JAKKS Pacific, Inc. — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017; comparisons are with Q1 2016 unless otherwise noted. JAKKS designs, markets, and distributes toys and consumer products through U.S. and Canada, International, and Halloween segments. Results are seasonal, with sales generally highest in the third and fourth quarters.
Financial performance
| Metric | Q1 2017 | Q1 2016 |
|---|---|---|
| Net sales | $94.5 million | $95.8 million |
| Gross profit / margin | $30.0 million / 31.8% | $31.2 million / 32.5% |
| Operating loss | $15.7 million | $13.8 million |
| Net loss attributable to JAKKS | $18.3 million | $17.4 million |
| Basic and diluted loss per share | $1.01 | $1.01 |
| Cash provided by operating activities | $9.9 million | $33.4 million |
- Sales declined 1.4%. U.S. and Canada sales fell 1.8% to $70.9 million; International sales fell 1.5% to $19.9 million; Halloween sales rose 8.8% to $3.7 million.
- Operating loss widened by $1.9 million. SG&A rose $0.7 million to $45.7 million, or 48.4% of sales versus 46.9%. Management attributed the increase primarily to C’est Moi product-line and Studio JP initiative overhead, partly offset by lower media spending.
- Halloween generated a $0.6 million gross loss, compared with $1.5 million gross profit a year earlier. The filing cites higher-cost product mix and customer allowances, despite increased sales.
- Interest expense declined to $2.9 million from $3.2 million, reflecting lower average debt following repurchases and retirements. The quarter’s $0.3 million tax benefit reflected a 1.8% effective rate; the comparable period had $0.4 million of tax expense.
Liquidity, cash flow, and debt
- At March 31, 2017, cash and cash equivalents were $57.5 million, restricted cash was $10.6 million, and working capital was $198.2 million, down from $236.6 million at year-end. Management attributed the working-capital decline mainly to the note exchange and retirement, net loss, and lower receivables.
- Operating cash flow was $9.9 million, versus $33.4 million. Receivables declined by $75.1 million and inventory by $8.0 million, while prepaid expenses increased $15.1 million and accounts payable and accrued expenses declined by $19.3 million and $20.0 million, respectively.
- Investing activities used $4.4 million, primarily for molds and tooling. Financing activities used $34.6 million, including $24.1 million cash paid in the exchange of $39.1 million principal amount of 2018 convertible notes.
- Convertible notes had $167.7 million principal outstanding ($164.6 million net carrying amount): $54.7 million of 4.25% notes due 2018 and $113.0 million of 4.875% notes due 2020. The company also had $10.0 million outstanding under its $75 million revolving facility, which matures in 2019.
- Borrowings and standby letters of credit exceeded the revolver borrowing base by $10.6 million at quarter-end; the company funded the shortfall with restricted cash. It reported compliance with credit-facility financial covenants.
- Management said cash, operating cash flow, and credit-facility availability should meet working-capital and capital needs for at least 12 months, while noting seasonal needs and that additional financing may be required if the business grows significantly.
Material changes, outlook, and risks
- The $39.1 million 2018-note exchange reduced principal by $39.1 million in return for $24.1 million cash and approximately 2.9 million common shares. This contributed to the increase in shares issued and outstanding shown on the balance sheet.
- After quarter-end, an agreement to sell 3,660,891 shares to Hong Kong Meisheng for $19.3 million closed on April 27, 2017; proceeds were designated for general corporate purposes.
- No specific revenue or earnings guidance is provided. Management cautions that seasonality, cancelable orders, and uncertain consumer demand make backlog and quarterly results unreliable indicators of full-year performance.
- Future minimum guarantees under product and character licenses totaled $73.3 million, excluding $30.3 million in advances already paid; $46.8 million was due within 12 months.
- Customer concentration is notable: Wal-Mart, Target, and Toys “R” Us generated 46.2% of Q1 sales, and the three largest customers represented about 46.3% of accounts receivable at March 31. Management warns that customer financial distress could adversely affect results.
- The company reported $2.3 million of income-tax reserves, primarily related to potential Hong Kong tax settlement and withholding-tax matters. Ordinary-course litigation was not expected by management to have a material effect; no material risk-factor changes were reported.
Key facts for investors to verify
- Whether the Halloween segment’s gross loss and weaker consolidated margins persist or improve in subsequent quarters.
- Whether operating cash generation recovers, considering seasonal working-capital swings and the Q1 decline in operating cash flow.
- Availability under the borrowing base and the conditions for releasing the $10.6 million of restricted cash.
- Execution and dilution effects of the Meisheng share issuance, alongside the remaining convertible-note maturities and terms.
- Customer concentration, the $46.8 million of license minimum guarantees due within 12 months, and resolution of tax contingencies.