JAKKS Pacific, Inc.
Q3 2019 Earnings Call Transcript

Published: 9 Nov 2019

[Operator:]

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 products. 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's 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 refers to non-GAAP financial measures such as adjusted EBITDA. Unless otherwise stated, 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 will now like to turn the call over to Stephen Berman.

[Stephen Berman:]

Good morning, everyone, and thank you for joining us today. This morning, we're 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 five 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 nine months of 2019, is up 22% over the same period last year.Sell-throughs have been strong across Bass 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 Pokemon. Our Nintendo toy learner 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 number one 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 propose 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 changing insourcing, modified logistics and price increases were 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?

[Brent Novak:]

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 five 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 margin 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

[Stephen Berman:]

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 has 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 two years, we have been dealing with such issues as the bankruptcy and subsequent liquidation of Toys"R"Us, top toys 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?

[Operator:]

[Operator Instructions] And we do have a question on the line from Stephanie Wissink from Jefferies.

[Ashley Helgans:]

This is Ashley Helgans on for Steph Wissink. Thanks for taking our question.

[Stephen Berman:]

Good morning, Ashley.

[Ashley Helgans:]

Good morning and Congrats on the quarter.

[Stephen Berman:]

Thank you.

[Ashley Helgans:]

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?

[Stephen Berman:]

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 leverage in the model.

[Ashley Helgans:]

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

[Stephen Berman:]

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 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.

[Ashley Helgans:]

Okay, great. Thanks so much guys and congrats again.

[Stephen Berman:]

Thank you.

[Operator:]

[Operator Instructions]

[Stephen Berman:]

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.

[Operator:]

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