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Edited Transcript of JAKK earnings conference call or presentation 9-May-19 8:30pm GMT

Q1 2019 JAKKS Pacific Inc Earnings Call

MALIBU May 15, 2019 (Thomson StreetEvents) -- Edited Transcript of JAKKS Pacific Inc earnings conference call or presentation Thursday, May 9, 2019 at 8:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Brent T. Novak

JAKKS Pacific, Inc. - Executive VP & CFO

* Stephen G. Berman

JAKKS Pacific, Inc. - Co-Founder, Chairman, CEO, President & Secretary

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Conference Call Participants

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* Stephanie Marie Schiller Wissink

Jefferies LLC, Research Division - Equity Analyst

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Presentation

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Operator [1]

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Good afternoon, and welcome to the JAKKS Pacific First Quarter 2019 Earnings Conference Call with Management, who will review financial results for the quarter ended March 31, 2019.

JAKKS issued its earnings press release earlier today. Presentation slides containing information covered in both today's earnings press release and call are available on our website in the Investors section. This presentation includes videos showing some of our key products.

On the call this afternoon are Stephen Berman, Chairman and Chief Executive Officer; and Brent Novak, Chief Financial Officer. Mr. Berman will provide an overview of the quarter and provide highlights of the product lines and current business trends. Then Mr. Novak will provide details, comments regarding JAKKS Pacific's financial and operational results prior to opening up the call for questions. (Operator Instructions)

Before we begin, the company would like to point out that any comments made about JAKKS Pacific's future performance, events or circumstances including the estimates of sales and/or adjusted EBITDA in 2019 as well as any other forward-looking statements concerning 2019 and beyond are subject to safe harbor protection under federal securities laws. These statements reflect the company's best judgment based on current market trends and conditions today and are subject to certain risks and uncertainties, which could cause actual results to differ materially from those projected in forward-looking statements.

For details concerning these and other such risks and uncertainties, you should consult JAKKS' most recent 10-K and 10-Q filings with the SEC as well as the company's other reports subsequently filed with the SEC from time to time.

In addition, today's comments by management will refer to the non-GAAP financial measures such as adjusted EBITDA unless stated otherwise, the most directly comparable GAAP financial metric has been reconciled to the associated non-GAAP financial measure within the company's earnings press release issued today or previously.

As a reminder, this conference is being recorded.

With that, I would now like to turn the call over to Stephen Berman.

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Stephen G. Berman, JAKKS Pacific, Inc. - Co-Founder, Chairman, CEO, President & Secretary [2]

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Good afternoon, everyone, and thank you for joining us today. This afternoon, we are going to review our performance during the first quarter of 2019. I will talk about how our brands and products performed in the quarter compared to last year and to our expectations. After my comments, Brent will discuss our financial performance.

As has been the case for over a year now, the toy industry in several markets around the world is still feeling the reverberations of the disruption caused by the liquidation last year of Toys "R" Us. That liquidation commenced at the end of Q1 2018 and continued through the end of second quarter, affecting not only shipments to TRU, but to other retailers during the liquidation, and it changed the consumer behavior. We believe year-over-year comparisons in the industry won't really be clean until the second half, and even then, we'll be clouded by the changes in consumer behavior, which affected the timing of retail purchases.

We saw sales contributions from new licensed products, notably Godzilla, Harry Potter, Fancy Nancy, Aladdin and Nintendo. Considering how strong the calendar is for later in the year, have us encouraged that we'll see a strong second half, and we continue to have a solid base of evergreen products and categories. Kids Only! and Moose Mountain are both off to a good start, reversing recent weakness.

Net sales in Q1 declined approximately 24% compared to last year as a result of several challenges, some of which were felt across the toy industry and some of which are specific to our products.

In the first quarter of 2018, most toys suppliers, particularly those, like us, who are designated critical vendors, had significant shipments to Toys "R" Us, which obviously was not repeated in 2019 and has not been fully absorbed by other retailers. We had final sales to certain Toys "R" Us entities of approximately $9.5 million in 2018 first quarter. In addition, we believe the fact that Easter came 3 weeks later this year shifted some revenue from Q1 to Q2. We estimate this accounted for a mid, high single-digit percentage reduction in revenue in Q1 2019.

Looking at our products, the sales decline was primarily because of lower sales of several entertainment-driven licensed product lines especially sales of our Incredibles 2 products, which you saw significantly decline in demand as expected. We also had sales declines in Moana, Frozen 1, Tangled and Elena of Avalor as well as proprietary brands such as Squish-Dee-Lish.

