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Edited Transcript of JAKK earnings conference call or presentation 7-Nov-19 2:00pm GMT

Q3 2019 JAKKS Pacific Inc Earnings Call

MALIBU Nov 10, 2019 (Thomson StreetEvents) -- Edited Transcript of JAKKS Pacific Inc earnings conference call or presentation Thursday, November 7, 2019 at 2:00:00pm 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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* Ashley Elizabeth Helgans

Jefferies LLC, Research Division - Equity Associate

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Presentation

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Operator [1]

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Good morning, and welcome to the JAKKS Pacific Third Quarter 2019 Earnings Conference Call with Management, who will review financial results for the quarter ended September 30, 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 product.

On the call this morning 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 product lines and current business trends, then Mr. Novak will provide detailed 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 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 morning, everyone, and thank you for joining us today. This morning, we are going to review our performance during the third quarter of 2019. I will start with some general comments about our third quarter performance, including the products that drove our sales growth. After my comments, Brent will discuss our financial performance, after which I will come back on to discuss some drivers for the holiday season and make additional comments before opening the call up for questions.

We were pleased that we're able to show net sales growth of 18% for the quarter ended September 30, 2019, when compared to 2018 third quarter, which was the strongest year-over-year sales growth rate we have posted in nearly 5 years. The growth was driven by several strong brands and by online sales of our products.

The upcoming release of Disney's Frozen 2 drove sales of all of our Frozen products, including those tied to the original film. Our costume division Disguise saw year-over-year growth of 16% in the third quarter, and through the first 9 months of 2019 is up 22% over the same period last year. Sell-throughs have been strong across vast accounts and online, with strong sales of Toy Story 4, Nintendo, Disney Princess, Descendants 3 as well as new introductions of Aladdin live-action, Bendy the Ink Machine and Pokémon.

Our Nintendo toy line of products were up over 50% in the third quarter, benefiting from the strong resurgence of Nintendo in the video game market as well as strong momentum going into fourth quarter. Bowser's castle playset is the #1 new item in the Nintendo line of products and the positive POS of this item is pulling through sales of the range of 2.5-inch figures and other playsets across retailers globally.

Our line of Sonic the Hedgehog figures and Plush made its global debut and is off to a terrific start. Fans of the games have reacted very positively to the JAKKS' execution of this property. Godzilla and Toy Story 4 were also solid contributors to the quarter, even though Godzilla was an exclusive with one retailer.

Sales of our products through online channels were up 32% in Q3 and represented 12% of our total net sales. Our international sales were basically flat compared to Q3 of last year, as we continue to work through some changes, but reflects a considerable improvement over the first half. Our strong growth in the areas above more than offset some of the big decreases in several brands, including Incredibles 2, Fancy Nancy, Moana, Harry Potter and Squish-Dee-lish.

Our sales increase comes despite the fact that retailers are tightening their inventory commitments and are relying more on domestic shipments than direct import. We have not really seen much of a shift in our mix from direct import to domestic, but we know that this is something the retailers are paying attention to.

On the tariff front, we continue to evaluate the potential impact that the tariffs proposed to go into effect on December 15 might have on our business. Obviously, the impact on 2019 would be minimal, although retailers may have taken some products in a bit earlier to avoid potential tariffs. But looking to 2020, there are a number of levers we can pull to mitigate the impact, including change in insourcing, modified logistics and price increases where possible. These steps in the past have been effective at offsetting the negative effects of tariffs.

Back to our performance. So off to a strong start on sales for the second half of 2019, and we are optimistic that we can keep the momentum going through the holidays. As important, our gross margins were up, our SG&A expenses were lower as a percentage of sales, and our adjusted EBITDA was up 64% 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 morning, everyone. I will first review the financial highlights from the P&L and then provide more color on the sales composition before finishing up with some balance sheet commentary.

Net sales for the 2019 third quarter were $280.1 million compared to $236.7 million last year. This is the biggest year-over-year increase we've had in quarterly net sales in nearly 5 years. As Stephen said, the increase came from multiple sources, including new and older products, which together more than offset the declines of several properties, and I will review the various ups and downs as I discuss the sales performance of each product category.

Gross margins in the quarter was 28.9%, up from 27.2% in Q3 of last year. The main driver of the increase was lower product costs as a percentage of net sales, lower closeout sales and lower amortization of tools and molds, which more than offset a 210 basis point increase in royalty expense as a percent of sales.

The higher royalties and lower product costs are a function of the product mix shifting more towards licensed products, including sales of the Frozen properties and continued strong performance of our Halloween product category.

Our Q3 direct selling expenses rose by just under 14% on a year-over-year basis but declined slightly as a percent of net sales. Total SG&A expenses rose by only 2% in Q3 on a year-over-year basis, but declined to 16% of net sales as a result of prior cost-reduction initiatives. The effect of the increase in net sales and gross margin and the tight expense management was that our operating income rose 78% from $20 million in Q3 of last year to $35.7 million in Q3 of this year.

