JAKKS Pacific - Earnings Call - Q2 2013

Transcript

Speaker 0

Good afternoon, ladies and gentlemen. Thank you for joining the JAKKS Pacific Second Quarter twenty thirteen Earnings Call with management. Today, JAKKS will review the results for the second quarter ended June 3033, which the company released earlier today. On the call today are Stephen Berman, President and Chief Executive Officer and Joel Bennett, Executive Vice President and Chief Financial Officer. Mr.

Berman will first provide an overview of the quarter then Mr. Bennett will provide detailed comments regarding JAKKS Pacific's financial and operational results. Mr. Berman will then conclude the prepared portion of the call with highlights of the product lines and current business trends prior to opening up the call for your questions. Your lines will be on a music hold on mute for the first portion of the call.

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 earnings per share for 2013 as well as any forward looking statements concerning 2013 and beyond are subject to Safe Harbor protection under the 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 such other risks and uncertainties, you should consult JAKKS most recent 10 ks and 10 Q filings with SEC as well as the company's other reports subsequently filed with SEC from time to time. With that, I will now turn the call over to Mr. Berman.

Speaker 1

Good afternoon, everyone, and thank you for joining us today. The toy landscape continues to be challenging and we are disappointed in our second quarter results and lower guidance for 2013. Several factors contributed to the downturn, including poor sales performance of some of our key product lines, including Monsuto and The Wings Club. Unusually cool weather also affected some seasonal toy sales and we can see more aggressive markdowns occurring at retail, thus being cleared for back to school product selling season. Movie properties have shorter windows at retail now, which has impacted sales of our Smurf products and throughout the industry few movie toy sales are meeting expectations.

Struggling retailers both in The U. S. And internationally are plagued with slow toy sales and weakening international currencies, which have resulted in decreased orders and changes in purchasing policies, including one of our largest international customers in Europe experienced financial issues, which resulted in the discontinuation of their credit insurance coverage. Retailers in general are more focused on mitigating risk and thus managing their orders tightly. Higher expenses and operating costs are also contributing factors to our 2013 performance.

In response to this, we are undertaking several initiatives to return the company to profitability and growth, including a suspension of our quarterly dividend and a deep restructuring plan designed to reduce operating costs. In addition, we are working to accelerate our initiatives and process to develop our DreamPlay toy offerings for 2014 and beyond in an effort to keep up with We believe the decline in sales reflect the growth of the digital age with kids increasingly turning to smart devices for play and entertainment. Today's To successfully compete in such an environment and to cater to the growing youth digital market, we are working to develop product that creatively combines the power of digital content with the inherent value of the physical product. Combining all the capabilities of the ID technology with amazing content, kids will be able to bring their toys to life from the physical world to the digital world starting this fall with DreamPlay Little Mermaid products. This will give the kids the best of both worlds, the toys they love and the smart devices and gaming that they increasingly spend more time on combined into a one seamless experience.

This marks an effortless evolution in entertainment. The possibilities are endless With the convergence of this historic technologies and expansive product line, we will be bringing a vast library of content to life like never seen in any way. We are building our Dreamplay infrastructure with talented individuals who have come to Jack's from across content development, animation and technology companies. Our Dreamplay development team is working aggressively to create rich and compelling content, game features and more to deliver genre defining innovation this fall. 2013 is the year we lay down the foundation of our Dreamplay venture and we expect to see the fruits of our labor in 2014 with new consumer demand for our products.

We expect Dreamplay to help Jack's achieve substantial long term and long range growth and profitability justifying the investment in the technology and content that we are making. At the same time, we remain focused on our core evergreen brands and categories that continue to do a solid business day in and day out. We are looking to our core business to continue as the constant platform of our business. These are the areas in which we are one of or the category leaders such as CDI Role Play and Dress Up, Moose Mountain Flip to Floor Ride Ons and Play Environments, Kids Only Kids License Outdoor Furniture and Outdoor Kids products, Maui Toys Sky Balls for all different areas of sports, Hulu Hoop and Fun Noodles, Tolly Tots preschool products including Disney Dolls, Greco Dolls and Evergreen at Doll Accessories and our Disguise Halloween business. Our core Jack's boys and girls basic non promoted product lines such as MXS, Train World, Kid Fiti, El Chavo product, our successful 31 inches figure line of giant license action figures and our Nintendo license line of plush figures and other toys are all constant evergreen businesses.

The list goes on and are great examples of everyday toys that our under tween crowd love to play with and enjoy and that parents and caregivers feel good about buying. Our industry prospects are increasingly tied to developing countries, rising middle class and their newfound willingness to spend money on toys for their kids. Growing our international business continues to be a top priority and we recently finalized agreements to ship our Disney Princess products to Brazil, Mexico and other Latin American countries. Our TALI TOSS Disney Princess Dolls are shipping to Mainland China and we are in the process of fulfilling reorders for these products for China. With this strong approach, our basic business and our Dreamplay initiatives, we believe we will lay the groundwork for a more profitable 2014 and beyond.

I would now like to turn the call over to Mr. Joel Bennett to review our financial results for the second quarter of twenty thirteen and then I will give a further update of our business this year and beyond. Joel?

