JAKKS Pacific, Inc.
Q4 2019 Earnings Call Transcript

Published: 19 Feb 2020

[Operator:]

Good morning, everyone. Welcome to the JAKKS Pacific Fourth Quarter and Full Year 2019 Earnings Conference Call with management, who will review financial results for the quarter ended December 31, 2019 and the full year ended December 31, 2019. JAKKS issued its earnings press release earlier today. Our earnings release and presentation slides for today's call are available on our website in the Investors section.On the call this morning are Stephen Berman, Chairman and Chief Executive Officer; and John Kimble, Chief Financial Officer. Mr. Berman, will first provide an overview of the quarter along with highlights of product lines and current business trends. Then Mr. Kimble will provide detailed comments regarding JAKKS Pacific's financial and operational results. Mr. Berman will then return with additional comments and some closing remarks, 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 2020, as well as any other forward-looking statements concerning 2020 and beyond, are subject to Safe Harbor protection under federal security 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 like to turn the call over to Stephen Berman.

[Stephen Berman:]

Thank you, and good morning everyone and thank you for joining us today.For more than 20 years, JAKKS sought to create a revenue base that consist of mostly evergreen product categories that are enhanced by continual refreshing of relevant licenses, while at the same time pursuing opportunities with promotional products, I am proud to say that our results in 2019 show successful execution of this strategy and I'd like to start today's conversation with an overview of the great progress JAKKS Pacific made in 2019 and the strategic focus, innovative creativity, unfettered determination that led to accomplishing our stated goals and growing both sales and margin. After John's comments on our financial performance, I will return with some brief comments about our major product categories, and what we are doing in 2020.During the quarter, we exceeded our internal expectations for top line and adjusted EBITDA, finishing both the fourth quarter and the full year with positive adjusted EBITDA. We grew total sales by 15% over the fourth quarter of last year, and our full year sales were up by 5%. Sales within our International segment were strong in fourth quarter and up more than 40% year-over-year. We did exceptionally well with Frozen 2 which contributed strongly to our total growth and helped us grow our gross sales by over 35%.We continue to have a solid base of evergreen products in categories where we are the industry leader, which helped us grow the seasonal category by over 50% over fourth quarter last year, and we have seen nice increase in our sales to online retailers.In addition to the increase in sales, we also tightly manage our operating expenses, cut in our overhead significantly compared to fourth quarter of last year. As a result, we were able to produce better financial results for the fourth quarter and for the year that we had expected. As John will detail shortly, our gross margin in the fourth quarter was up over 30% and posted a positive adjusted EBITDA for both the quarter and the full year.2019 was a strong rebuilding year for JAKKS. We've experienced positive results for both evergreen brands and great licenses and remain committed to delivering maximum value to our consumers and our shareholders in the short, medium and long-term. So let me provide greater details on the most significant and meaningful activities and guiding principles JAKKS leverage this past fiscal year.As many you may know, NPD recently reported that U.S. retail toy sales were down for the fourth quarter and down 4% for the full year. This decline came on top of the declines from last year, it was not generally expected. We are quite pleased that we were able to post our second consecutive quarter of double-digit sales in the fourth quarter, and that we are able to grow our full year sales for the first time since 2014. Experts will debate the many reasons for the industries decline last year, including the Thanksgiving shift, changes in consumer buying behavior, the strength of movie properties earlier in the year et cetera.But the reasons for our growth are simple, we had several products and categories that were very strong and they were able to more than offset the weakness of other products, as well as the overall retail sales decline in toys. The improvements we saw were directly attributed to our anticipation of the industry-wide sales challenge, and the steps that we have actively been taking to reduce our costs leading to significant improvements in our operating cost structure.Excluding a number of non-reoccurring charges, our total SG&A costs were down significantly compared to last year for both the fourth quarter and the full year. Our inventories at year-end were down as a percent of sales and our accounts receivable were both down in dollars and as a percent of sales.We maximize and nurture a strong platform of evergreen brands and properties. In fourth quarter, we had strong sales of several new or recently launched products led by Frozen 2, Nintendo, Xtreme Power Dozer, Fly Wheels and Princess style collection.Our seasonal business thrived in 2019 with strong performances from our Ride-Ons, Ball Pits, Tents, Kid Furniture and our new skateboard brand Redo which had strong placement in late fourth quarter at both Walmart and Target. Evergreen brands such as Disney Princess, Power Rangers, PJ Masks, Microsoft Halo and Nintendo performed very well for our disguised business.Some of this positive sales contribution was offset by the decline in several entertainment properties that had previously contributed significant sales in fourth quarter 2018 but had an absence of new content in 2019 including Incredibles 2, Fancy Nancy, Moana and Harry Potter. Additionally, we saw as expected continued declines in Squish-Dee-Lish which we launched in the second half of 2017.JAKKS has managed a broad product portfolio for optimal leverage opportunities and greatest risk diversification. We are nimble, agile and opportunistic by actively orchestrating programs with existing licenses, new licensing partnerships, private label businesses and the creation and launch of original IP.JAKKS's own brands such as Perfectly Cute, Kitten Catfe, Fly Wheels, Xtreme Power Dozer, Creepy Crawlers, Redo Skateboards and others have established a stable long term foundation opening opportunities for JAKKS to expand its retail footprint across more aisles and to more categories, as well as opening the door to incremental licensing and retailer partnership opportunities.We have brought a culture of spirit that fosters innovation and creativity across the company. Employees are empowered to bring forward ideas related to any core function. This desire to make a different shine store in our products and then the passion our people bring to the many operations across the company.We believe this makes a meaningful difference both internally, with employees, as well as externally with licensors, retail partners, consumers and more. Brands like Fly Wheels, Kitten Catfe, Xtreme Power Dozer, Toilet Paper Plasters and Morf among others are driven by our internal passionate innovators and they have full company support.In a recent study, we identified that approximately 25% of the JAKKS's employee base has been with the company for more than five years, and that approximately 64% of these employees have been with JAKKS for more than 10 years serving across a broad range of cross-functional divisions and departments.We remain committed to seeking out the most effective and efficient ways to reach our highly fragmented multi-segment consumer base. We employ strategies and tactics designed not only to maximize awareness for our end product user, the Kids but also to stimulate purchase convergence amongst those with purchasing power including parents, collectors and gift givers.2019 was a pivotal year as JAKKS devoted resources to wide range reaching media activities, as well as a highly targeted campaign that allowed for meaningful opportunities to test, learn and to optimize. Marketing is an ever-changing landscape driving awareness with kids via traditional cable television, digital streaming video, in gaming and in social media apps and relatable influencer partners, while driving purchase conversions both in-store and online with paid social media digital media and sponsored search-related activities.We are always on the lookout for opportunities to improve margins and profitability without reducing product quality or sacrificing internal culture. In 2019, we successfully implemented the following

