Edited Transcript of JAKK earnings conference call or presentation 13-May-20 9:00pm GMT

It has been less than 3 months since our last conference call. At that time, the big question was when will our Asian suppliers be back to normal production. Now we’re all asking ourselves when will anything be normal. While in many ways, everything is different, in some ways, they are the same. JAKKS has been built on the idea that a strong collection of evergreen products and brands supplemented by opportunistic promotional initiatives can do well, and we continue to see that.

Our sales were down a modest 6% in the quarter compared to last year, but we see several areas of strength, and our retail POS remains encouraging. Led by Frozen 2 and Disney Princess role play, dolls and play environments, our girls toys were up 35% year-over-year in the quarter. Our boys toys were down, but excluding the declines in some entertainment properties, we saw strength in Nintendo and Sonic the Hedgehog. Seasonal products like kids furniture have been very strong at retail, and our disguise business was up nicely year-over-year.

Clearly, the retail landscape has changed quickly and dramatically, but kids still like to play and parents still want to give their children good products to play with. That being said, the ability to go to stores, to interact with other kids and to consume new entertainment content has changed. JAKKS has been diligently working to adapt to the new patterns of consumer behaviors, and we believe we have some strategic advantages. With kids spending much more time at home away from social settings and traditional play groups, products such as activity tables, video games and fantasy and role play toys have performed well, whereas action figures and some dolls and some collectibles have not performed as well.

Fortunately, for JAKKS, we have a very strong position in a wide range of categories like ball pits and activity tables. In addition, our foot to floor ride-ons are steady sellers and our Cute Girls Hairstyles is a new activity line for us. And the dolls that have done well are tied to high-quality entertainment content with strong brand recognition, such as the likes of Frozen 2 and Disney Princess.

An additional key business focus continues to be reducing cost and preserving cash. As John will discuss later, our gross margin showed a nice increase year-over-year, while we have simultaneously reduced our operating expenses. Last year, we exited some low-margin product categories like Funnoodle, and we have worked to cut cost by downsizing. In addition to reducing our workforce with layoffs this quarter, we also asked all employees to take a temporary reduction in pay, including the executive team.

Prior to the pandemic, we implemented a multi-tier development program focused on designing and developing products specific to the following retail channels: mass, which is including of Walmart, Target, Amazon, Tesco, Edeka and ALDI, to name a few; specialty, including T.J. Maxx, Ross, GameStop and others; big box, which includes Costco, Sam’s Club and BJ’s; dollar trade, including Family Dollar, Five Below and others. This development initiative with stratified price points has allowed JAKKS to pivot accordingly into opportunities and segments during this disruptive time where other companies have been more drastically affected by retail store closures.

We also know we have many strategic strengths, most notably our strong licensing partnerships, our long-standing manufacturing relationships and great partnerships with our retail customers. POS sales at our largest customers was positive in Q1 and has been even more positive in April. Our China manufacturing partners have returned to near-normal levels of production, and we believe that our many stable and evergreen product lines can do well in any economic environment, and we remain confident that we will emerge from this even stronger than we were before the pandemic began.

After John gives an update on our financial performance, I will return with some brief comments about our major product categories and what we are doing for the balance of 2020.

With that, I will turn the call over to John.

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John L. Kimble, JAKKS Pacific, Inc. – Executive VP & CFO [3]

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Thank you, Stephen, and good afternoon, everyone. Net sales for the 2020 first quarter were $66.6 million, down 6% compared to $70.8 million last year. Reported net loss attributable to common stockholders for the first quarter was $12.3 million or $0.41 per basic and diluted share compared to a net loss of $29.2 million or $1.24 in the first quarter of last year.

As a reminder, certain elements of our capital structure are mark-to-market quarterly based on a few factors, inclusive of our share price. The net loss in Q1 2020 includes noncash gains totaling $9.8 million, reflecting changes in the fair value of our convertible senior notes and the derivative liability associated with our preferred stock. By comparison, the net loss in the first quarter of 2019 also included changes in the fair value of our 2020 convertible senior notes but also a number of charges related to our 2019 recapitalization process. Excluding the impact of such charges as well as stock compensation expense, our adjusted net loss attributable to common stockholders in the first quarter of 2020 was $21.9 million or $0.72 per basic and diluted share compared to a loss of $23 million or $0.98 per basic and diluted share in the first quarter of 2019, an improvement of $0.26.

