JAKKS Pacific, Inc. — Q2 2015 Form 10-Q
Reporting period: Three and six months ended June 30, 2015; filed August 10, 2015. JAKKS designs, markets and distributes toys and consumer products through Traditional Toys and Electronics, and Role Play, Novelty and Seasonal Toys. Financial statements are unaudited. Dollar amounts below are in millions unless stated otherwise.
Financial performance and position
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Net sales | $131.1 | $124.2 | $245.3 | $206.7 |
| Gross profit / margin | $39.3 / 30.0% | $37.8 / 30.5% | $74.7 / 30.4% | $61.4 / 29.7% |
| Operating loss | $(3.0) | $(4.8) | $(7.2) | $(19.7) |
| Net loss attributable to JAKKS | $(5.7) | $(9.1) | $(13.3) | $(25.4) |
| Loss per diluted share | $(0.30) | $(0.43) | $(0.69) | $(1.17) |
- Sales and segments: Q2 revenue rose 5.6%. Traditional Toys and Electronics sales increased 28.1% to $63.4 million, led by Frozen and Disney Princess dolls, Funnoodle water toys and licensed ride-ons and wagons. Role Play, Novelty and Seasonal sales fell 9.4% to $67.7 million, primarily reflecting higher competitively priced Disguise sales in the prior-year quarter. For the first half, segment sales were $128.4 million (up 50.9%) and $116.9 million (down 3.9%), respectively.
- Margins and expenses: Q2 gross margin declined 0.5 percentage points, as higher royalty rates and product mix offset sales growth. SG&A was $42.3 million, down slightly from $42.6 million, and fell to 32.3% of sales from 34.3%. First-half SG&A increased $0.8 million to $81.9 million, but decreased as a share of sales to 33.3% from 39.2%.
- Other income, interest and taxes: Q2 included $1.7 million of income from a partial recovery related to a former video-game joint venture; the company said further recoveries were uncertain. Interest expense was $3.1 million in Q2 and $6.1 million for the first half, up from the respective prior-year periods, mainly due to the 2018 and 2020 convertible notes. First-half income tax expense was $1.7 million, primarily related to foreign taxes.
- Cash flow: Operating activities provided $50.3 million in the first half, versus $32.6 million used in the prior-year period. The improvement was primarily driven by a $117.4 million decrease in accounts receivable, partly offset by lower accrued expenses and sales-return reserves. Investing activities used $11.2 million, including $5.1 million for headquarters leasehold improvements and $6.1 million for molds and tooling. Financing activities used $0.2 million.
- Liquidity and debt: June 30 cash and equivalents were $110.3 million; working capital was $232.0 million, compared with $246.2 million at year-end 2014. Long-term debt was $215.0 million, comprising $100 million of 4.25% convertible notes due 2018 and $115 million of 4.875% convertible notes due 2020. No revolver borrowings were outstanding under the $75 million GE facility; letters of credit were $7.9 million and reported excess borrowing capacity was approximately $14.6 million. The company reported compliance with the facility’s financial covenants.
- Balance-sheet movements: Accounts receivable fell to $117.1 million from $234.5 million at year-end, while inventory rose to $91.9 million from $78.8 million. Total assets were $510.7 million, down from $561.8 million.
Material changes and outlook
- First-half revenue increased 18.7%, while operating and net losses narrowed substantially versus 2014. Traditional Toys and Electronics drove sales growth; Role Play, Novelty and Seasonal sales were lower.
- Management said cash, operating cash flows and credit-facility availability should be sufficient for working capital and capital expenditures for at least the next 12 months. It cautioned that growth and seasonal working-capital needs could require additional financing, which may not be available on acceptable terms.
- Toy sales are seasonal, generally strongest in the third and fourth quarters; working-capital needs also tend to peak then. Orders are generally cancelable until shipment, making backlog an uncertain indicator of future sales. Interim results may not indicate full-year performance. The filing provides no specific revenue or earnings guidance.
- Future minimum guarantees under character and product licenses totaled $82.3 million, excluding $21.6 million in advances already paid; $28.1 million was due over the next 12 months. Royalties generally ranged from 1% to 16% of net sales.
- Cash and short-term investments held by foreign subsidiaries were $102.0 million at June 30, 2015. The company said it intended to fund long-term liquidity needs through operations, cash and credit availability.
Risks, contingencies and notable items
- Customer concentration: Wal-Mart, Target and Toys “R” Us accounted for 40.1% of first-half sales; the three largest customers represented approximately 39.9% of receivables at June 30. Customer order cancellations, credit problems or reduced purchases could affect results.
- Legal matters: A securities class action remained pending; a motion to dismiss the third amended complaint was argued in July 2015 and a decision was pending. The company said it believed the claims were without merit but could not assure the outcome or rule out material adverse effects. A derivative action had reached an agreement in principle to settle, subject to court approval; final approval procedures remained unresolved.
- Other business risks: The filing highlights dependence on licensed characters and minimum royalties, product popularity and consumer preferences, competition, third-party manufacturers, international sourcing and currency exposure, product safety and intellectual-property claims. It also notes possible cash demands if convertible-note holders obtain repurchase rights following a defined fundamental change.
- Repurchase authorization: In June 2015, the board authorized repurchases of up to $30 million of common stock and/or convertible notes; none had been purchased by June 30.
- Accounting and controls: No goodwill impairment was recorded in the first half. Management reported disclosure controls were effective and no material change in internal control over financial reporting during the period. The company was evaluating the revenue-recognition standard, with mandatory adoption stated as January 1, 2018.
Investor verification checklist
- Check whether the strong first-half operating cash flow, heavily aided by receivables collection, is sustained as seasonal sales and working-capital requirements increase.
- Track segment sales and gross margins, especially royalty rates, product mix and the sustainability of Traditional Toys and Electronics growth.
- Review cash availability, revolver borrowing capacity and covenant compliance alongside the $215 million of convertible notes and their potential repurchase provisions.
- Assess the timing and recoverability of the $82.3 million in future license minimum guarantees and the concentration of sales and receivables among major retailers.
- Follow developments in the securities class action and derivative-action settlement, including any potential financial or operational impact.