[John Kimble:]

Thank you, Stephen, and good morning everyone.Net sales for 2019 fourth quarter were $152.5 million up 15% compared to $132.3 million last year. Reported net loss attributable to common stockholders for the fourth quarter was $20.6 million or $0.70 per diluted share compared to a net loss of $3.2 million or $0.14 in the fourth quarter of last year.The net loss in Q4 2019 includes a number of noncash charges of $10.7 million such as intangibles impairment and tooling disposal and the change in fair value of the derivative liability associated with our preferred stock. Adjusted EBITDA for the 2019 fourth quarter was $3.3 million compared to a negative $1.6 million in the fourth quarter of 2018.Adjusted net loss attributable to common stockholders for the fourth quarter was $0.26 per diluted share, an improvement of $0.11 over the same period last year. For the full year of 2019, net sales were $598.6 million up 5% compared to $567.8 million in the prior year.Reported net loss attributable to common stockholders for 2019 fiscal year was $56 million or $2.16 per diluted share compared to a net loss of $42.4 million or $1.83 in 2018. Included in the 2019 full year losses of $13.2 million loss on extinguishment of debt associated with the recapitalization we completed in Q3 of 2019 and $10.7 million associated with the aforementioned charges and change in fair value recognized in Q4 of 2019.Adjusted EBITDA for the full year of 2019 was $18.9 million compared to $2.3 million for the full year 2018. Adjusted net loss attributable to common stockholders for the full year of 2019 was $0.73 per diluted share an improvement of $0.52 over 2018.Our girls targeted businesses was the biggest driver of growth in both Q4 and for the full year inclusive of doll, role play and dress-up toys we achieved $99.6 million in Q4 up 37% compared to the comparable quarter last year. As one might expect the release of Frozen 2 provided both a lift for our existing Frozen product, as well as an opportunity for new product tied to the film. Those sales more than offset some of the anticipated declines in various older product lines related to properties such as Fancy Nancy, Moana and Squish-Dee-Lish.For the full year girls toys were up 14% to $301.7 million in 2019 compared to $263.6 million in 2018 largely attributable to the aforementioned drivers. Sales of action figures vehicles role play and electronics products in our boys category for the 2019 fourth quarter were $22.9 million down 20% compared to $28.8 million last year. Positive contributions from our Nintendo products in addition to launches of our Fly Wheels and Xtreme Power brands were not enough to compensate for downsides and a mix of entertainment driven properties such as Incredibles 2, Harry Potter and some non-entertainment properties such as Stanley Black & Decker, and our TP Blaster brand.For the full year boys toys were down 29% to $79.2 million in 2019 compared to $111 million in 2018. The decline in Incredibles 2 was somewhat mitigated by upsides during the year from properties like Godzilla and Sonic. Sonic remains an ongoing program for us in 2020.Sales of seasonal products including licensed Ride-Ons, Ball Pits, Play Structures, Kids Furniture and MorfBoard were $23.1 million in the 2019 fourth quarter up 16% from $19.9 million in 2018 as strong sales of Ride-Ons offset declines in MorfBoard and Maui Outdoor toys.For the full year seasonal products were up 10% to $90 million in 2019 compared to $81.9 million in 2018 with the same factors that drove Q4 sales also driving full year results. Sales in our Halloween category decreased $3 million in the fourth quarter of 2019. However when it comes to the very seasonal nature of Halloween, we're much more focused on full year performance. For full year 2019, the Halloween segment was up 18% to $119.6 million.Sales of baby doll accessories, figures, plush and games in our preschool and activity category were $3.1 million in the fourth quarter of 2019 down from $3.9 million in 2018. The decrease was driven primarily by lower sales of Daniel Tiger's Neighborhood, as well as declines in our Pull My Finger game, our 2019 launch of Gigantosaurus contributed positively for both the quarter and full year.For the full year preschool and activity products were down 16% to $8.1 million in 2019 compared to $9.7 million in 2018. Looking at sales by business segment, U.S. and Canada net sales for the fourth quarter were 13% up to $113.6 million compared to $100.9 million in the prior year quarter driven by the same factors described earlier in the product group descriptions.International sales for the 2019 fourth quarter were stronger at $35.2 million up 43% compared to $24.6 million in the 2018 fourth quarter driven by strength in Australia, Asia and Europe. For the full year net sales of our International segment were $94.5 million compared to $101.9 million in 2018 representing a decrease of $7.4 million or 7%. The decrease in net sales was primarily driven by lower sales of Incredibles 2, Disney Princess products and Squish-Dee-Lish partially offset by higher sales of Frozen 2 which was not sold in the prior year period.We already mentioned Halloween sales in the category breakdown earlier, moving down the P&L, reported gross margin in the 2019 fourth quarter was 30.4% down slightly compared to 30.6% in the 2018, fourth quarter. Gross margin for the full year was 26.6% compared to 27.4% in 2018 with the decrease driven by product mix toward lower margin products earlier in the year and a higher royalty expense as a percentage of sales.SG&A expenses including direct selling expenses and depreciation and amortization and the 2019 fourth quarter totaled $57.2 million or 37.5% of net sales compared to $44.9 million or 33.9% of net sales in 2018. For the full year SG&A expenses in 2019 totaled $177.1 million or 29.6% of net sales compared to $187.9 million or 33.1% of net sales, a dollar reduction of 5.7%.Net cash used in operating activities was $4.3 million for the fourth quarter of 2019 up when compared to net cash used in operating activities of $3.2 million in the fourth quarter of 2018, primarily due to an increase in royalty advances.For the full year 2019, net cash provided by operating activities was $21.8 million up when compared to net cash used in operating activities of $624,000 in 2018. Free cash flow was a negative $6.1 million in the 2019 fourth quarter and a negative $5.4 million in the 2018 fourth quarter. For the full year 2019 free cash flow was positive $12.4 million compared to a negative $12.4 million in 2018.As of December 31, 2019 our cash and cash equivalents, including restricted cash totaled $66.3 million compared to $58.2 million 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 new licensed opportunities.Accounts receivable as of December 31, 2019 were $117.9 million, down from $122.3 million as of December 31, 2018. DSOs improved in the fourth quarter to 71 days from 85 days reported in the 2018, fourth quarter.Inventory as of December 31, 2019 was up only slightly to $54.3 million versus $53.9 million at the end of the fourth quarter of 2018. DSIs in the 2019 fourth quarter was 62 days down from 70 days in the 2018 fourth quarter.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 currently have no outstanding balance under our credit facility.Capital expenditures during the fourth quarter of 2019 were $1.8 million compared to $2.2 million in the fourth quarter of 2018. For the full year 2019, CapEx was $9.4 million compared with $11.8 million in 2018. The diluted loss per share calculation for the fourth quarter of 2019 was based on a weighted average of 29.6 million common shares outstanding. For the full year 2019, the diluted loss per share calculation was based on a weighted average of 26 million shares.And with that I will now hand the call back over to Stephen for some additional remarks.