We believe that on the strength of several new product launches especially those tied to high-profile films, we'll be able to experience a strong second half, and therefore, have not adjusted our full year expectations for the top line. Also later in the second quarter after the second half of this year, the Sky has a strong lineup of film-related and television-related new properties. To name a few are from Frozen 2, Toy Story 4, Lion King live action, Pokémon, LEGO Movie 2, Descendants 3, Kim Possible and Top Wing, to name a few. That being said, gross margins came in weaker than we would have liked impacting profitability in the 2019 first quarter, which has also reduced our full year adjusted EBITDA expectations, which Brent will discuss shortly.

We were able to partially offset the effects of the lower sales and gross margin in 2019 first quarter because we anticipate the industry-wide sales challenge and took steps last year to reduce our costs with SG&A costs declining significantly in the first quarter and on a year-over-year basis.

I will now turn the call over to Brent Novak. Brent?

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Brent T. Novak, JAKKS Pacific, Inc. - Executive VP & CFO [3]

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Thank you, Stephen, and good afternoon, everyone. I will first review the financial highlights from the P&L and then provide more color on sales composition before finishing up with some balance sheet commentary.

Net sales for the 2019 first quarter were $70.8 million, down 24% compared to $93 million last year. As Stephen said, the decline was essentially due to 3 factors. First, in Q1 of last year, our final sales to certain Toys "R" Us entities were approximately $9.5 million. While some of these sales have been picked up by other retailers, we believe the whole toy industry is still experiencing lower sales to consumers, and therefore, less demand for shipments.

Second, the fact that Easter fell on April 21 this year compared to April 1 of last year results in a shift of some sales from Q1 to Q2. We estimate this shift was between 5% and 8% of 2018 first quarter sales.

Third, our Q1 2018 sales benefited significantly from licensed properties especially Incredibles 2. That declined year-over-year as expected. And the main drivers of licensed product this year are launching later in 2019.

Gross margin in the quarter was 20.2%, down from 24.7% in Q1 of last year. The main driver of the decrease was substantial shift in sales away from higher-margin licensed products toward some of our lower-margin evergreen products as well as selling through some older products at lower margins, which also helped drive our inventory balance down. In addition, we had higher excess in obsolete charges compared to a credit in Q1 of 2018, which contributed to the decrease in gross margin.

Our direct selling expenses declined 34% year-over-year, the result of lower co-op advertising expenses and a decline in marketing costs, which is due in part to the timing as a result of the Easter shift and planned media spend later in the year.

Total SG&A expenses declined about 35% despite the inclusion of cost related to our ongoing negotiations with Meisheng and other bondholders regarding Meisheng's plan to increase its investment in JAKKS in the 2019 first quarter.

The year-over-year decline is primarily due to the cost-reduction plan implemented in the 2018 fourth quarter and the $13.8 million bad debt charge reported in the 2018 first quarter related to the Toys "R" Us liquidation.

Net interest expense was $3 million, up from $1.9 million as a result of higher borrowings and a higher average borrowing rate.

Income tax benefit for the first quarter of 2019 was $200,000 compared to $2.3 million in Q1 of last year. The variability of the income tax provision is based on changes in taxable income levels in various tax jurisdictions in which we operate.

Reported net income attributable to JAKKS' shareholders was a loss of $29.2 million in Q1 of 2019 or $1.24 per diluted share compared to a loss of $36.2 million or $1.57 per diluted share in Q1 of last year.

Adjusted EBITDA for the first quarter of 2019 was negative $17.1 million compared to negative $14.6 million in the first quarter of 2018.

The sales drivers in the first quarter of 2019 by category were as follows: Sales of dolls, role play and dress-up, plush and activity products in our girls category amounted to $29 million for the 2019 first quarter, down 35% compared to $44.5 million in the comparable quarter last year. We saw positive contributions from girl's toys from Fancy Nancy and Who's Your Llama. These brands were more than offset by the expected declines in a number of girls lines, including several entertainment content-driven lines such as Moana, Frozen, Elena of Avalor and Tsum Tsum as well as our slow rise foam product, Squish-Dee-Lish, which was launched in the second half of 2017, but demand for this category is expected to wane in 2019.

