JAKKS Pacific, Inc. — Q3 2021 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2021. The company designs, markets, and distributes toys and consumer products, including costumes. Amounts below are in U.S. dollars; financial statement amounts are generally in millions unless otherwise noted.
Financial performance
| Metric | Q3 2021 | Q3 2020 | Nine months 2021 | Nine months 2020 |
|---|---|---|---|---|
| Net sales | $237.0 | $242.3 | $433.2 | $387.6 |
| Gross profit | $74.9 | $74.6 | $132.9 | $107.7 |
| Gross margin | 31.6% | 30.8% | 30.7% | 27.8% |
| Operating income | $36.7 | $37.5 | $35.8 | $11.8 |
| Net income (loss) | $36.4 | $32.4 | $(2.7) | $(2.8) |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $(26.9) | $15.9 |
- Q3 sales declined approximately 2.2% year over year, while nine-month sales increased approximately 11.8%. Nine-month growth came from both segments: Toys/Consumer Products sales rose 9.2% to $334.4 million, and Costumes sales rose 21.2% to $98.8 million.
- Q3 operating income was slightly lower despite improved gross profit; operating margin was 15.5% in both periods. Nine-month operating income increased substantially, with operating margin rising to 8.3% from 3.0%.
- Q3 net income included a $6.2 million gain from forgiveness of the Paycheck Protection Program loan. Other significant items included fair-value losses on convertible notes and the preferred-stock derivative. Nine-month results also included a $7.4 million debt-extinguishment loss and a $16.5 million fair-value loss on convertible notes.
- Q3 net income attributable to JAKKS was $36.3 million; basic earnings per share were $4.08 and diluted earnings per share were $3.97. Nine-month net loss attributable to JAKKS was $2.8 million, or $0.56 per share.
- Interest expense was $2.7 million in Q3 versus $5.6 million in Q3 2020, and $11.9 million for the nine months versus $16.7 million. Nine-month cash interest paid was $11.5 million.
Liquidity, cash flow, and debt
- At September 30, cash, cash equivalents, and restricted cash totaled $26.7 million, down from $92.7 million at year-end 2020. Working capital was $114.0 million, compared with $112.6 million at December 31, 2020.
- Nine-month operating cash use was $26.9 million, versus cash provided of $15.9 million in 2020. The principal drivers included increases of $106.1 million in accounts receivable and $51.2 million in inventory, partly offset by higher payables and accrued expenses. Investing activities used $6.3 million; financing activities used $32.5 million.
- The company refinanced its prior term loan in June 2021. At quarter-end, it had $98.8 million outstanding under the 2021 BSP first-lien term loan, maturing June 2027, and $0.1 million of residual convertible-note indebtedness. The JPMorgan revolving facility had no borrowings and $43.1 million of excess availability; $9.7 million of letters of credit were outstanding.
- The BSP term loan carries interest at LIBOR plus 6.50%–7.00% or base rate plus 5.50%–6.00%, subject to floors and leverage-based pricing. It includes leverage covenants and a minimum cash requirement initially set at $20 million. The company reported compliance with its financial covenants at September 30.
- As of November 10, 2021, the company reported $8 million borrowed under the JPMorgan facility. Management stated that cash, expected operating cash flow, and credit availability were sufficient for working capital and capital expenditure needs over the following 12 months.
Material changes and management commentary
- Q3 Toys/Consumer Products sales fell 7.6%, reflecting declines in Doll/Dress-Up/Nurturing Play and Seasonal/Outdoor, partly offset by double-digit growth in Action Play and Collectibles. Costume sales rose 16.4% as retailers planned for a stronger Halloween season.
- For the nine months, improved segment gross margins reflected lower average royalty rates and, for Costumes, product-line efforts targeting better margins. Management also cited higher freight costs as a partial offset in Toys/Consumer Products.
- Two customers, Target and Walmart, together represented 52.3% of Q3 sales; the top three customers, including Amazon, represented 63.9%. The filing identifies customer concentration, vendor health, and demand forecasting as potential sources of material risk.
- The business is seasonal, with sales generally strongest in the third and fourth quarters and working-capital needs highest in the second and third quarters. Customer orders are generally cancelable until shipment, limiting backlog’s usefulness as a sales indicator.
- Management said COVID-19 effects remained uncertain and it could not estimate the pandemic’s impact on 2021 or 2022 results, liquidity, or financial condition. Disclosed concerns included supply-chain and labor disruption, product availability, changing consumer demand, and retail disruptions. No specific financial guidance was provided.
Risks, contingencies, and unusual items
- COVID-19 uncertainty, supply-chain disruption, freight costs, dependence on key customers and vendors, and seasonal demand may affect sales, margins, and liquidity.
- Future minimum royalty guarantees totaled $23.5 million, of which $18.6 million was due over the next 12 months. The company also reported a $47.7 million reserve for sales returns and allowances.
- Two putative class actions remained pending: one concerning the 2020 reverse stock split proxy process and one alleging California wage-and-hour violations. Damages sought were unspecified, and the company said it could not estimate potential losses.
- The BSP term loan and JPMorgan facility contain restrictive covenants and customary default provisions. The BSP lender/arranger and certain noteholders have related-party connections disclosed in the filing.
- The $6.2 million PPP loan was fully forgiven in September 2021 and recognized as a gain. Changes in Level 3 fair-value estimates for the convertible notes and preferred-stock derivative affected reported earnings.
Important facts for investors to verify
- Whether Q4 and full-year demand, particularly holiday toy and costume sales, supports the growth seen in the first nine months.
- How working-capital requirements evolve, including collection of receivables and inventory levels, given the nine-month operating cash outflow and seasonal cash needs.
- Whether cash and revolving-credit availability remain adequate relative to the $20 million minimum-cash covenant and the term-loan leverage requirements.
- The impact of freight and supply-chain costs, customer concentration, and the company’s ability to maintain segment margins.
- Developments in the two class actions, related-party financing arrangements, and the valuation volatility of preferred-stock and convertible-note instruments.