[Stephen Berman:]

Thank you, John.As I said earlier in each of our major product categories we have a mixture of evergreen products, continually refreshed licenses and opportunistic promotional products. Our base of evergreen products reliably produces strong year-over-year consistent revenues and we augment this with innovative and creative promotional products and lines based on our current licenses.In our Girls division for 2020 among our new products we have Kitten Catfe, a line of preschool products based on kittens and which is our own IP and Cute Girls Hairstyles which is a hairstyling line based on a popular social media channel. A broad line of our Disney Princess Style Collection, Frozen 2 with the new spring line of lower-priced products and a broader new fall line with new products and their interactive Singing Elsa Doll.In addition, our Minnie Mouse lines also have broader distribution for this year and Daniel The Tiger, and Giganotosaurus also continuing for preschoolers with broader distribution. In addition we hope there will be other licenses that we should be able to talk about soon.In our Boys division we continue to see growth in Nintendo and will have broader global distribution of this line during 2020 and beyond. Our Saga product lines notably Sonic the Hedgehog has seen nice sell-through and should get a nice boost from the successful release of the movie last weekend. We will also be launching a line of toys based on the popular book series Last Kids on Earth. In addition we are expecting strong sales from our relaunch of Fly Wheels which was one of the most successful proprietary products JAKKS has ever had.In our seasonal division, we will benefit from having a full year of sales of our line of license indoor play tents, and our innovative Redo Skateboards and the relaunch of Eyeclops. Finally, we are looking forward to a number of strong licenses in our Disguise costume segment including Trolls 2, Frozen 2, Harry Potter, Wizard of the World, Zombies 2, Mulan, Bakugan and others. And we are especially excited to be announcing today we'll be bringing out costumes based on the five times Grammy Award winner Billie Eilish, one of the hottest new recording artists of all time.Let me additionally add that we'll continue to see broader global rights for many of these licensed products. These are universal play patterns and the licenses translate very well and we will continue to get the rights in more and more countries. In addition, we have a new partnership in Europe with more costumes which is expanding our reach and sales opportunities.In summary we have made a lot of progress. And while we know we have a lot more to do, we believe we have made tremendous strides. We are operating in a consistently fluctuating retail and consumer marketplace, and we are prepared to address changes with both speed and agility. We know we still have improvements to make but as a company we are gratified to have achieved good growth at a time when industry sales remain challenged. With that in mind, I firmly believe that we are positioned for global success and we will drive to deliver meaningful contributions to our partners, consumers and all key stakeholders.Before I open the call to questions, I'd like to comment on the coronavirus and how it's affected us and what we are doing. Our thoughts and prayers go out to those affected by the outbreak. Any company was sourcing products from China has to be flexible during this period of disruption. We have been adjusting the work shifts, and are working with our suppliers to minimize the disruption.All of that said, we are not in a position to know how this will affect our prior to production suppliers in various segments and our manufacturers, and therefore our sales. We think it's reasonable to expect industry-wide delays in terms of production and deliveries around the world.We are rescheduling any China-based direct import shipments and production loss during the past week and we are monitoring the situation closely to determine how quickly our manufacturing partners can resume full production levels and catch up on missed activity.While this is normally a slower production period for us, we're reviewing toolmaking, tooling capacities, product procurement, production and flow of goods going forward into the Halloween season and beyond.While we have been moving product manufacturing to other countries and are producing products in Vietnam, Cambodia and India, the majority of our current production comes out of China. We will update you on this when we report first quarter results in April.With that we will now take questions. Operator?