Adjusted EBITDA for the 2020 first quarter was negative $13.9 million compared to a negative $17.1 million in the first quarter of 2019.

Our girls targeted business was strongest during the quarter. Inclusive of dolls, role play and dress-up toys, girls toys was $39.2 million in Q1, up 35% compared to $29 million in the first quarter of last year. As was the case in the fourth quarter, the big driver was Frozen, both toys related to Frozen 2, which was released in theaters late in Q4 of 2019, but also for toys tied to the original Frozen. Other girls toys that were strong included Kitten Catfe, our own aspirational doll and collectible world of Catfe-inspired surprises as well as our new Minnie Mouse fashion doll line launched in partnership with Disney, which began shipping last quarter. Those sales more than offset some of the anticipated declines in various other product lines, particularly those related to older entertainment properties such as Moana, Aladdin and Fancy Nancy as well as our own Squish-Dee-lish line.

Sales of action figures, vehicles, role play and electronics products in our boys category for 2020 first quarter were $9.7 million, down 36% compared to $15.1 million last year. Positive contributions from our Fly Wheels line of proprietary action vehicles, Sonic the Hedgehog and Nintendo Super Mario products were more than offset by declines in entertainment-driven properties such as Godzilla, Harry Potter and Incredibles 2 as well as some nonentertainment properties such as our TP Blaster brand.

Sales of seasonal products, including licensed ride-ons, ball pits, play structures, kids activity tables and MorfBoards were $12.9 million in the 2020 first quarter, down 42% from $22.2 million in the first quarter of 2019 and strong sales of ride-ons offset declines in MorfBoards and Maui outdoor toys. The biggest decline in Maui is the result of the discontinuation of Funnoodles, a low-margin category we exited last year and referenced last quarter when we took an impairment charge against the intangibles associated with that acquisition.

Sales in our Halloween category increased about 10% to $4 million in the first quarter of 2020 compared to $3.6 million last year. Sales of baby doll accessories, figures, plush and games in our preschool and activity category were $0.8 million in the first quarter of 2020, down from $0.9 million in the same quarter of 2019. The decrease was driven by lower sales of Daniel Tiger’s Neighborhood as well as declines in our Pull My Finger game, which offset the contribution of Gigantosaurus, which was launched last year.

Looking at sales by business segments. Sales in our toys and consumer products segment, which includes all markets around the world, were down 6.8% to $62.6 million compared to $67.2 million in the first quarter of last year. The decrease was driven by the same factors noted above in the product discussion. Australia, New Zealand, Asia, Latin America and Europe were all stronger, while the U.S. and Canada were down 11% year-over-year. And as we already noted above, our Halloween segment was up around 10%.

Looking at the rest of the P&L. Reported gross margin in the 2020 first quarter was 24.6% compared to 20.2% in the 2019 first quarter. Steady improvements in our product margins and lower obsolescence reserves outpaced higher royalty charges incurred in the quarter. Sharply lower spend for SG&A expenses, including direct selling expenses and depreciation and amortization in the 2020 first quarter totaled $32.3 million or 48.6% of net sales compared to $38.4 million or 54.1% of net sales in the first quarter of 2019.

Net cash used in operating activities was $18.9 million for the first quarter of 2020 compared to net cash used in operating activities of $1.9 million in the first quarter of 2019, primarily due to higher media and warehouse costs incurred in Q4 as well as higher royalty payments year-over-year.

Free cash flow was negative $20.5 million in the 2020 first quarter and a negative $4.4 million in the 2019 first quarter.

As of March 31, 2020, our cash and cash equivalents, including restricted cash, totaled $44 million compared to $66.3 million at the end of 2019 and $47.4 million as of March 31, 2019. As of April 30, 2020, the company had $42 million of cash on hand and $36 million of availability on its revolving credit facility, resulting in total liquidity of over $78 million.

Accounts receivable as of March 31, 2020 were $64.8 million, down from $117.9 million as of December 31, 2019, and $67.8 million at March 31, 2019. DSOs for the 2020 first quarter increased to 89 days from 86 days reported in the 2019 first quarter.

