JAKKS Pacific, Inc. — Q3 2016 Form 10-Q
Reporting period: Three and nine months ended September 30, 2016; filed November 9, 2016. The company designs, markets, and distributes toys and other consumer products, including Halloween costumes. Unless otherwise stated, amounts below are in U.S. dollars and millions.
Financial results and liquidity
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Net sales | $302.8 | $337.0 | $539.6 | $582.3 |
| Gross profit / margin | $94.9 / 31.4% | $104.3 / 31.0% | $170.9 / 31.7% | $179.0 / 30.7% |
| Operating income / margin | $34.4 / 11.4% | $44.6 / 13.3% | $19.5 / 3.6% | $37.4 / 6.4% |
| Net income attributable to JAKKS | $30.6 | $45.8 | $8.8 | $32.6 |
| Basic / diluted EPS | $1.91 / $0.82 | $2.47 / $1.12 | $0.53 / $0.36 | $1.72 / $0.89 |
- Cash flow: Operating activities used $20.7 million in the first nine months, versus providing $8.9 million in the prior-year period. Investing activities used $17.5 million, primarily for property, molds, and tooling; financing activities used $19.7 million, including $13.5 million for common-stock repurchases.
- Cash and working capital: Cash was $45.5 million and restricted cash $2.7 million at September 30, down from $102.5 million cash at December 31, 2015. Working capital was $247.6 million, versus $255.0 million at year-end.
- Debt and borrowing availability: Convertible notes had $212.3 million principal outstanding ($207.9 million net of issuance costs): $99.3 million of 4.25% notes due 2018 and $113.0 million of 4.875% notes due 2020. No revolving-credit borrowings were outstanding; the $75 million facility had $24.7 million of excess borrowing capacity, including $2.7 million of restricted funds in the process of being returned. The company reported compliance with its financial covenants.
- Margins and expenses: Gross margin improved year over year, but operating margin declined as lower sales and higher SG&A weighed on results. Nine-month SG&A rose $9.8 million, including higher marketing, product-development, and general and administrative costs.
Material changes versus the prior comparable period
- Q3 sales declined 10.2%; nine-month sales declined 7.3%. Operating income fell 22.9% in Q3 and 47.9% for the first nine months. Nine-month net income attributable to JAKKS fell to $8.8 million from $32.6 million.
- International sales were particularly weak: down 26.3% in Q3 and 29.1% year to date, with declines in the UK and Western Europe. Management cited reduced customer buying power following the British pound’s devaluation and lower-than-expected movie-licensed product sales.
- Q3 U.S. and Canada sales decreased 7.0%, partly due to suspended shipments to a major U.S. customer and weaker-than-expected movie-licensed products. Nine-month sales were nearly flat, supported by selected product lines. Halloween sales were up slightly in Q3 but down 2.3% year to date.
- Traditional Toys and Electronics sales declined to $163.5 million in Q3 from $204.3 million; Role Play, Novelty and Seasonal Toys increased to $139.3 million from $132.7 million.
- Receivables rose to $272.3 million from $163.4 million at year-end, and inventory rose to $75.1 million from $60.5 million. Management attributed operating cash use chiefly to the receivables increase, partially offset by higher payables. Days sales outstanding were 83 days, versus 80 days a year earlier.
Outlook, risks, contingencies, and unusual items
- Outlook: No specific numerical full-year guidance is provided in the filing. Management said cash from operations, cash on hand, and credit-facility availability should be sufficient for working capital, capital expenditures, and anticipated operating needs for at least 12 months. It cautioned that seasonality and growth may consume cash and additional financing may not be available on commercially reasonable terms.
- Seasonality and commitments: Sales and working-capital needs are typically highest in the third and fourth quarters. Orders are generally cancelable until shipment, making backlog an unreliable indicator. License agreements require $91.0 million of future minimum guarantees, excluding $21.0 million in advances already paid; $47.0 million is due within 12 months.
- Customer and product exposure: Walmart, Target, and Toys “R” Us represented 47.1% of Q3 sales and 47.2% of nine-month sales. The company also depends on licensed characters and products, making it exposed to consumer preferences, licensing costs and renewals, and the success and timing of related media.
- Other risks: The filing highlights competition, reliance on third-party manufacturers, international sourcing and currency exposure, product-safety regulation, and the possibility of cash repurchase obligations on convertible notes after a defined fundamental change. Foreign subsidiaries held $40.4 million of cash and short-term investments at September 30.
- Litigation: A securities class action remained pending; the company said it intended to defend the claims and could not assure the outcome. A shareholder derivative action had reached an agreement in principle to settle, subject to court approval; the judge had indicated approval of the settlement, with the attorneys’ fee issue under advisement. The company said ordinary-course claims were not expected to have a material effect.
- Unusual items: Nine-month 2015 other income included $5.6 million from the reversal of a Maui acquisition earn-out liability; no comparable amount was recorded in 2016. The 2016 period included $0.2 million of shareholder short-swing-profit disgorgement and $0.2 million from a former joint venture’s partial repayment. A $0.127 million discrete tax benefit was recorded in Q3 2016.
Most important facts for investors to verify
- Whether suspended shipments to the major U.S. customer resume, and how sales and receivables from the largest retailers evolve.
- Whether the sharp year-to-date international sales decline and the impact of sterling weakness persist.
- Cash conversion and working-capital trends, particularly collections, inventory levels, and seasonal funding requirements.
- The timing and economics of the $47.0 million of license minimum guarantees due within 12 months, alongside the company’s remaining liquidity and note maturities.
- The resolution and potential financial effect of the securities class action and derivative litigation.
- The share-count and earnings implications of convertible notes and repurchases; the filing reports materially different basic and diluted EPS, so the diluted EPS calculation and its assumptions warrant review.