[Operator:]

[Operator Instructions] We have a question from Stephanie Wissink from Jefferies.

[Ashley Helgans:]

This is Ashley Helgans on for Steph, thanks for taking our questions. So to start on the coronavirus. Where are your factory partners in terms of having personnel back and capacity online today? And then where do you expect them to be in the next two to four weeks?

[Stephen Berman:]

So based throughout China there is so many variations with provinces and different segments of manufacturing. So for instance our - major cut and sew supplier which is located in Hangzhou in the outskirts of Hangzhou is starting to get up and running almost at full capacity because - they only have had two affected people in that province.So they are able to get much more labor, but it truly depends on the actual manufacturing capabilities and the segments in which are located from Shenzhen to Guangdong to Hangzhou. So it really depends on the actual area. So at this point in time, there's a flow of labors coming into specific manufacturers and then there are no flows of labor going to other manufacturers. But right now with where we stand.I'm on the phone each evening on a WeChat call with each manufacturer that are our major components. And it's a really by day process. They're hoping to have more labors come in and cross borders by next week but it really just depends where they are located and actually the amount of labor that they need during this off-season period. So it's really by manufacturer or by factory is how it works.

[Ashley Helgans:]

Okay great, thank you. And then if I could just squeeze in one more. Payables in the quarter were up 15% in line with sales. But when we look at the returns and allowances on the balance sheet they were up 30%. How should we think about this gap?

[John Kimble:]

Yes, Ashley it's John. I'll take a stab at that one. That is in line I think with our last quarter's results as well and it's something we are kind of keeping an eye on in terms of getting. Top of mind I have couple of different thoughts as to why that's happening, but we'll probably have to take it offline to give you something which is a little bit more fact-based rather than gut-based.

[Ashley Helgans:]

Okay. We can take it offline. Thanks so much for the color and look forward to seeing you guys next week.

[John Kimble:]

I mean I think to answer your question. We don't see it as a temporary sort of blip in terms of how the balance sheet is trending. We think that's probably more in line with our current mix and where the business is heading next year.

[Operator:]

We have a question from Gerrick Johnson from BMO Capital Markets.

[Gerrick Johnson:]

Hi Stephen, what was the $11 million impairment in tooling write-down what did that relate to?