Inventory as of March 31, 2020, was $48.2 million versus $54.3 million at December 31, 2019, and $44.7 million as of March 31, 2019. DSIs in the 2020 first quarter were 116 days compared to 89 days in the 2019 first quarter. In looking at DSIs on a trailing 12-month basis, we were at 52 days for both periods.

As of December 31, 2019, the company’s debt includes $1.9 million of convertible senior notes due June 2020, $37.6 million of recapitalized convertible senior notes due July 2023 and $134.8 million owed under our term loan due February 2023. We intend to pay off the $1.9 million worth of notes this quarter on schedule. We currently have no outstanding balance under our credit facility.

Capital expenditures during the first quarter of 2020 were $1.6 million compared to $2.5 million in the first quarter of 2019. The diluted loss per share calculation for the first quarter of 2020 was based on a weighted average of 30.2 million common shares outstanding.

And with that, I will now hand the call back over to Stephen for some additional remarks.

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

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Thank you, John. Looking toward the second half of the year, there is obviously a lot of uncertainty about the state of the economies around the world: how quickly retailers will bounce back once they have reopened, what affect the current high levels of unemployment will have on the consumer spending even if people started going back to work very soon and how long the changes in consumer buying behavior will persist. That said, we are managing our inventory positions tightly. We are working harder than ever on our SKU efficiencies and managing tooling and product development spending. We remain laser-focused on staying flexible and adaptable to changing market conditions around the world while being good long-term stewards of our investors’ capital.

At the same time, we have spent considerable time and energy over the past quarter, staying connected with our network of suppliers, customers, licensors and other business partners to be helpful where we can and remind them that we are there to be problem solvers for them, particularly during this unusual time. What we have in our favor are evergreen products based on established play patterns, strong relationships with the world’s best kids intellectual property companies, retail customers that are strong enough to survive these challenges, manufacturing partners that are some of the best in the world and a single-site U.S. distribution facility that was built to meet the challenge of getting goods to retailers and individual customers rapidly.

To elaborate, number one, relevant lasting play patterns. Our products are based on play patterns that have been proven over many decades to be fundamental activities for kids around the world: role play, dress up, doll play, vehicle play, collecting plush and otherwise, outdoor fun and activity, arts and crafts.

Number two, powerful licenses. Our licensing partners are responsible for some of the most popular intellectual properties in the world, including the Walt Disney Company, Marvel, Pixar, DC Comics, Warner Bros, NBCUniversal and so many others. We even have licensing deals with some of our bigger friendly competitors like Lego, Hasbro and Mattel. We are also in the process of discussing some new and exciting licenses.

Number three, new IP. We continue to develop our own IP, which serves the purpose of rounding out a balanced portfolio while also building long-term value for JAKKS and our partners.

Number four, stable retail customers. Our top retail customers are Walmart, Target, Amazon, Costco, Tesco and Smith’s, to name a few. Amazon is obviously ideally positioned for an environment like this. And Walmart and Target have both done an excellent job of capturing sales both in stores and online. We are fortunate to have such great relationships with most of these healthy retailers.

Established and reliable supply chain. Our manufacturing partners once again proved during the first quarter how quickly they could rebound. We are grateful for those relationships, which we have built and maintained for more than 25 years. Our distribution facility is operated by an experienced, professional and smart staff and is able to meet the demands of just-in-time inventory logistics as well as overnight shipments to individual customers. In fact, our direct-to-consumer business is thriving, and our order volume for spring has been close to what we experienced during November and December last year.

From a product standpoint, we have several items we expect to do well in 2020. From the girls division, we expect good sales from Frozen 2; Kitten Catfe, which is our own proprietary product; and Cute Girls Hairstyles, which is supported by a popular YouTube channel of the same name.

From boys, we continue to see good sales from Fly Wheels, and we expect continued strong sales of Nintendo-based toys. Nintendo Switch is the best-selling video game system right now and its newly released Animal Crossing has been a smash hit among gamers of all ages. We also expect good sales from toys based on Last Kids on Earth and a proprietary brand of Xtreme Power Dump Truck.

In seasonal toys, our ReDo Skateboards have done well and should continue to be strong through the year, and we expect our reintroduction of Eyeclops to be a strong seller as an activity toward this year.

