JAKKS Pacific, Inc. — Q3 2015 Form 10-Q
Reporting period: Three and nine months ended September 30, 2015; filed November 9, 2015. JAKKS designs, markets and distributes toys and consumer products through Traditional Toys and Electronics and Role Play, Novelty and Seasonal Toys. Figures below are in U.S. dollars; financial statement amounts have been converted from thousands to millions.
Financial performance
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Net sales | $337.0m | $349.4m | $582.3m | $556.0m |
| Gross profit / margin | $104.3m / 31.0% | $94.7m / 27.1% | $179.0m / 30.7% | $156.1m / 28.1% |
| Operating income / margin | $44.6m / 13.3% | $43.8m / 12.5% | $37.4m / 6.4% | $24.1m / 4.3% |
| Net income attributable to JAKKS | $45.8m | $44.1m | $32.6m | $18.7m |
| Basic / diluted EPS, as reported | $2.47 / $1.12 | $2.33 / $1.03 | $1.72 / $0.89 | $0.90 / $0.61 |
Q3 sales declined 3.5% year over year, while gross profit and operating income rose. For the first nine months, sales increased 4.7%, operating income increased 55%, and attributable net income increased 74%. SG&A increased to $59.7m in Q3 and $141.6m year to date, representing 17.7% and 24.3% of sales, respectively.
- Q3 segment sales: Traditional Toys and Electronics grew 17.5% to $204.3m; Role Play, Novelty and Seasonal Toys fell 24.4% to $132.7m.
- Nine-month segment sales: Traditional Toys and Electronics rose 28.5% to $332.7m; Role Play, Novelty and Seasonal Toys declined 16.0% to $249.6m.
- Management attributed Traditional segment growth to products including Frozen toddler dolls, Nintendo plush and figures, and Star Wars figures. Role Play segment weakness reflected lower sales of Marvel Halloween costumes and Frozen role-play/dress-up and Halloween costumes.
- Gross margin improved with lower product costs and, in Role Play, lower royalties and improved costing. Higher royalty rates on product mix partly offset Traditional segment cost savings. SG&A increases included media spending, bonuses, cooperative advertising, legal costs and temporary labor; year-to-date costs also included the new corporate offices.
Cash flow, liquidity and debt
- Cash from operating activities was $10.1m for the first nine months of 2015, versus cash used of $105.2m in the 2014 period. The 2015 result included a $58.3m use of cash from higher receivables, partly offset by a $38.5m increase in accounts payable.
- Investing activities used $18.4m, including spending on the new headquarters and molds/tooling. Financing activities provided $17.8m, principally from $25.0m of credit-facility borrowings and partly offset by $7.0m of share repurchases.
- Cash and cash equivalents were $81.2m at September 30, 2015, including $70.6m held by foreign subsidiaries. Working capital was $271.6m, versus $246.2m at December 31, 2014. Accounts receivable was $292.9m and inventory $81.4m; receivables days outstanding were 80, unchanged year over year.
- Debt included $215.0m of long-term convertible notes and $25.0m outstanding on the secured revolving facility. The $75.0m facility matures March 27, 2019; reported excess borrowing capacity was approximately $9.4m, with $8.1m of standby letters of credit. The revolver rate was approximately 2.56%; the company reported compliance with its financial covenants.
- Management said cash, operating cash flow and available credit were expected to be sufficient for working capital and capital expenditures for at least 12 months. The filing cautions that growth and seasonal working-capital needs could require additional financing, which may not be available on acceptable terms.
Outlook, risks and unusual items
- The filing provides no specific numerical earnings or sales guidance. Management notes that toy and Halloween sales are seasonal, generally concentrated in Q3 and Q4, and that orders are generally cancelable before shipment; backlog may therefore be a poor indicator of future sales.
- Q3 other income included $5.6m from reversing the remaining Maui acquisition earn-out liability after 2015 targets were not met; the comparable 2014 quarter included $5.9m from the same type of adjustment. The company said no Maui earn-out liabilities would remain after December 31, 2015.
- Nine-month results included $1.7m received in partial settlement of amounts owed by a former video-game joint venture partner; additional recovery was uncertain. The filing also reports $1.7m of nine-month joint-venture income in its statements, while the MD&A describes the $1.7m recovery separately.
- Future minimum guarantees under product and character licenses totaled $77.8m, excluding $17.5m in advances already paid; $29.1m was due within 12 months. Minimum royalty commitments can create costs even if product sales are insufficient.
- Major-customer concentration is significant: Wal-Mart, Target and Toys “R” Us represented 41.8% of nine-month sales and 33.0% of receivables at September 30. Other risks include dependence on licensed characters, product acceptance, third-party manufacturers, international operations and currency movements.
- A securities class action remained unresolved, with a motion to dismiss under submission. A shareholder derivative action had reached a proposed settlement; after the quarter, the judge indicated at a November 2, 2015 hearing that the settlement would be approved by formal order, while taking attorneys’ fees under advisement. Management warned that an adverse class-action outcome could materially affect the company.
- The company reported effective disclosure controls and no material change in internal control over financial reporting during the period. Adoption of the new revenue standard was under evaluation; mandatory adoption was stated as January 1, 2018.
Most important facts for investors to verify
- Confirm the reported EPS figures and their presentation: diluted EPS is materially below basic EPS, and the filing’s share and conversion reconciliation warrants review.
- Assess how much reported profit growth depends on the Maui earn-out reversal and other nonrecurring or uncertain joint-venture recoveries.
- Monitor receivables, collections and seasonal working-capital needs, alongside the limited reported excess capacity under the revolver.
- Review the maturity, conversion and fundamental-change terms of the $215m convertible notes, and test covenant headroom under weaker operating conditions.
- Track license minimum guarantees, customer concentration and the resolution and potential costs of the pending securities litigation and derivative settlement.