[John Kimble:]

It’s John again. The $11 million isn’t tooling per se it was a mix of three different things. Tooling that we ended up writing down faster than we normally would depreciate was a little bit less than $1 million of that. Most of that was attributable to some incredibles tool stuff which we thought was essentially at end of life faster than we would have normally expected it to be. And some tooling that was put in place chasing Tsum Tsum back in early 2018.The big piece of that was $9-plus million of intangible impairment off the P&L relating to the acquisition of Maui that was done back in 2012. As the company kind of reviews the product line in a greater level of detail and looks for - are we investing our resources in the right places and maximizing margin. As I think you might know the company exited the fund little business last year along with - at the same time evaluating how that business is doing and what the prospects of it were.And although along with having some leadership changes in that business over the past several months and kind of looking at it carefully in terms of where it is and where we think it's going. During the quarter it made sense to revisit that intangible value and to essentially go and write it down. So that was the majority of that Q4 write-down. I believe there is also a piece to associated with the derivative element of our preferred stock which is something we have to mark-to-market every quarter.

[Gerrick Johnson:]

And Stephen you talked a lot about consistent revenue and building out stable evergreen businesses. So I guess the obvious question here is how much of your growth in the quarter came from Frozen and Frozen 2 in particular. And then do you still think that Frozen 2 will be as big in 2020 for you as it was in 2019?

[Stephen Berman:]

Okay so firstly, we don't breakout actually - the actual property revenue. But Frozen obviously Frozen 2 was the strong property for us. And this year or last year at the same time our Princess sales held extremely strong throughout the Frozen [indiscernible]. So previously in 2013/2014 Princess slowed down while Frozen picked up. We had a good benefit of Princess doing extremely well not just the basic Princess, but our new style collection.So going forward we have a broad array of our Princess line that's expanding and we are ahead of Frozen in the sense of product development. The first time around we didn't have a spring line because we didn't know the success. This time around we have a very nice spring line which is at lower price points which is really set up across - the board at U.S. and international customers. And then we have which was our number one SKU was a Sing-A-Long Elsa Doll which we had in 2014 that we are launching for fall 2020.So in addition to Frozen being strong last year we see it strong this year. We will have a - the sky is Frozen 2 line much more broader than we did in 2019 as the movie came in October and no one really new about Frozen 2 in October 31st last year.

[Gerrick Johnson:]

So it sounds like you're very confident in Frozen 2 in 2020. But do you think it will be contribute as much to P&L in 2020 as 2019?

[Stephen Berman:]

I would say it won't contribute as much or it possibly can. What we're excited for is the DVD launch I think I believe it's at the end of this month and the streaming launch. But that being said our Princess sales are growing. So the actual area of business itself is extremely stable and growth. And in addition we actually have a very strong tent-pole [ph] movie launch property which is called Raya which is Disney's November animated film which was pretty much Moana happened years ago.Frozen and we're looking forward to the launch of Raya which will be in November and we have a broad array of products very similar to what we did in Frozen or Frozen 2.

[Gerrick Johnson:]

And then one more from me. So DSOs I think they were down 14 days yet international was up over 40% compared to the U.S. at what over 13%. So with the shift to international shouldn't DSOs have expanded so, what explains the better collection this year?

[John Kimble:]

Yes that's a good question. Yes to be honest I don't think we have an answer for you off the cuff on that. We are mindful that as we expand the international business, the DSO metric usually doesn't necessarily work in our favor. But we were happy to sort of see where we were at the end of the quarter.

[Gerrick Johnson:]

Okay.

[John Kimble:]

And we're moving on to New Year.

[Gerrick Johnson:]

All right, all right. I want to keep going retail POS and inventory?

[Stephen Berman:]

Right now retail PO, I'm sorry.

[Gerrick Johnson:]

Inventory and channel, yes retail POS?

[Stephen Berman:]

Inventory and channel - is actually extremely I'd say low for the normal period of time versus last year. By good fortune we ended the year pretty clean at retail. We didn't have any major issues across the board both U.S. and internationally. And there has been other companies have had some major issues. So we're looking going into this 2020 pretty lean at retail inventories.

[Gerrick Johnson:]

Okay good and POS in the quarter?

[John Kimble:]

I don't have that off the top of my head, I'm sorry. We could do that offline.

[Operator:]

Thank you.

[Stephen Berman:]

Well that is it for the conference call today. We appreciate everybody being on the call and we're looking forward to having our first quarter conference call in April and talking more about 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.