Finally, we have a great lineup of licensed costumes this year for Halloween, including Frozen 2, Billie Eilish, Mulan, Trolls, Harry Potter and Bakugan, to name a few. At this point, it’s unclear how different Halloween will be this year, but we expect consumers will insist on dressing up, even if it’s just to show off on social digital platforms, video calls, small school events as well as small parties. We know there are challenges ahead, and the JAKKS team has been doing a great job of working from home, and we’ve been diligently striving to get our offices ready and safe so that our employees, vendors and customers can return.

We are working to stay ahead of the curve. We were founded with a very entrepreneurial mindset, focusing on speed to market and adapting to all types of retail environments and changes in consumer behavior, which allows us to provide the products needed for the times we are in, whether it’s a pandemic or just the normal vagaries of the kids consumer business. For the reasons I just outlined, we are confident that we can emerge from these times in a strong position.

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) Our first question comes from the line of Stephanie Wissink from Jefferies.

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

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This is actually Ashley Helgans on for Steph. We were wondering if you could break down the gross margin improvement. How much was related to cost restructuring? And how much related to product mix benefits?

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John L. Kimble, JAKKS Pacific, Inc. – Executive VP & CFO [3]

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Sure. It’s John. I’ll take that. You’re looking at it year-over-year is your question?

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

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Yes, please.

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John L. Kimble, JAKKS Pacific, Inc. – Executive VP & CFO [5]

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Because we did roll backwards a little bit from last quarter. I mean really from an overall point of view, it was really much more driven by product cost improvement, more so than anything in our restructuring program. Our royalties are up a bit year-over-year in that area. But we still had good expansion from a product margin point of view as it relates especially to our newer product. Part of our slipping back from where we were last quarter was moving out some of that older product at a more discounted rate.

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Ashley Elizabeth Helgans, Jefferies LLC, Research Division – Equity Associate [6]

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Okay. Great. And then, Stephen, if I could just have one for you. You mentioned the potential for new licenses. Are you seeing some opportunities for maybe companies who will make it through this disruption?

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

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Thank you, Ashley. It goes both ways. We’ve been very opportunistic in entrepreneurial, working with our retailers and with our licensors. Due to this disruptive period, there’s many companies that are having some major issues, whether teetering bankruptcy or already are in that process of being bankrupt. So we’ve been working diligently and daily and hourly on many new opportunities that’s out there. So we’re excited about that. And during these unprecedented times, even though it’s a very sad and disheartening time for families and the world, there is opportunity there if you’re staying nimble and ahead of things. And we think that we are and licensors and retailers have been backing some hopeful new opportunities going forward. So yes, we’ve been very aggressive on that.

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Operator [8]

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(Operator Instructions) Our next question comes from the line of Gerrick Johnson from BMO Capital Markets.

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Gerrick Luke Johnson, BMO Capital Markets Equity Research – Senior Toys and Leisure Analyst [9]

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Just wondering how the conversations are going right now with your retailers as they plan for the fall. Are they thinking about pushing back set dates? Or what kind of conversation are you having at this point? I know there’s a lot of uncertainty. But right now, how are they feeling about the back half and holidays?

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Stephen G. Berman, JAKKS Pacific, Inc. – Co-Founder, Chairman, CEO, President & Secretary [10]

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So for the ones that are currently — call it, the retailers that are out there that have groceries or necessities, such as the Amazons, the Walmarts, the Walgreens, the Meijers, the Costcos and so forth, CVSs and so on, their planning is normal. The set dates that — the normal sets that we normally have for fall are still planned as set dates. What has changed are different dates that were for movie launches that are either been pushed out or delayed. So those dates have either been canceled or changed appropriately based off of movies i.e., Mulan’s coming out, I believe it’s in July now; [Soul is going to be] coming out in the first quarter, and we changed for those appropriate timetables.

But for, call it, the Halloween set dates that we have, those have all been still set and in place. People are just taking a more cautious view on ensuring that they have the right inventory and are being focused on, call it, the real selling patterns and selling properties versus taking risk on items that may not have a win to it. They’d rather take a conservative approach. So the basic businesses that we’re in and all the platforms of the outdoor furniture, the foot to floor ride-ons, the ball pits, the evergreen areas are consistent with the normal set dates that we’ve had. And then anything new is just being moved around and dealt with by individual retailers.

