JAKKS PACIFIC INC quarterly report, Q1 FY2014

JAKKS Pacific, Inc. — Q1 2014 Form 10-Q

Reporting period: Three months ended March 31, 2014; comparisons are with the three months ended March 31, 2013 unless noted. JAKKS designs, develops, markets and distributes toys and consumer products through Traditional Toys and Electronics, and Role Play, Novelty and Seasonal Toys. Toy sales are seasonal, typically strongest in the third and fourth quarters; first-quarter results are not necessarily indicative of full-year results.

Financial performance and liquidity

Metric	Q1 2013	Q1 2014
Net sales	$78.1 million	$82.5 million
Gross profit / gross margin	$23.4 million / 29.9%	$23.6 million / 28.5%
SG&A	$47.2 million	$38.5 million
Operating loss	$(23.8) million	$(14.9) million
Net loss / diluted loss per share	$(27.6) million / $(1.26)	$(16.3) million / $(0.74)
Operating cash flow	$(5.7) million	$(11.1) million

• Revenue increased 5.7%. Traditional Toys and Electronics sales declined 6.6% to $35.6 million; Role Play, Novelty and Seasonal Toys sales rose 17.4% to $46.9 million.
• Gross profit was nearly flat as cost of sales rose faster than revenue. Consolidated gross margin declined 1.4 percentage points.
• Operating loss narrowed by $8.9 million, mainly as SG&A fell $8.7 million. Management cited lower legal/professional costs, salaries and benefits, marketing, product development and testing, partly offset by higher acquisition amortization and temporary help.
• Interest expense declined to $2.2 million from $2.8 million, primarily because credit-facility borrowings were lower than in the prior-year period. The tax benefit was $0.5 million; the effective tax rate was 2.88%.
• Cash and cash equivalents were $113.4 million at March 31, 2014, versus $117.1 million at December 31, 2013. The filing’s MD&A rounds cash to $113.6 million. Working capital was $120.4 million, down from $136.3 million at year-end.
• Operating activities used $11.1 million of cash; investing activities used $0.9 million, including $1.2 million for property and equipment; financing activities provided $8.4 million. Cash declined $3.7 million during the quarter.
• At March 31, total liabilities included $48.1 million of short-term debt and $100.0 million of convertible senior notes. The notes comprise $39.0 million of 4.50% notes due November 1, 2014 and $100.0 million of 4.25% notes due August 1, 2018. The company also had $10.0 million outstanding under its new revolving facility.

Material changes and management commentary

• Role Play growth was attributed primarily to Frozen-themed role-play and dress-up products and higher Maui Toys sales. Traditional segment declines reflected lower orders from several retailers and tapering sales of Monsuno, Winx Club and Spy Net products, partly offset by 31-inch boys’ action figures.
• Traditional segment gross margin weakened: cost of sales was 77.8% of segment sales versus 70.5%, reflecting closeout sales and a product mix with higher royalty expense. Role Play segment cost of sales improved to 66.7% of sales from 69.6%.
• On March 27, 2014, JAKKS entered into a secured, $75 million revolving credit facility with GE Capital, maturing March 27, 2017. Availability depends on eligible receivables and inventory; reported borrowing capacity was approximately $12.8 million at quarter-end, with $10.0 million drawn. The rate was approximately 3.48%. JAKKS reported covenant compliance at March 31.
• The remaining $39 million of 2014 convertible notes mature in November 2014. Management anticipated using cash on hand and credit-facility availability to repay them. The filing warns that reduced or unavailable facility access could impair repayment capacity.
• Management stated that cash flows, cash balances and facility availability were expected to cover working capital and capital expenditure needs for at least the next 12 months, while noting that significant growth could require additional financing. Foreign subsidiaries held $83.5 million of cash and short-term investments at March 31.
• Future minimum guarantees under character and product licenses totaled $48.6 million, excluding $23.1 million in advances already paid; $29.5 million was due within 12 months.

Risks, contingencies and unusual items

• Customer concentration increased: Wal-Mart, Target and Toys “R” Us represented 50.0% of Q1 sales, compared with 44.5% a year earlier. The three largest customers represented 48.2% of receivables at March 31. Customer order cancellations, credit issues or reduced purchases could affect results and cash collection.
• A securities class action alleges misleading statements about financial projections and performance; the company says it believes the claims are without merit and intends to defend them. A consolidated shareholder derivative action alleges, among other matters, fiduciary-duty and proxy-statement violations. Outcomes and potential damages are uncertain; the company cautions that an adverse result could materially affect it.
• Key risks include changing consumer preferences and short product life cycles, dependence on licensed properties and minimum royalty commitments, intense competition, third-party manufacturing and international sourcing, product safety and intellectual-property claims, foreign currency exposure, and covenant compliance. Many customer orders are cancelable before shipment.
• Pacific Animation Partners had ceased production of its television show in December 2013; no production costs were incurred in Q1 2014. The company reported $0.3 million of joint-venture income in Q1 2014, versus a $0.6 million loss a year earlier.
• No goodwill impairment was reported for the periods presented. Interim financial statements are unaudited and include normal recurring adjustments; no specific full-year revenue or earnings guidance is provided in this filing.

Important facts for investors to verify

• Whether the company can refinance or repay the $39 million of 2014 notes at maturity, and the amount of borrowing capacity actually available under the borrowing-base facility.
• Whether covenant headroom remains adequate as results fluctuate seasonally, particularly under the facility’s EBITDA tests and later fixed-charge coverage requirements.
• How sales and margins develop in the two segments, including the durability of Frozen-related demand and the effect of royalties and closeout activity.
• Whether large-customer concentration, receivables collection and the $29.5 million of license guarantees due within 12 months affect cash needs.
• Developments, potential exposure and timing in the securities class action and derivative litigation.