increased to 29.17 million from 26.96 million at year-end. The company adopted ASC 606 on January 1, 2018; it reported no material effect on revenue or cost of sales.
Outlook, risks, and unusual items
Management stated that cash, projected operating cash flow, and borrowing availability should be sufficient for working capital, capital expenditures, and debt repayment over the next 12 months, subject to mitigating plans. This assessment depends on operating performance, financing access, and other assumptions; the filing provides no numerical sales or earnings guidance. The company was in initial negotiations to amend and extend its Wells Fargo facility and said it could not assure completion or alternative financing on acceptable terms. If financing is unavailable, it may need to restructure costs or adjust inventory purchases and supplier payment terms, potentially harming revenue and operations.
- On July 26, 2018, after quarter-end, JAKKS exchanged $8.0 million face amount of notes due August 2018 for 3.25% convertible notes due November 2020. The filing does not indicate that the remaining 2018 notes were also exchanged.
- Meisheng had made a non-binding proposal to acquire additional shares at $2.95 per share, potentially increasing its ownership to 51%, alongside possible debt restructuring or refinancing. A board special committee was evaluating the proposal; no transaction was assured.
- Future minimum royalty guarantees were $101.9 million, excluding $21.4 million of advances already paid; $44.6 million was due over the next 12 months.
- The toy business is seasonal, with sales generally strongest in the third and fourth quarters and working-capital needs highest in the second and third quarters. Orders are generally cancelable before shipment, limiting backlog’s usefulness as a sales indicator.
- Risks include customer concentration, TRU-related credit exposure, product-demand forecasting, dependence on licensors and vendors, covenant compliance, variable-rate borrowing costs, and refinancing needs. The company reported compliance with its credit-facility and term-loan covenants at June 30. Routine litigation was not believed material; no off-balance-sheet arrangements were reported.
Key facts for investors to verify
- Whether JAKKS extended or refinanced the Wells Fargo facility before its March 2019 maturity, and the resulting availability, covenants, and maturity terms.
- The amount and repayment or refinancing status of the 2018 convertible notes remaining after the July 26 exchange, and the terms of debt maturing in 2020.
- Whether the company sustains liquidity and covenant compliance while operating cash flow is negative and royalty commitments remain substantial.
- TRU receivable recoveries, the adequacy of the doubtful-account and sales-return reserves, and any further customer-credit exposure.
- Progress and outcome of Meisheng’s non-binding proposal, including any effects on ownership, governance, financing, or dilution.
- Whether sales, gross margins, and segment operating performance improve during the seasonally important second half.