The ones that are changing are the ones that have been closed during this period of time, call it the specialty retailers throughout the U.S. and around the world. You have Smith’s in the U.K. that closed down and opens up again in July. You have had Ross, T.J. Maxx. So those ones are just adapting as getting ready for back-to-school, and they have planned everything as normal for the holiday season but also taking a cautious approach and being very opportunistic of positive initiatives. If there’s opportunity, they want more goods. If things aren’t — are slowing, they want to be able to back off of goods.

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Gerrick Luke Johnson, BMO Capital Markets Equity Research – Senior Toys and Leisure Analyst [11]

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So is this expediting that shift to domestic that we’ve been seeing over the last couple of years, are we going to be even more domestic fulfillment this year? Is FOB dead? Or how do we look about that kind of fulfillment?

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Stephen G. Berman, JAKKS Pacific, Inc. – Co-Founder, Chairman, CEO, President & Secretary [12]

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Well, for JAKKS, FOB is alive and well, and I think we maybe even picked up slightly on a percentage basis of being more FOB on a percentage basis this year than we did last year. It’s something that we’ve started since inception. For the major customer — or major manufacturers that do domestic inventory, it’s going to be much more of a domestic focus. But specifically for us like JAKKS, our Halloween business is at least 70% plus FOB, and that hasn’t changed. And our third quarter, which is an FOB quarter majority, is still our largest quarter. So for JAKKS Pacific, it’s really an FOB business this year as it always has. But we’re trying to turn it much more on an FOB, so we have less liability going into the fourth quarter and having inventory needs domestically for the retailers.

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Gerrick Luke Johnson, BMO Capital Markets Equity Research – Senior Toys and Leisure Analyst [13]

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Okay. And then at retail, we’ve seen strength in those specific categories and other categories have been rather weak. Are you now seeing — as we progress along, are we seeing more broadening of retail performance in other categories?

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Stephen G. Berman, JAKKS Pacific, Inc. – Co-Founder, Chairman, CEO, President & Secretary [14]

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Certainly, I think it’s consistent to what’s happened during the first 4 months of the year. It’s the areas that have done well, call it, the games, the puzzles, the activities, the — like our ball pits, our table and chairs, our daily role play business has been very solid. But I think we’re going to need to wait until the summertime when birthdays come about, and we’re out of this very depressing environment at home. When people start celebrating a little bit more with birthdays and a little bit more of these events, you’ll see that some of the normal toy business come into effect. But I do believe the medium price points to lower price points during this time is much more feasible to consumers versus the higher price points that we’ve seen in the past. So we’re seeing a — at least for us, a much better uptick under lower price points or average price points versus the higher-priced-point product.

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Gerrick Luke Johnson, BMO Capital Markets Equity Research – Senior Toys and Leisure Analyst [15]

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Okay. And retail inventory, how does your inventory look at retail right now?

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Stephen G. Berman, JAKKS Pacific, Inc. – Co-Founder, Chairman, CEO, President & Secretary [16]

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I’m going to let John. I don’t have the data in front of me.

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John L. Kimble, JAKKS Pacific, Inc. – Executive VP & CFO [17]

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He said at retail?

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Stephen G. Berman, JAKKS Pacific, Inc. – Co-Founder, Chairman, CEO, President & Secretary [18]

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At retail?

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Gerrick Luke Johnson, BMO Capital Markets Equity Research – Senior Toys and Leisure Analyst [19]

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Yes.

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Stephen G. Berman, JAKKS Pacific, Inc. – Co-Founder, Chairman, CEO, President & Secretary [20]

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I don’t know if we have — I don’t have that right in — inventory right now is down. I don’t have the exact percentages, if you need. Our Walmart inventory is down 60% and Target, 41%, on our boys business. This is all I have right now in front of me, Gerrick. But if you can get back to me, I can get back to you or we can do an off-line call and give you much more detail.

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Operator [21]

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At this time, I’m showing no further questions.

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Stephen G. Berman, JAKKS Pacific, Inc. – Co-Founder, Chairman, CEO, President & Secretary [22]

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Everybody, thank you for the call today. I know we have off-line calls with several people that have been scheduled and booked, but please, everyone that’s on the call, stay healthy and well, and look forward to having our call in July for our second quarter earnings and focusing on the second half of 2020. Everyone, please stay healthy and well, and thank you very much.

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Operator [23]

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Ladies and gentlemen, this concludes today’s conference call. Thank you for participating. You may now disconnect.