Business context and reporting period
JAKKS Pacific, Inc. designs, markets and distributes toys and other consumer products, including licensed toys, dolls, costumes, seasonal goods and pet products. This Form 10-K covers the fiscal year ended December 31, 2016; the company is seasonal, with 66.5% of annual sales in the third and fourth quarters. The filing reports full-year results and unaudited quarterly data, not a standalone “2016 Q4” filing.
Key financial metrics
| Metric | 2016 | 2015 |
|---|---|---|
| Net sales | $706.6 million | $745.7 million |
| Gross profit / gross margin | $223.0 million / 31.6% | $228.6 million / 30.6% |
| Operating income / margin | $17.1 million / 2.5% | $30.5 million / 4.1% |
| Net income attributable to JAKKS / diluted EPS | $1.2 million / $0.07 | $23.3 million / $0.71 |
| Cash from operating activities | $16.7 million | $65.8 million |
| Cash and cash equivalents at year-end | $86.1 million | $102.5 million |
| Working capital | $236.6 million | $255.0 million |
SG&A rose to $205.9 million (29.1% of sales) from $198.0 million (26.5%). Interest expense was $13.0 million. The income tax provision was $4.1 million, a 76.8% effective rate, while pretax income was $5.4 million.
Material changes versus the prior comparable period
- Sales declined 5.2%, while operating income fell 44.0% and attributable net income fell from $23.3 million to $1.2 million. Higher marketing, product development and depreciation and amortization costs contributed to the operating profit decline.
- Gross margin improved by 1.0 percentage point, reflecting lower product costs and mix, but SG&A as a share of sales increased by 2.6 points.
- International sales fell 22.7% to $131.2 million, primarily due to weaker customer buying power after the British pound devaluation and lower-than-expected movie-licensed product sales. U.S. and Canada sales were essentially flat at $478.6 million; Halloween sales declined 0.4% to $96.8 million.
- Operating cash flow decreased to $16.7 million from $65.8 million. Receivables and inventory increased, and accounts receivable days rose to 96 from 90.
- Cash declined $16.5 million. Year-end working capital remained substantial, but declined $18.4 million.
Debt, liquidity and commitments
At year-end, principal outstanding was $93.9 million on 4.25% convertible notes due 2018 and $113.0 million on 4.875% notes due 2020; the balance-sheet carrying amount was $203.0 million after issuance costs. The company also had $10.0 million outstanding under its $75.0 million secured revolving facility, with $12.1 million of excess borrowing capacity after availability requirements and letters of credit. It was in compliance with the facility’s financial covenants.
Management said cash, operating cash flows and cash equivalents should meet working capital, capital expenditure and anticipated operating needs for at least 12 months. Planned 2017 capital expenditures were approximately $14.0 million. Contractual obligations totaled $390.7 million, including $92.3 million of future minimum license and royalty guarantees ($52.0 million due within one year) and $45.1 million of operating lease payments.
Outlook, risks and unusual items
- Management expected new international sales offices and distribution expansion to support growth in 2017, and planned a U.S. and Canada launch of C’est Moi makeup and skincare products in Q4 2017; anticipated sales before launch were nominal. No specific revenue or earnings guidance was provided.
- Key risks include reliance on licensed brands and minimum royalties, concentrated retail customers (Wal-Mart, Target and Toys “R” Us represented 48.4% of 2016 sales), intense competition, product acceptance and seasonality, overseas manufacturing and foreign exchange exposure, and the need to finance working capital and license commitments.
- Goodwill impairment tests found no impairment, but year-end fair value exceeded carrying value by only 2.0% for U.S. and Canada and 2.0% for Halloween, leaving limited headroom in those reporting units.
- The tax provision was unusually high relative to pretax income. The company recorded a $49.3 million valuation allowance against deferred tax assets and disclosed approximately $206 million of cumulative undistributed foreign subsidiary earnings for which U.S. deferred tax liability had been provided. Tax examinations and uncertain tax positions remain relevant.
- A securities class action was dismissed with prejudice in December 2016. A shareholder derivative action was settled, with the impact reflected in the financial statements; routine other claims were not expected to be material.
- After year-end, the company exchanged about $39.1 million principal of 2018 notes for 2.9 million shares and approximately $24.1 million cash, reducing remaining 2018 note principal to about $54.7 million. In March 2017 it agreed, subject to approvals and regulatory filings, to sell 3,660,891 shares to a joint-venture partner for $19.3 million.
- The company reported effective disclosure controls and internal control over financial reporting; the auditor issued unqualified opinions on the financial statements and internal controls.
Most important facts for investors to verify
- Whether sales and margins stabilize, especially in International and Halloween, and whether elevated SG&A and marketing spending produces returns.
- Cash conversion and working capital trends, including receivables aging, inventory growth and the ability to meet royalty guarantees.
- Debt and liquidity after the 2017 note exchanges: confirm cash paid, shares issued, remaining maturities and revolver availability.
- The assumptions behind goodwill valuations, particularly the narrow 2.0% headroom in U.S. and Canada and Halloween.
- Tax outcomes, including realization of deferred tax assets, foreign earnings tax exposure and any changes in uncertain tax positions.
- Completion and terms of the proposed $19.3 million share sale, including resulting dilution and governance implications.