JAKKS Pacific, Inc. — Q1 2016 Form 10-Q
Business context and period: The company designs, markets and distributes toys and consumer products, organized into U.S. and Canada, International, and Halloween segments. This unaudited report covers the three months ended March 31, 2016; comparisons are with Q1 2015 unless noted. Toy sales are seasonal, generally strongest in the third and fourth quarters.
Key financial metrics
| Metric | Q1 2015 | Q1 2016 |
|---|---|---|
| Net sales | $114.2 million | $95.8 million |
| Gross profit / margin | $35.4 million / 31.0% | $31.2 million / 32.5% |
| SG&A | $39.6 million | $45.0 million |
| Operating loss | $4.2 million | $13.8 million |
| Net loss attributable to JAKKS | $7.6 million | $17.4 million |
| Loss per share, basic and diluted | $0.40 | $1.01 |
| Cash from operating activities | $38.8 million | $32.6 million |
| Capital expenditures | $3.1 million | $3.0 million |
At March 31, 2016, cash and cash equivalents were $118.9 million; working capital was $226.9 million. Current assets were $314.8 million and current liabilities $87.8 million. Total assets were $430.6 million, versus $499.6 million at December 31, 2015.
Convertible notes had a $207.8 million net carrying value; principal outstanding was approximately $99.4 million of 2018 notes and $113.0 million of 2020 notes. No revolving-credit borrowings were outstanding. The $75 million facility had $28.2 million of standby letters of credit and no excess borrowing capacity reported at quarter-end. The company reported compliance with its financial covenants.
Material changes versus Q1 2015
- Sales fell 16.1%. International sales declined 44.4% to $20.2 million, primarily due to lower Disney Frozen toddler-doll sales. U.S. and Canada sales fell 6.0% to $72.2 million, also affected by lower Frozen sales and expired licenses. Halloween sales rose to $3.4 million from $1.1 million.
- Traditional toys and electronics sales fell to $42.0 million from $65.0 million; role-play, novelty and seasonal toys increased to $53.8 million from $49.2 million.
- Gross margin improved to 32.5% from 31.0%, but SG&A rose 13.7% and reached 46.9% of sales, compared with 34.7%. Management attributed the increase mainly to higher marketing costs, including timing related to an earlier Easter.
- Operating loss widened to $13.8 million from $4.2 million. Operating cash flow declined to $32.6 million from $38.8 million.
- Cash increased from $102.5 million at year-end, while accounts receivable declined to $85.5 million from $163.4 million and inventory to $53.5 million from $60.5 million. Financing used $12.6 million, including $9.8 million for share repurchases and $1.9 million to repurchase convertible notes.
Outlook, risks and unusual items
- No quantified earnings or sales guidance is provided. Management believes cash, operating cash flows and credit-facility availability will meet working-capital and capital-expenditure needs for at least the next 12 months, while cautioning that seasonality and growth could require additional financing.
- Future minimum license guarantees were $89.4 million, excluding $25.1 million in advances already paid; $43.7 million was due within 12 months. License agreements generally include minimum royalty commitments, even if sales are insufficient to cover them.
- Management identifies product popularity, licensing and renewal terms, customer concentration, competition, third-party manufacturing, international operations, foreign exchange, product safety, and seasonal forecasting as significant risks. The three largest customers represented 46.1% of Q1 sales; Wal-Mart alone represented 28.9%. Customer orders are generally cancelable until shipment.
- A securities class action remained pending: the company’s motion to dismiss the third amended complaint had been argued, with no decision reported. A shareholder derivative matter had reached a proposed settlement; the court indicated it would approve the settlement, while attorneys’ fees remained under advisement. The company says it intends to defend the class action and cannot assure its outcome.
- After quarter-end, the company repurchased and retired approximately $0.6 million principal amount of 2018 notes in April 2016. The filing reports no goodwill impairment for the quarter and no off-balance-sheet arrangements.
Important facts for investors to verify
- Why International sales and operating performance deteriorated, and whether the product and licensing mix can stabilize.
- Actual borrowing availability under the revolver: despite its $75 million headline size, reported excess capacity was nil at quarter-end, with $28.2 million in standby letters of credit.
- Timing and funding of the $43.7 million of license minimum guarantees due within 12 months, alongside seasonal working-capital needs.
- Repayment, conversion and potential cash-repurchase exposure for the 2018 and 2020 notes, and the status of litigation and the proposed derivative-action settlement.
- Whether increased marketing and other SG&A can be supported by sales growth, and how customer concentration and order cancellations affect forecasts.