JAKKS Pacific, Inc. — Q3 2014 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2014. Amounts below are in millions, except per-share data. JAKKS designs, produces, markets and distributes children’s toys and consumer products through Traditional Toys and Electronics, and Role Play, Novelty and Seasonal Toys.
Financial performance and position
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Net sales | $349.4 | $310.9 | $556.0 | $495.2 |
| Gross profit / margin | $94.7 / 27.1% | $91.4 / 29.4% | $156.1 / 28.1% | $117.0 / 23.6% |
| Operating income (loss) | $43.8 | $39.7 | $24.1 | $(28.5) |
| Net income (loss) | $44.1 | $36.6 | $18.7 | $(37.8) |
| Diluted EPS | $1.03 | $1.11 | $0.61 | $(1.73) |
| Operating cash flow | Not separately stated | Not separately stated | $(105.2) | $(90.4) |
- Sales and segments: Q3 sales grew 12.4%. Traditional Toys and Electronics sales rose 10.8% to $173.8 million; Role Play, Novelty and Seasonal sales rose 14.0% to $175.6 million. Management cited Frozen-related products, higher Halloween costume sales and, year to date, Maui products. Nine-month sales increased 12.3%.
- Profitability: Q3 gross margin contracted 2.3 percentage points, with higher royalties and lower prices on some Halloween products among the cited factors. Nine-month operating results improved from a loss to income, aided by higher sales, lower SG&A and prior-year inventory and license-guarantee write-downs. SG&A was $132.0 million for the nine months, down from $145.5 million.
- Unusual item: Q3 other income was $5.9 million, principally a credit from reversing the Maui earn-out accrual after management determined the 2014 targets would not be met. This boosted pretax and net income and should be distinguished from recurring operating performance.
- Cash, working capital and liquidity: Cash was $88.6 million at September 30, down from $117.1 million at year-end. Working capital was $250.4 million, versus $136.3 million at December 31, 2013. Operating cash use of $105.2 million reflected substantial increases in receivables and inventory; investing cash use was $7.9 million, while financing provided $84.6 million. Accounts receivable were $304.3 million and inventory $88.8 million at quarter-end, compared with $101.2 million and $46.8 million, respectively, at year-end.
- Debt: Balance-sheet debt totaled approximately $253.9 million, consisting primarily of convertible notes; no GE revolving-facility borrowings were outstanding. The $75 million GE facility had approximately $67.5 million of borrowing capacity, subject to availability and covenants. The $39 million 4.50% notes due November 1, 2014 were paid at maturity after quarter-end. The remaining notes included $100 million due 2018 and $115 million due 2020. Interest expense for the first nine months was $9.2 million, up from $7.2 million.
- Other metrics: Basic EPS was $2.33 for Q3 and $0.90 for the nine-month period. The filing reports diluted EPS of $1.03 and $0.61, respectively. Income tax expense was $2.5 million for the nine months, with an 11.93% effective rate.
Material changes, outlook and risks
- Management said cash on hand, expected operating cash flows and available credit should meet working-capital and capital-expenditure needs for at least the next 12 months. It cautioned that seasonal demand and growth can consume cash and additional financing may be needed; no numerical revenue or earnings guidance is provided.
- Toy sales and working-capital requirements are seasonal, typically strongest in the third and fourth quarters. Customer orders are generally cancelable until shipment, limiting the usefulness of backlog as a sales indicator.
- Future minimum guarantees under license agreements were $58.1 million, excluding $15.5 million in advances already paid; $38.2 million was due within 12 months. Minimum royalties, product popularity, customer concentration, and inventory forecasting are material business risks.
- Wal-Mart, Target and Toys “R” Us together represented 49.1% of Q3 sales and 46.1% of nine-month sales. Customer concentration can expose the company to sales, collection and pricing risks.
- The company reported compliance with GE facility financial covenants at September 30. A covenant breach or loss of facility access could constrain liquidity. Convertible notes also permit cash repurchase in specified fundamental-change circumstances.
- A securities class action remained pending, with a motion to dismiss the amended complaint under submission as of the filing. In a separate derivative action, most claims were dismissed; remaining fiduciary-duty claims were referred to mediation. The company said it intended to defend the class action and could not assure its outcome.
- Management identified risks from licensed-product demand and renewal terms, competition, third-party manufacturing, international operations and currency movements, product safety and litigation. Disclosure controls were reported effective, with no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether Q3 sales growth and the shift toward Frozen-related products are sustainable, and how royalties and product mix affect gross margins.
- How much of reported earnings reflects recurring operations versus the $5.9 million Maui earn-out credit, and whether diluted EPS trends are comparable across periods.
- Receivables and inventory quality, collections and seasonal cash needs, given the year-to-date operating cash outflow and sharp balance increases.
- Debt repayment and refinancing requirements, including the reported post-quarter payment of the $39 million 2014 notes, remaining convertible-note terms and GE facility covenant headroom.
- Execution and funding of the $58.1 million in future license minimum guarantees, and exposure to large retailers and licensors.
- Developments in the pending securities class action and derivative litigation, including any financial effect not quantified in the filing.