JAKKS Pacific, Inc. — Q3 2019 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2019. The unaudited filing covers a seasonal global toy and consumer-products business with U.S. and Canada, International, and Halloween segments.
Financial performance and position
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Net sales | $280.1 million | $236.7 million | $446.1 million | $435.5 million |
| Gross profit / margin | $80.9 million / 28.9% | $64.3 million / 27.2% | $112.9 million / 25.3% | $115.2 million / 26.5% |
| Operating income (loss) | $35.7 million | $20.0 million | $(7.0) million | $(27.8) million |
| Net income (loss) attributable to JAKKS | $16.4 million | $15.7 million | $(35.3) million | $(39.1) million |
| Basic EPS | $0.60 | $0.68 | $(1.43) | $(1.69) |
- Q3 diluted EPS was $0.51 versus $0.38. The difference from basic EPS reflects dilutive securities, including convertible notes.
- Q3 sales increased 18.3%; gross margin improved 1.7 percentage points. For the nine-month period, sales increased 2.4%, but gross profit declined and gross margin fell 1.2 points.
- Operating cash flow was $26.1 million for the first nine months, compared with $2.6 million a year earlier. Investing cash outflow was $7.6 million, primarily for molds and tooling; financing cash outflow was $0.8 million.
- At September 30, cash and cash equivalents were $71.0 million, plus $4.9 million restricted cash. Working capital was $109.7 million. Current assets were $360.5 million and current liabilities were $250.8 million.
- Reported short- and long-term debt, net, totaled approximately $177.7 million. The new first-lien term loan had $134.8 million principal outstanding; the amended Wells Fargo revolving facility had $5.0 million borrowed and $44.5 million excess availability. Cash, including restricted cash, was $75.9 million.
Material changes and drivers
- Q3 U.S. and Canada sales rose 23.7%, International sales rose 3.7%, and Halloween sales rose 16.1%. Frozen 2 contributed to growth across segments; Toy Story 4 and Descendants 3 also supported Halloween sales.
- For the nine months, U.S. and Canada sales rose 2.9% and Halloween sales rose 22.2%, while International sales fell 23.2%, reflecting weaker sales of several older licensed products.
- Nine-month SG&A fell to $113.7 million from $142.5 million, partly because the 2018 period included a $12.0 million bad-debt charge, primarily related to Toys “R” Us liquidation, and because of lower compensation, advertising, and product-development costs.
- Q3 included a $13.2 million loss on extinguishment of debt. Nine-month acquisition-related and other charges were $6.0 million, compared with $0.4 million, primarily associated with strategic and refinancing transactions.
Outlook, financing, and risks
- In August 2019, the company completed a recapitalization that refinanced or extended substantially all convertible debt and extended the revolving facility. It issued new common and Series A preferred equity, replaced the prior GACP term loan with a $134.8 million first-lien term loan, and amended the Wells Fargo ABL facility. The new term loan matures in February 2023, bears 10.5% interest (8.0% cash and 2.5% payment-in-kind), and is secured by substantially all company assets.
- The term loan requires minimum EBITDA of $34 million and minimum liquidity of $10 million beginning with the quarter ending September 30, 2020. The ABL facility includes a $25 million minimum-liquidity covenant and other availability and financial requirements. The company reported compliance with applicable ABL covenants at September 30, 2019.
- Management stated available cash, projected operating cash flow, and ABL borrowing capacity should be sufficient for working capital and capital expenditures over the next 12 months. This is conditional on operating performance, sales, customer collections, vendor support, and other factors.
- The company’s business is seasonal, with sales generally highest in the third and fourth quarters; orders are generally cancelable before shipment, and management cautioned that backlog and quarterly results may not predict full-year results.
- Customer concentration is significant: Walmart and Target represented 50.9% of Q3 sales and 49.4% of nine-month sales. The three largest customers accounted for about 43% of gross receivables at quarter-end.
- Future minimum royalty guarantees totaled $65.0 million, excluding $30.3 million in advances already paid; $39.7 million was due within 12 months. Other risks include dependence on licensed brands, demand forecasting, key vendors, product competition, and customer credit.
- The Series A preferred stock carries a 6% annual dividend, board representation and consent rights, and potential change-of-control redemption premiums. A related redemption derivative was recorded as a $4.9 million long-term liability. The company reported no material change to previously disclosed risk factors and no material litigation outcome quantified in this filing.
Important facts for investors to verify
- Whether operating cash flow and seasonal collections can support working capital as receivables and inventory rise, and whether management’s 12-month liquidity assessment remains achievable.
- Compliance with the new term-loan EBITDA and liquidity tests beginning in September 2020, alongside the ABL facility’s liquidity and availability covenants.
- The full economic cost and dilution implications of the recapitalization, including high-cost secured debt, convertible-note resets, preferred dividends and redemption rights, and additional common shares issued.
- Whether growth from Frozen 2 and other current licensed products can offset weaker international sales and sustain margins as royalty rates and product mix change.
- Customer concentration, the collectability of receivables, vendor relationships, and the timing and funding of minimum royalty commitments.