JAKKS Pacific, Inc. — FY 2017 Form 10-K
Reporting period: Fiscal year ended December 31, 2017. This annual filing also reports fourth-quarter results. Amounts below are in U.S. dollars; financial statement figures are generally in millions unless noted.
Business context
JAKKS designs, markets and distributes toys and related consumer products, including licensed character toys, dolls, costumes and seasonal products. It reports three segments: U.S. and Canada, International, and Halloween. The business is highly seasonal: 65.1% of FY 2017 sales occurred in the third and fourth quarters. Wal-Mart, Target and Toys “R” Us accounted for 54.6% of annual sales combined.
Financial performance and liquidity
| Metric | FY 2017 | FY 2016 |
|---|---|---|
| Net sales | $613.1 | $706.6 |
| Gross profit / gross margin | $155.7 / 25.4% | $223.0 / 31.6% |
| SG&A | $206.3 | $205.9 |
| Operating income (loss) | $(64.2) | $17.1 |
| Net income (loss) attributable to JAKKS | $(83.1) | $1.2 |
| Diluted EPS | $(3.89) | $0.07 |
| Operating cash flow | $11.4 | $16.7 |
Sales fell 13.2% year over year. U.S. and Canada sales declined 15.1% to $406.4 million; International declined 18.3% to $107.2 million; Halloween increased 2.8% to $99.5 million. Operating results were negative in all three segments in 2017: U.S. and Canada $(35.7) million, International $(13.2) million, and Halloween $(15.3) million.
Fourth quarter: Sales were $136.6 million versus $167.0 million in Q4 2016; gross margin was 22.1% versus 31.2%; operating loss was $26.6 million versus $2.4 million; net loss was $30.5 million versus $7.8 million; diluted loss per share was $1.33 versus $0.47.
At year-end, cash was $65.0 million, working capital $146.9 million (down from $236.6 million), total assets $370.3 million and stockholders’ equity $94.5 million. Operating activities generated $11.4 million, investing activities used $14.8 million and financing activities used $21.4 million; cash declined by $21.1 million to $65.0 million. Inventory fell to $58.4 million from $75.4 million, while net accounts receivable fell to $142.5 million from $173.6 million.
Debt included $5.0 million outstanding on the revolving credit facility and convertible notes with $154.6 million net carrying value ($21.1 million current and $133.5 million long-term). The notes’ principal amounts were approximately $155.7 million. The company reported compliance with credit facility covenants at year-end and $14.1 million of excess borrowing capacity. Contractual obligations totaled $314.7 million, including $57.1 million of future minimum license guarantees, $60.8 million of operating leases and debt and interest obligations.
Material changes and unusual items
- Gross margin contracted 6.2 percentage points. Management attributed the deterioration principally to minimum royalty guarantee shortfalls, inventory impairment and product mix; SG&A remained broadly flat as sales declined.
- FY 2017 included $13.5 million of goodwill and intangible impairment charges: $8.3 million goodwill, $2.9 million DreamPlay technology rights and $2.3 million trademarks and trade names. The company also wrote off its $7.0 million DreamPlay, LLC investment.
- The company recorded $9.6 million of excess and impaired inventory charges and $20.5 million of write-downs of license advances and minimum guarantees not expected to be recovered through sales. Bad-debt expense included a $8.9 million Toys “R” Us bankruptcy-related write-off; the filing also reports $11.8 million provision for doubtful accounts in the cash flow reconciliation.
- In 2017, JAKKS exchanged or retired $51.1 million principal amount of 4.25% notes due 2018, paying $35.6 million in cash and issuing approximately 3.0 million shares. It extended another $21.5 million of those notes to November 2020 at 3.25%, with a conversion price of $3.05. It also issued 3.7 million shares to a Meisheng affiliate for $19.3 million.
- The Tax Cuts and Jobs Act generated provisional tax accounting, including a stated $34.3 million provisional amount in income tax expense, partially offset by fully valued tax attributes. The reported income tax expense was $1.6 million; the filing says the tax accounting was provisional and would be completed in 2018. A $89.7 million valuation allowance was recorded against deferred tax assets.
Outlook, risks and contingencies
Management said cash flows from operations and cash on hand should be sufficient for working capital and capital expenditure needs for at least 12 months from the report’s issuance. It expected 2018 capital expenditures of approximately $14 million and planned a U.S. and Canada launch of C’est Moi makeup and skincare products in Q1 2018. The filing provides no quantitative sales or earnings guidance.
Toys “R” Us filed for bankruptcy in September 2017 and, on March 15, 2018, sought authority to wind down U.S. operations and close all 735 U.S. stores. At December 31, JAKKS had $22.8 million of gross pre-petition receivables, reserved $8.9 million, and had $18.6 million of post-petition receivables. By March 15, the filing reported $13.1 million of post-petition receivables and a $13.1 million net exposure after insurance claim and reserve; management said collectibility and future revenue effects remained uncertain.
Key risks include dependence on a concentrated customer base and licensed brands, customer credit and retailer failures, changing consumer demand, intense competition, minimum royalty commitments, reliance on third-party manufacturers principally in China, foreign currency and trade risks, product safety and intellectual property claims, and the ability to service or refinance convertible notes. Minimum guaranteed license payments due within 12 months were $40.7 million. The company did not use derivatives to hedge currency or interest-rate risks. Ordinary-course litigation was not expected by management to have a material effect. BDO issued unqualified opinions on the financial statements and internal controls.
Important facts for investors to verify
- Recoverability of Toys “R” Us receivables, insurance proceeds and the impact of the retailer’s liquidation on future sales.
- Whether 2017’s lower revenue, weak margins and losses persist, and whether the inventory, license-advance and impairment charges are recurring or signal reduced product demand.
- Liquidity and refinancing capacity for convertible notes, including the $21.2 million notes due August 2018, alongside $40.7 million of minimum license guarantees due in 2018.
- Final 2018 accounting for the Tax Act and the realizability of deferred tax assets subject to the $89.7 million valuation allowance.
- Execution and economics of the C’est Moi launch, and effects of 2017 equity issuance and convertible-note exchanges on share count and dilution.