JAKKS Pacific, Inc. — Q3 2011 Form 10-Q
Reporting period: Three and nine months ended September 30, 2011. Amounts are in millions of dollars, except per-share data. JAKKS designs, markets and distributes toys and children’s consumer products in two segments: Traditional Toys and Electronics; and Role Play, Novelty and Seasonal Toys.
Financial performance
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Net sales | $332.4 | $348.7 | $536.7 | $549.3 |
| Gross profit / margin | $105.7 / 31.8% | $111.0 / 31.8% | $175.0 / 32.6% | $179.4 / 32.7% |
| Operating income / margin | $50.1 / 15.1% | $51.6 / 14.8% | $37.3 / 6.9% | $39.2 / 7.2% |
| Net income / margin | $34.8 / 10.5% | $40.4 / 11.6% | $28.5 / 5.3% | $38.2 / 7.0% |
| Diluted EPS | $1.10 | $1.23 | $0.97 | $1.22 |
Cash flow and liquidity: Operating activities used $2.6 million in the first nine months, versus $1.8 million used a year earlier. Investing activities used $16.7 million and financing activities used $26.9 million; cash declined $46.1 million from the start of the year to $232.2 million. Working capital was $401.4 million at September 30, up from $387.3 million at December 31, 2010. Management said cash and expected operating cash flows should meet anticipated operating needs for at least the next 12 months.
Debt: The company reported $91.5 million of convertible senior notes, net, on the balance sheet; the notes have $100 million principal, bear 4.50% interest and mature November 1, 2014. Interest expense was $6.1 million for the nine-month period.
Material changes versus comparable periods
- Q3 sales declined 4.7% year over year; nine-month sales declined 2.3%. Traditional Toys and Electronics sales rose 9.5% in Q3 and 7.1% year to date, while Role Play, Novelty and Seasonal sales fell 15.3% and 10.2%, respectively. Lower Halloween costume sales were a key drag; strength in several licensed toys and children’s furniture partly offset the declines.
- Q3 operating income fell 2.9%, although operating margin improved to 15.1% from 14.8%, helped by lower SG&A. Nine-month operating income declined 5.0% and operating margin fell to 6.9% from 7.2%.
- Net income declined 13.7% in Q3 and 25.4% for nine months. The nine-month comparison includes a substantially higher tax provision in 2011: the effective rate was 23.9%, compared with 3.9% in 2010, when a discrete $11.1 million tax benefit was recorded. The 2011 period included a $1.3 million discrete tax benefit.
- Receivables and inventory increased from year-end to $239.7 million and $55.8 million, respectively, reflecting seasonal working-capital needs. Nine-month operating cash flow remained negative despite reported net income.
Outlook, commentary and notable items
- The company gave no specific revenue or earnings guidance. It emphasized toy-industry seasonality: sales and working-capital needs are generally highest in the third and fourth quarters, and orders are cancelable until shipment, limiting backlog’s usefulness as a sales indicator.
- Future minimum guarantees under product and character licenses totaled $89.7 million, with $45.2 million due within 12 months, in addition to $38.7 million in advances already paid. Royalty rates generally range from 1% to 14% of net sales.
- In October 2011, JAKKS acquired Moose Mountain Toymakers for approximately $16 million in cash, subject to working-capital adjustment and a contingent payment. The purchase was funded from existing cash.
- Oaktree Capital made a non-binding, highly conditional $20-per-share acquisition proposal. The board determined it was inadequate and not in shareholders’ best interests; the company reported no accepted offer.
- The company repurchased and retired 1,206,300 shares for $19.3 million in Q3, completing its $30 million authorization. It also reported a $0.10-per-share cash dividend payable October 3, 2011.
- A California lawsuit alleges unauthorized use of models’ likenesses and seeks unspecified damages. The company disputes the claims but said it could not estimate potential losses. Other routine proceedings were not expected by management to have a material effect.
- Key risks include reliance on a small number of retailers and licensors, product and character popularity, license renewal and minimum royalty commitments, competition, seasonal forecasting, third-party manufacturing concentrated in China, foreign exchange exposure, product safety and customer credit risk. Wal-Mart, Toys “R” Us and Target together represented 52.6% of nine-month sales.
Important facts for investors to verify
- Whether seasonal Q4 sales and collections convert the elevated receivables and inventory into cash, and whether the reported 66 days of receivables outstanding is maintained.
- Sales trends and margins in Role Play, Novelty and Seasonal Toys, particularly Halloween products, and the performance of licensed products relative to royalty costs.
- Funding and cash-flow implications of $45.2 million in license minimum guarantees due over the next year, the Moose Mountain acquisition and the remaining convertible notes.
- Customer and licensor concentration, including major retailers’ credit quality and the renewability and economics of significant licenses.
- Developments in the Nouveau litigation and any change in the company’s assessment of potential exposure.