Sales of Action Figures, Vehicles, Role Play and electronic products in our boys and other category for the 2019 first quarter were $15.1 million, down 26% compared to $20.5 million last year. Positive contributions from Harry Potter, Nintendo, Godzilla were more than offset by declines in Incredibles 2.

Sales of seasonal products including license to ride ons, ball pits, kids furniture, Maui outdoor activity products and MorfBoards were $22.2 million in the 2019 first quarter, up 3% from $21.6 million in 2018, as we saw a nice rebound in sales of ball pits and ride ons, and kids outdoor furniture also did well.

Sales in our Halloween category, which is also one of our business segments, decreased $1.6 million to $3.6 million in the first quarter of 2019 compared to $5.2 million in 2018 due in part to the timing of orders and shipments as this business is heavily skewed to the third quarter.

Sales of baby doll accessories, figures, plush and games in our preschool and activity category were $900,000 in the first quarter of 2019, down from the $1.2 million reported in the first quarter of 2018. The decrease was driven almost entirely by declines in our Pull My Finger game.

Looking at sales by business segment. U.S. and Canada net sales for the first quarter of 2019 were $57.4 million compared to $70.5 million last year driven by the same factors in the product group descriptions.

International sales for the 2019 first quarter were $9.8 million compared to $17.3 million in 2018 driven by declines in Incredibles 2 and Squish-Dee-Lish products, and we already mentioned Halloween sales in the category breakdown earlier.

Net cash used in operating activities was $1.9 million for the first quarter of 2019 compared to net cash used in operating activities of $11.4 million in the first quarter of 2018 due to changes in working capital. Free cash flow was negative $4.4 million in the 2019 first quarter compared to negative $14 million in the 2018 first quarter.

As of March 31, 2019, our cash and cash equivalents including restricted cash totaled $47.4 million compared to $46.8 million as of March 31, 2018, and $58.2 million at the end of 2018. The decline in cash from year-end is primarily due to paying down the $7.5 million credit facility balance that was outstanding at the end of 2018. We continue to focus on improving the company's liquidity position while also balancing the need to invest in the business and secure new licenses.

Accounts receivable as of March 31, 2019, was $67.8 million, down from $93.9 million as of March 31, 2018, and $122.3 million at the end of 2018. DSOs improved in the 2019 first quarter to 86 days from 91 days reported in the 2018 first quarter.

Inventory as of March 31, 2019, was [$44.7 million] versus $54 million as of March 31, 2018, and $53.9 million at the end of 2018. DSIs in the 2019 first quarter were 89 days compared with 91 days in the 2018 first quarter.

As of March 31, the company's debt includes principal amounts of $113 million for convertible notes due June 2020, $29.5 million for previously exchanged convertible notes due November 2020 and our $20 million term loan with Great American. There were no borrowings outstanding under our credit facility at March 31.

Capital expenditures during the first quarter of 2019 were $2.5 million compared to $2.6 million in the first quarter of 2018. The diluted loss per share calculations for the first quarter is based on a weighted average of 23.6 million common shares outstanding compared to 23.1 million for the first quarter of 2018. The 2019 diluted share count excludes 23.4 million shares underlying our outstanding convertible senior notes.

Before I pass the call back over to Stephen, I would like to discuss our expectations for 2019. As Stephen mentioned, although we believe the worst is behind us regarding the TRU liquidation, we continue to believe that there will be some disruptions through the second quarter of 2019. That said, we continue to be encouraged by comments we are getting from our customers regarding some of our products and the content coming in 2019, specifically Frozen 2. But we do believe our gross margins will continue to see pressure into the second quarter of 2019. Currently, we believe net sales in 2019 will increase year-over-year by approximately 5% or to $596 million, give or take, a few percentage points.

Our 2019 top line expectation remains unchanged. But given the gross margin pressure we expect in the first half of 2019, we now estimate that our adjusted EBITDA for the 2019 year will be roughly $22 million. Adjusted EBITDA excludes significant nonrecurring and noncash items including stock-based compensation expense, acquisition-related costs and restructuring charges, many of which pertain to future events and are not currently estimate-able with a reasonable degree of accuracy. Therefore, no reconciliation to GAAP amounts can be provided.

From a seasonality perspective, we continue to expect 2019 gross sales to be more significantly weighted toward the back half of the year. We currently estimate that approximately 27% of our gross sales will be generated in the 2019 first half with the balance generated in the back half of the year.

And with that, I will now turn the call back over to Stephen. Stephen?