Interest expense was $4.6 million in Q3, up from $3.1 million last year as a result of higher borrowings and a higher average borrowing rate, including noncash costs for payment in kind interest associated with amended Oasis convertible notes and the new secured term loan and the amortization of debt issuance costs and the debt discount associated with the new secured term loan.

The provision for income taxes for the third quarter of 2019 was approximately $1 million compared to $2 million in Q3 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 $16.4 million in the 2019 third quarter or $0.51 per diluted share compared to $15.7 million or $0.38 per diluted share in Q3 of last year. Adjusted EBITDA for the third quarter of 2019 was $44.1 million, an increase of 64% over the $27 million reported in the third quarter of 2018.

The sales drivers in the third 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 $142.9 million for the 2019 third quarter, an increase of 40% compared to $102.3 million in the comparable quarter last year. We saw positive contributions from our Frozen properties and Toy Story 4. These brands offset the expected declines in a number of girls lines, including several entertainment content-driven lines such as Incredibles 2, Fancy Nancy and Moana as well as Squish-Dee-lish.

Sales of Action Figures, Vehicles, Role Play and Electronic products in our boys and other categories for the 2019 third quarter were $30.8 million, down 24% compared to $40.6 million last year. Positive contributions from Nintendo, our own extreme power and TP Blaster and Godzilla were more than offset by declines in other brands, including Incredibles 2 and Harry Potter.

Sales of seasonal products, including licensed ride-ons, ball pits, kids furniture, Maui outdoor activity products and MorfBoards were $27.6 million in the 2019 third quarter, up 11% from $24.9 million in 2018. We had a nice quarter with our kids outdoor furniture, ball pits and tents, our Fly Wheels brand and MorfBoards sales, which were partially offset by a decline in our Maui products.

Sales in our Halloween category, which is also one of our business segments continued to perform well in 2019 and increased 16% to $75.8 million in the third quarter of 2019 compared to $65.3 million in 2018. The sales increase in the third quarter was led by various licensed properties, including Frozen 2 and Toy Story.

Sales of baby doll accessories, figures, Plush and games in our preschool and activity category were $3 million in the 2019 third quarter compared to $3.6 million in the comparable quarter last year. Declines in our Pull My Finger game and Daniel Tiger’s Neighborhood more than offset the sales of Gigantosaurus in the quarter.

Looking at sales by business segment. U.S. and Canada net sales for the third quarter of 2019 were $165.1 million, up 24% compared to $133.5 million last year, primarily driven by Frozen 2 and Disguise.

International sales for the 2019 third quarter were $39.2 million, up 3% compared to $37.9 million in 2018, with declines in Incredibles 2, Moana, Squish-Dee-lish and Tsum Tsum largely offsetting strong sales of Frozen 2. And we already mentioned Halloween sales in the category breakdown earlier.

Net cash provided by operating activities was $35 million for the third quarter of 2019 compared to net cash provided by operating activities of $11.3 million in the third quarter of 2018 due to improved operating results and changes in working capital. For the first 9 months of 2019, net cash provided by operations was $26.1 million, well above the $2.6 million provided in the same period last year.

Free cash flow was $32.6 million in the 2019 third quarter compared to $8.3 million in the 2018 third quarter. As of September 30, 2019, our cash and cash equivalents, including restricted cash, totaled $75.9 million compared to $57.1 million as of September 30, 2018, and $37 million last quarter. The increase in cash from last quarter was primarily due to operating cash inflows and additional borrowings.

Accounts receivable as of September 30, 2019, was $200.8 million, down from $205.4 million as of September 30, 2018. DSOs improved in the 2019 third quarter to 66 days from 80 days reported in the 2018 third quarter. Inventory, as of September 30, 2019, was $65.3 million versus $64.5 million as of September 30, 2018. DSIs in the 2019 third quarter were 40 days compared with 44 days in the 2018 third quarter.

As of September 30, the company's principal amount of debt consists of $1.9 million of convertible notes due June 2020; $37.6 million of convertible notes due in 2023, issued to Oasis; $134.8 million of secured term loan due in 2023, issued to certain prior holders of the convertible notes due June 2020; and $5 million outstanding on the company's recently extended credit facility with Wells Fargo. The term loan with Great American was prepaid in full on August 9 in connection with the recapitalization transaction.

Capital expenditures during the third quarter of 2019 were $2.4 million compared to $3 million in the third quarter of 2018. The earnings per diluted share calculation for the third quarter is based on 60.3 million shares, which consists of a weighted average of 27.1 million common shares outstanding, plus 31.6 million shares from convertible notes, plus 1.6 million related to the dilutive effect of outstanding stock-based awards. The numerator of the diluted EPS calculation included an add-back of 14.4 million related to interest and other adjustments associated with the convertible notes, including the 12.8 million loss on extinguishment of the convertible notes associated with the recapitalization transaction.

