JAKKS Pacific, Inc. — Q3 2013 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2013. JAKKS designs, markets and distributes children’s toys and consumer products through Traditional Toys and Electronics, and Role Play, Novelty and Seasonal Toys. Amounts below are in U.S. dollars; financial statement figures are in millions unless otherwise noted.
Financial performance
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Net sales | $310.9 | $314.5 | $495.2 | $533.3 |
| Gross profit / margin | $91.4 / 29.4% | $96.7 / 30.8% | $117.0 / 23.6% | $167.2 / 31.3% |
| Operating income (loss) | $39.7 | $37.3 | $(28.5) | $18.0 |
| Net income (loss) | $36.6 | $30.4 | $(37.8) | $14.7 |
| Diluted EPS | $1.11 | $1.10 | $(1.73) | $0.59 |
| Operating cash flow | Not presented quarterly | $(90.4) | $(19.3) |
- Q3 sales declined 1.1% year over year. Traditional Toys and Electronics sales fell 8.4% to $156.9 million, while Role Play, Novelty and Seasonal sales rose 7.5% to $154.0 million.
- For the first nine months, sales fell 7.1% and gross margin declined to 23.6%. Management cited lower sales in several licensed products, closeout sales, excess-inventory reserves, and write-downs of royalty minimum guarantees not expected to be earned.
- Q3 operating income increased despite lower sales, as SG&A fell $7.7 million, partly reflecting lower marketing, cooperative advertising, personnel and legal/advisory costs. Nine-month SG&A was down $3.7 million but rose as a share of sales, to 29.4% from 28.0%.
- Q3 income tax expense was $0.3 million; nine-month expense was $0.4 million and included a $1.4 million discrete tax benefit. Nine-month results also included a $2.0 million equity-method joint-venture loss.
Liquidity, cash flow and debt
- At September 30, cash and cash equivalents were $51.5 million, down from $189.3 million at December 31, 2012. Working capital was $195.2 million, versus $186.6 million.
- Operating activities used $90.4 million of cash in the first nine months, mainly reflecting a $152.5 million increase in accounts receivable; accounts payable and accrued expenses partly offset the outflow. Receivables were $258.0 million, up from $105.5 million at year-end. Inventory was $59.1 million.
- Investing activities used $8.4 million and financing activities used $39.0 million. Financing included issuance of $100 million of 4.25% convertible notes due 2018 and repurchase at par of $61 million of 4.50% notes due 2014. Principal remaining was $39 million on the 2014 notes and $100 million on the 2018 notes; reported net carrying value of convertible notes was $137.8 million.
- The $75 million revolving credit facility was paid off in April 2013. The company was seeking replacement or alternative financing at filing. Management said cash and operating cash flows should meet anticipated needs for at least 12 months, while warning that additional financing may be needed and may not be available on acceptable terms.
- Cash held by foreign subsidiaries was $34.8 million. Repatriation above approximately $62 million was subject to a 25% tax, according to the filing.
Outlook, risks and contingencies
- No specific revenue or earnings guidance was provided. Management emphasized toy-industry seasonality: sales and working-capital needs are generally highest in the third and fourth quarters, and customer orders may be canceled until shipment.
- Future aggregate minimum guarantees under character and product licenses were $79.0 million, excluding $21.3 million in advances already paid; $44.8 million was due within 12 months.
- Two purported securities class actions filed in July 2013 alleged misleading statements about product demand and financial disclosures. They were at a preliminary stage; the company said it intended to defend them but could not predict the outcome.
- Key risks include dependence on a small number of retailers and licensed properties, changing consumer preferences, seasonal demand and cancellable orders, reliance on third-party manufacturers principally in China, foreign-exchange exposure, and access to financing. Wal-Mart, Target and Toys “R” Us together represented 47.2% of Q3 sales.
- DreamPlay Toys product sales began in Q3. The filing flags the risk that unsuccessful DreamPlay initiatives could require write-downs of related investments. No goodwill impairment was reported through September 30.
Important facts for investors to verify
- Progress and terms of replacement credit financing, and liquidity through the seasonal working-capital peak.
- Collection of the sharply higher accounts receivable balance, customer credit quality, and the adequacy of doubtful-account and sales-return allowances.
- Whether gross margins recover as closeouts, excess inventory and royalty-guarantee write-downs subside.
- Sales performance of licensed and newly launched products, including DreamPlay, and the ability to meet license minimum guarantees.
- Developments in the securities litigation and any potential financial exposure; the filing does not provide a clear estimate of damages.