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Stephen G. Berman, JAKKS Pacific, Inc. - Co-Founder, Chairman, CEO, President & Secretary [4]

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Before we get to Q&A, I will share some thoughts on some of the properties and trends we think will be important in 2019. We continue to be optimistic about the second half of 2019 for a number of reasons. First, when we get past the noisy comparison with last year, we expect more of the TRU business to be picked up by other retailers.

Second, 2019 has already been a great year for created content. The lineup of content for the rest of this year is terrific, and we have more than our share of licenses that we expect will drive sales.

Third, we continue to expand our own IP, consistent with our strategic goal of having our own IP constitute a higher portion of our total sales.

And finally, in our seasonal area, we added a play tent category, which is off to a terrific start.

We have several Disney properties that should benefit from either new or continued content, including Fancy Nancy, which continues to do very well in ratings on Disney Junior, was launched very successfully for us in fall 2018. The show has been greenlight by Disney for another 2 seasons, and we'll continue to expand our line with a focus on the hottest segments, our fashion dolls, Role Play and dress-up.

We have products tied to Toy Story 4 such as Buzz Lightyear Star Command Center. And during the second quarter, we should see good sales of dolls, dress-ups and Role Play items tied to Disney's live-action release of Aladdin. The movie release is May 24, and our product is just getting shelves now. We expect strong sell-through given the very early POS and social media buzz.

This year, Disney is celebrating the 30th anniversary of their release of Little Mermaid, and we have special products for that including a beautiful clamshell vanity. And of course, Frozen 2 will be out in time for Thanksgiving. We have summer products shipping in the weeks leading up to the box office release, including special feature dolls, dress-up and Role Play. One key driver I would note is a Playdate Sven, a kid-sized reindeer styled after the popular character from the original film. We expect the Frozen brand to be a significant factor in both the second half of 2019 and well into 2020 and beyond.

In addition to the Disney licenses we just discussed, we also have several other licenses that should do well this year. Harry Potter was a big contributor to our first quarter sales, and we have a toys tied to Gigantosaurus, a new animated TV series on Disney Junior featuring dinosaurs. And even though the movie doesn't open in theaters until late this summer, we already are seeing good sell-throughs of Godzilla products, a Walmart exclusive. And we expect the film release to keep sales strong.

Video game-related toys continue to sell well for us and other companies. Nintendo has done very well for us in recent years. Our Nintendo sales grew over 25% in Q1 2019 versus Q1 2018, and the products continue to do very well at retail. We have Mega Man Action Figures based on the classic video game, and Sonic the Hedgehog is another beloved video game character that will benefit from new content about TV and in theaters in 2019.

We have several products based on our own IP that look promising for 2019 starting with TP Blaster Sheet Storm, the follow-up to last year's surprise hit, TP Blaster Skid Shot. Slap Ninja is a fun action game while Piñata Fiesta is a line of collectibles and activity sets, which will broaden our presence in both those categories.

MorfBoard should benefit not only from a broader distribution for the full year but also from the addition of an electronic motor giving riders yet another way to experience the versatility of the MORF activity platform. And X-Power Dozer is our latest powered vehicle line.

In conclusion, we are still seeing the disruption from Toys"R"Us liquidation more than 12 months later. Our second quarter will see some benefit from the Easter shift, but the big driver of products and licenses are still skewed more to the second half. We are encouraged by the performances of some of our new brands and line extensions. The rightsizing of our cost structure puts us in a good position to improve profitability in 2019 and beyond.

With that, we will now take questions. Operator?

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question is from Steph Wissink from Jefferies.

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Stephanie Marie Schiller Wissink, Jefferies LLC, Research Division - Equity Analyst [2]

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Just a couple of questions for us. I think, Stephen, the first one is for you. As you think about the holiday season for 2019, how should we think about some of the retail space that you opened last year, new retailers for you, a continuation of some of that new development? And then how much are you leaning into some of the bigger retailers? You mentioned the Godzilla partnership on an exclusive basis at Walmart. How should we think about kind of the channel mix that you're planning for, for the holidays 2019?

