JAKKS Pacific, Inc. — Q2 2017 Form 10-Q
Business context and period: Toy and consumer-products designer, marketer, and distributor, reporting the quarter and six months ended June 30, 2017. Its segments are U.S. and Canada, International, and Halloween. Results are unaudited; management cautions that toy-industry seasonality makes interim results potentially unrepresentative of the full year.
Financial performance
| Metric | Q2 2017 | Q2 2016 | First half 2017 | First half 2016 |
|---|---|---|---|---|
| Net sales | $119.6 million | $141.0 million | $214.1 million | $236.8 million |
| Gross profit / margin | $33.7 million / 28.2% | $44.8 million / 31.8% | $63.7 million / 29.8% | $76.0 million / 32.1% |
| Operating loss | $14.1 million | $1.1 million | $29.8 million | $14.9 million |
| Net loss attributable to JAKKS | $16.7 million | $4.4 million | $35.1 million | $21.8 million |
| Loss per share, basic and diluted | $0.77 | $0.27 | $1.77 | $1.30 |
Cash flow: In the first half, operating activities provided $13.2 million, versus $18.7 million in 2016; investing activities used $7.6 million, mainly for molds and tooling; financing activities used $26.3 million. Cash, cash equivalents, and restricted cash declined to $67.6 million from $86.1 million at year-end 2016. The company reported $64.1 million of cash and $3.5 million of restricted cash at June 30.
Balance sheet and debt: Working capital was $191.0 million, down from $236.6 million at year-end. Current assets were $289.4 million and current liabilities $98.4 million. Convertible notes had $155.7 million principal outstanding ($153.0 million net of issuance costs): $42.7 million due 2018 and $113.0 million due 2020. Revolver borrowings were zero at quarter-end; the $75 million facility matures in March 2019. Standby letters of credit totaled $28.2 million and exceeded borrowing-base availability by $3.5 million, which was funded with restricted cash. The company reported compliance with facility covenants.
Material changes and drivers
- Q2 sales fell 15.2% year over year; first-half sales declined 9.6%. U.S. and Canada sales fell 21.9% in Q2, principally from lower sales of Tsum Tsum, Frozen toddler dolls, XPV vehicles, and seasonal products. International sales fell 12.5%. Halloween sales rose 1.9% in Q2 and 2.6% for the first half, attributed to product mix.
- Gross margin contracted 3.6 percentage points in Q2. Management cited U.S. and Canada product mix, higher royalty rates, and increased mold/tooling depreciation; international mix improved, while Halloween first-half cost ratios worsened.
- SG&A rose to $47.8 million in Q2 and $93.6 million in the first half, and increased as a share of sales. A $2.3 million non-cash bad-debt charge was a key factor; first-half costs also reflected overhead for C’est Moi and the Studio JP animation initiative.
- First-half loss worsened despite lower interest expense ($5.5 million versus $6.4 million), as lower revenue and margins and higher SG&A weighed on results. A $2.3 million doubtful-account provision was recorded in operating cash-flow reconciliation.
- The company exchanged and retired $51.1 million principal amount of 2018 notes during the first half for cash and shares. It also issued 3.66 million shares to a Hong Kong affiliate of its China joint-venture partner for $19.3 million, increasing shares outstanding.
Outlook, risks, and unusual items
- Management believes operating cash flow, cash on hand, and credit-facility availability will meet working-capital and capital-expenditure needs for at least 12 months. It warns that seasonal needs or significant growth may require additional financing, which may not be available on acceptable terms.
- Seasonal sales generally peak in the third and fourth quarters; customer orders are generally cancelable until shipment, limiting the usefulness of backlog as a sales indicator. No specific revenue or earnings guidance is provided.
- Future minimum license guarantees were $69.6 million, of which $46.3 million was due within 12 months; $26.2 million of advances had already been paid.
- Customer concentration is significant: the three largest customers represented 42.6% of Q2 sales, and 42.9% of net receivables at June 30. Management identifies potential credit exposure if a major customer experiences financial difficulty.
- In August 2017, after quarter-end, JAKKS agreed in principle with a holder of $21.6 million face amount of 2018 notes to extend maturity to November 2020 and reduce the rate to 3.25%, subject to definitive documentation and approvals. The filing states the remaining 2018-note face amount would then be approximately $21.2 million.
- Management reported no goodwill impairment in the first half. Ordinary-course litigation was not believed likely to have a material effect; the filing reported no material change to previously disclosed risk factors. Disclosure controls were deemed effective.
Important facts for investors to verify
- Whether seasonal second-half demand, product launches, and customer orders recover enough to offset first-half sales and margin declines.
- Receivable collectability and customer concentration, including the effect of the bad-debt charge and allowance for doubtful accounts.
- Cash availability, borrowing-base headroom, letter-of-credit requirements, and compliance with the revolving facility’s covenants.
- Final terms and approvals for the proposed 2018-note maturity extension, and the resulting dilution or cash obligations from convertible notes and share issuance.
- Ability to meet near-term license guarantees and other seasonal working-capital needs while maintaining liquidity.