Before I pass the call back over to Stephen, I would like to discuss our expectations for the remainder of 2019. We continue to estimate that our net sales in 2019 will increase year-over-year by approximately 5% or grow to $596 million, give or take 1% or 2%. Our 2019 third quarter gross margins came in as expected. More or less, we did not experience the same level of gross margin pressures that we experienced in the first half of the year, and we have not seen such issues thus far in the fourth quarter. As a result, we continue to believe that our adjusted EBITDA this year will show significant improvement over last year and believe that our prior estimate of an adjusted EBITDA number for the 2019 year of roughly $22 million continues to be the top end of a range of possible outcomes with a low end of roughly $12 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 estimatable with a reasonable degree of accuracy, therefore, no reconciliation to GAAP amounts can be provided.

And with that, I will 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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Thank you, Brent. I will now share some thoughts on the properties and trends we think will be important for the holiday quarter. We continue to be optimistic for the holiday season for several reasons. We expect Frozen 2 and Nintendo, which contributed strongly to Q3, to continue to do well in Q4. We expect Play Tents, one of our newest segments, to contribute nicely to Q4 sales. Moose Mountain ball pits and Play Tents continue to be a strong seller and a perennial holiday big gift purchases. Minnie Mouse, Toy Story 4 and Paw Patrol have been particularly strong.

Our evergreen line of foot to floor ride-on business has seen expanded distribution for fall, and sales of the Fisher-Price Music Parade, Corn Popper and Paw Patrol SKUs have seen strong sales growth. From Disney, the 30th anniversary of the release of the Little Mermaid should lead to renewed interest in this line. The Disney Princess Style Collection has gotten rave reviews from retailers, particularly the Travel Case. Semua, which remains small but enjoyed strong growth in Q3, should benefit from our collaboration with Liza Koshy, one of the top influencers on Instagram.

After a weak first half of 2019, we expect our international sales to grow on a year-over-year basis in the fourth quarter. Video game-related toys continued to sell well for us and other companies. In addition to Nintendo, which continues to perform well and seen double-digit growth in POS at major retailers in Q3 and for the year, remains a steadily growing business. We also have Mega Man and Sonic the Hedgehog, benefiting from new entertainment content on one and strong fan recognition on the other.

In conclusion, we are excited by how this quarter shows what we are capable of without a number of concurrent major distractions. For more than 2 years, we have been dealing with such issues as the bankruptcy and subsequent liquidation of Toys"R"Us, Top-Toy and others, the proposal by Meisheng to take a controlling position as well as others expressing interest in us, which, of course, has not occurred, and a recapitalization transaction involving multiple entities, which has now put JAKKS back into a strong financial position for the future. We still have work to do, and we'll continue to take steps to improve our financial position, but the work we've done so far this year will allow me and the rest of our operating team to spend time on the work to be done to improve our financial position and our business for the future.

Before we get to Q&A, I'd like to address our announcement earlier today that our CFO Brent Novak will be leaving the company to pursue other opportunities. The company is currently conducting a search for its next CFO. Brent has been a valued member of the JAKKS' team since joining the company in April 2018. We wish him well in his future endeavors.

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 we do have a question on the line from Stephanie Wissink from Jefferies.

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Ashley Elizabeth Helgans, Jefferies LLC, Research Division - Equity Associate [2]

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This is Ashley Helgans on for Steph Wissink. Congrats on the quarter. So to start, is the cost model now in a place where leverage is possible? Or do you expect to achieve further benefits from noncore cost areas?

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

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Yes. No, I think that the cost model where we're at, I mean, there could be some tweaks here or there. But certainly, if gross margin holds, then certainly, there should be a leverage in the model.

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Ashley Elizabeth Helgans, Jefferies LLC, Research Division - Equity Associate [4]

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Okay. Great. And if I could squeeze in one more on Frozen 2. We wanted to just unpack the global demand trends you're seeing. And how should we think about the split of sales in 2019 versus 2020?

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

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So right now, with the Frozen 2, the split for the 2019 second half, I would believe it's around 65% to 35% approximately of the split. And as we've seen in the past with the original Frozen 1, international was a laggard in a sense of just the way that the movie was released. So we would expect to have the same type of a stronger 2020 for international than we would have in 2019.

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Operator [6]

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(Operator Instructions)

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Stephen G. Berman, JAKKS Pacific, Inc. - Co-Founder, Chairman, CEO, President & Secretary [7]

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Ladies and gentlemen, thank you very much. As there's no further questions today, I appreciate everyone on the call today. Looking forward to announcing our fourth quarter and year-end numbers early next year and looking forward to having a great positive 2020 and beyond. Thank you very much.

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Operator [8]

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Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.