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Stephen G. Berman, JAKKS Pacific, Inc. - Co-Founder, Chairman, CEO, President & Secretary [3]

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Okay. Well, Steph, thank you for the question. A few things. One, since the Toys"R"Us liquidation as well as the early -- or mid bankruptcy of Sears, Kmart and some other companies, we were well on our way with diversifying the retail space, some of which have been going through the alternative channels such as the Walgreens, the dollar stores and the clubs. So we've been really focusing on that prior to the TRU liquidation that expedited post the liquidation. So our expansion from the, call it, alternative distribution has grown dramatically and will grow even more in the second half with in-line space, which is shelf space as well as in-line store space, which will be sidekicks and pilot programs. Our business will have a really nice growth with the clubs as well as the dollar trade as well as the alternative channels like GameStop, Kohl's, Ross. All those businesses, to us, are going to be offsetting a good portion of what we lost with the Toys "R" Us. In addition to the Targets, the Walmart, the Amazons, even DICK's Sporting Goods, that we are seeing a dramatic increase in shelf space for the second half of the year because the consolidation of the Toys "R" Us, call it, gap has been pretty much filled into the second half of the year and retailers had a strong back half of 2018 and they're looking for the same. And some of which I'll use as we have our categories like the Sky, there's a tremendous amount of new content from the Descendents to Tangled, to Paw Patrol, to Lion King, to Toy Story, Pokemon, Frozen 2. We have a tremendous amount of content. So actually the Halloween business will have very strong growth for us this year versus last year. And then we are going to into one of the most exciting things for retailer is Frozen 2, which we are gearing up for a very strong worldwide launch that's on shelf this October 4 and the movie launch is November 21, which we do see a strong year this year and even a strong year next year in all retail avenues worldwide for Frozen.

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Stephanie Marie Schiller Wissink, Jefferies LLC, Research Division - Equity Analyst [4]

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Okay. That actually leads into my second question, which is around Frozen. If you can just help us frame up maybe what expectations were for Frozen 2 on a relative basis to Frozen 1 and where they started. And it sounds like the level of enthusiasm has actually been getting higher or bigger. Is the gap to the first film going to be very narrow? Or is it possible that we don't see that natural sequel film phenomenon where the content this time around could be just as strong? How are you thinking about the second film?

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Stephen G. Berman, JAKKS Pacific, Inc. - Co-Founder, Chairman, CEO, President & Secretary [5]

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So from working very closely with the Walt Disney Company and our Disney group has been working well over a year on this and some of which we haven't even gone through as some of them have kept everything very, very confidential. But we've been working much more tighter with them based off what we had successfully in the year 2013, '14 and '15 knowing the retail awareness, and call it, consumer acceptance, the increase from the original launch to the Frozen 2 launch is dramatically different in the sense of size and broadness and worldwide acceptance. And even the spring plans going into next year are very far ahead than what they were previously because retailers are banking it for the also, call it, the first half of 2020 for their DVD and streaming release, which were the biggest components of the strength of Frozen 2 when it was originally launched. So we learned of the SKUs that were strong in some of them which were weak when -- and I'd say when it was weak, they really weren't but for the success of Frozen, they were just not a successful as some of the large products. So our lineup, our exclusive lines that we have for a broad amount of retailers around the world is very, very thought out and their retail plans for Frozen 2, in general, is successfully strong, not just in toys but overall. And our core Frozen seasonal visits has been considerably strong today.

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Stephanie Marie Schiller Wissink, Jefferies LLC, Research Division - Equity Analyst [6]

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Okay. That's great. And then the last one maybe, Brent, this is for you is there is an 8-K filed today with an incremental disclosure on fiscal '20, and I'm wondering if you can just talk to the step-up in sales that you see in the outyear. And then more specifically, the step-up in EBITDA, which is quite substantial, if you can give us just a frame of reference for what you expect to see in terms of the profitability structure in the outyear.

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Brent T. Novak, JAKKS Pacific, Inc. - Executive VP & CFO [7]

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Okay. So I think we'll see, just on the gross sales, I think we commented last time that you'll have a full year of Frozen 2, so that'll be a significant driver on the top line. And then from an adjusted EBITDA standpoint or profitability standpoint, we expect that given with a newer product like Frozen 2 that'll generate higher margins, which is what we're expecting in the back half of 2019 as well. So if you inch up a little bit on the gross margin, we expect to hold our G&A relative -- or at least what's controllable relatively flat, so we should see that leverage finally start to drop down to the bottom line. So that's really kind of the driver is maybe inch up a bit in gross margin and flat controllable OpEx should give you leverage to drive that adjusted EBITDA higher.

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Operator [8]

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We have no further questions at this time. Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.