JAKKS PACIFIC INC - 10-Q Summary (Period Ended Sep 30, 2007)
Business Context and Reporting Period
This is a Quarterly Report (Form 10-Q) for JAKKS Pacific, Inc., a worldwide producer and marketer of children's toys, craft products, seasonal items, and pet products. The report covers the three and nine months ended September 30, 2007. The company operates through four reportable segments: Traditional Toys, Craft/Activity/Writing Products, Seasonal/Outdoor Products, and Pet Products.
Key Financial Metrics
| Metric | 9 Months Ended Sep 30, 2007 | 9 Months Ended Sep 30, 2006 | 3 Months Ended Sep 30, 2007 | 3 Months Ended Sep 30, 2006 |
|---|---|---|---|---|
| Net Sales | $572.0 million | $527.1 million | $318.4 million | $295.8 million |
| Gross Profit | $214.9 million | $206.3 million | $124.1 million | $112.9 million |
| Gross Margin | 37.6% | 39.1% | 39.0% | 38.2% |
| Operating Income | $74.9 million | $69.4 million | $65.1 million | $58.2 million |
| Net Income | $55.6 million | $49.2 million | $47.3 million | $40.5 million |
| Diluted EPS | $1.75 | $1.57 | $1.45 | $1.26 |
| Cash from Operations | $30.0 million | $7.5 million | N/A | N/A |
| Cash & Equivalents | $186.6 million | $133.0 million (Sep 2006) | $186.6 million | $133.0 million (Sep 2006) |
| Working Capital | $342.2 million | $280.4 million (Dec 2006) | N/A | N/A |
| Long-Term Debt | $98.0 million (Convertible Notes) | $98.0 million | $98.0 million | $98.0 million |
Material Changes vs. Prior Period
- Revenue Growth: Net sales increased 8.5% for the quarter and 8.5% for the nine-month period compared to the prior year. The Traditional Toys segment drove this growth with an 11.1% increase in sales for the nine months, largely due to the full nine-month impact of the Creative Designs acquisition and strong sales of WWE, Pokemon, and Hannah Montana products.
- Segment Performance: While Traditional Toys and Seasonal/Outdoor products grew, Craft/Activity/Writing Products saw a 23.0% decline in sales for the nine months due to lower sales of Flying Colors and Vivid Velvet activities.
- Profitability: Operating income increased 7.9% for the quarter and 7.9% for the nine months. Net income rose 13.0% for the quarter and 13.0% for the nine months.
- Cost Structure: Cost of sales as a percentage of net sales increased slightly for the nine months (62.4% vs 60.9%) due to product mix changes and higher royalty rates on certain licensed products. SG&A expenses decreased as a percentage of sales (24.5% vs 26.0%) primarily due to reduced advertising and promotional expenses.
- Joint Venture: Profit from the video game joint venture with THQ increased to $3.1 million for the nine months ended Sep 30, 2007, compared to $0.7 million in the prior year, driven by the "Smackdown vs. Raw 2007" game.
Guidance, Outlook, Risks, and Contingencies
- Forward-Looking Statements: The filing contains forward-looking statements regarding product demand, supply, and costs. Management does not undertake to update these statements.
- Litigation Risks:
- WWE Action: Ongoing litigation with WWE regarding alleged RICO violations and antitrust claims. Discovery is stayed pending motions to dismiss.
- Class Actions: Shareholder class actions alleging securities fraud related to the WWE licensing agreements are pending.
- Connecticut Action: WWE sued the joint venture and THQ regarding alleged improper sales of video games in Asia. The court ordered a 120-day stay until November 30, 2007.
- Joint Venture Dispute: The preferred return rate for the THQ joint venture is in dispute for the period beginning July 1, 2006. The parties have not agreed on a reset rate and are proceeding to arbitration. An estimated receivable of $17.1 million has been accrued pending resolution.
- Tax Contingencies: The company adopted FIN 48 in 2007, resulting in a $16.0 million reduction to retained earnings for unrecognized tax benefits. Approximately $21.5 million in income tax reserves remains as of September 30, 2007.
- Customer Concentration: The three largest customers (Wal-Mart, Toys 'R' Us, Target) accounted for 46.0% of net sales for the nine months ended September 30, 2007.
Investor Verification Checklist
- Joint Venture Receivables: Verify the status of the $17.1 million accrued preferred return receivable from the THQ joint venture and the timeline for the arbitration resolution.
- WWE Litigation: Monitor the status of the "WWE Action" and "Connecticut Action" lawsuits, as an adverse outcome could impact the video game license and toy licenses.
- Customer Concentration: Assess the financial health of top retailers (Wal-Mart, Toys 'R' Us, Target) given they represent nearly half of total sales.
- Tax Reserves: Review the $21.5 million income tax reserve and potential future adjustments related to FIN 48 adoption and transfer pricing audits in Hong Kong and the US.
- Convertible Notes: Note the $98.0 million convertible senior notes due in 2023, which are not currently convertible but have specific repurchase triggers in 2010, 2013, and 2018.