Speaker 2

Thank you, Stephen, and good afternoon, everyone. Net sales for the second quarter of twenty thirteen were $106,200,000 compared to net sales of $145,400,000 reported in the comparable period in 2012. The reported net loss for the second quarter was $46,900,000 or $2.14 per diluted share, which included charges for license minimum guarantee shortfalls of $14,100,000 and inventory impairment charges of 12,200,000 This compares to net income of $200,000 or $01 per diluted share reported in the comparable period in 2012, which included $1,700,000 or $05 per diluted share for legal and financial advisory fees and expenses related to the 2011 unsolicited indication of interest. Net sales for the six months ending June 3033 were $184,300,000 compared to $218,800,000 in 2012. The net loss reported for the six month period was $74,400,000 or $3.4 per share, which includes $800,000 of pre tax charges for the financial and legal advisory fees and expenses and charges for license minimum guarantee shortfalls of $14,100,000 and inventory impairment of $12,200,000 This loss compares to a net loss for the first six months of twenty twelve of $15,800,000 or $0.61 per diluted share, which included $3,100,000 of pre tax charges or zero nine dollars per diluted share of financial and legal advisory fees and expenses.

Worldwide sales of products in our traditional toys and electronics segment, which includes dolls, action figures, vehicles, electronics, plush and pet products were $45,600,000 for the second quarter of twenty thirteen compared to $72,000,000 for the second quarter of twenty twelve. And sales for traditional toys were $83,700,000 for the first six months of twenty thirteen versus $113,600,000 for the first six months of twenty twelve. Sales this quarter in this segment were led by our Disney Princess Dolls, foot to floor ride ons and Smurf toys that was down overall this quarter. Worldwide sales from our role play novelty and seasonal toys segment, which includes role play products, novelty toys, Halloween costumes, indoor and outdoor kids furniture and outdoor activity and pool toys were $60,600,000 in the second quarter of twenty thirteen compared to $73,000,000 for the second quarter in twenty twelve. And sales for role play novelty and seasonal toys were $100,600,000 for the first six months of twenty thirteen compared to $104,900,000 for the first six months of twenty twelve.

Disney Princess dress up and role play, Halloween costumes from disguise and outdoor products dominated in this category this quarter, but was also down overall this quarter. Included in the category numbers sales of $19,900,000 for the second quarter of twenty thirteen compared to $29,500,000 for the second quarter of twenty twelve. International sales for the first six months of twenty thirteen and 2012 were $36,600,000 and $39,100,000 respectively. Disney Princess Dolls and Smurfs drove second quarter sales in the international market. Gross margin for the second quarter of twenty thirteen and 2012 were 2.132.3% of net sales respectively.

And gross margin for the first half of twenty thirteen was 13.9% of net sales compared to 32.2% of net sales in the first half of last year. The significant decrease as a percentage of net sales in 2013 is primarily due to charges taken in the second quarter of $14,100,000 for license minimum guarantee shortfalls and $12,200,000 for related inventory impairment charges due to lower than expected sales. Normal margins are expected to be achieved in the third and fourth quarters. SG and A expenses in the second quarter of twenty thirteen were $46,500,000 or 43.8% of net sales as compared to $46,800,000 or 32.2% of net sales in 2012. SG and A for the first half of twenty thirteen was $93,700,000 or 50.9% of net sales compared to $89,800,000 or 41% of net sales.

The increases as a percentage of net sales for the quarter and year to date are primarily attributable to lower net sales and the addition of incremental overhead and amortization related to our Maui acquisition, Dreamplace start expenses as well as the write off of tools and molds related to underperforming or discontinued products, though offset in part by the full quarter impact of Q4 twenty twelve and Q1 twenty thirteen headcount reductions. Operations used cash of $36,900,000 for the second quarter of twenty thirteen compared to having used cash of $25,400,000 in 2012. As of June 3033, the company's working capital was $117,000,000 including cash and equivalents and marketable securities of $70,000,000 Depreciation and amortization was approximately $5,000,000 in the second quarter of twenty thirteen compared to $5,500,000 for the second quarter of twenty twelve. As for our tax rate, the anticipated tax benefit of $5,300,000 that shifted from the first quarter to the third quarter will not be realized due to the expected U. S.

Full year taxable loss. Capital expenditures were $1,000,000 for the second quarter of twenty thirteen compared to $4,400,000 for the second quarter of twenty twelve and in line with our expectations. For the full year, we expect capital expenditures to amount to around $14,000,000 Accounts receivable as of June 3033 were $94,900,000 down from $121,600,000 at the end of the second quarter of twenty twelve due to lower sales in 2013. DSOs in 2013 increased modestly to eighty days, up five days from 2012. Inventory as of June 3033 was $56,700,000 down from the June 3032 level of $60,800,000 as we continue to manage inventory levels in light of sales levels, resulting in slightly lower DSIs of sixty nine days in 2013, down from sixty eight days in 2012.

Turning to our revised guidance for 2013, the company currently anticipates net sales for the full year of approximately $620,000,000 with revised net loss of approximately $56,100,000 or $2.56 per diluted share. Including the second quarter charges taken and also third and fourth quarter non recurring restructuring and other charges of $4,500,000 The revised guidance represents a reduction from our previously anticipated full year net sales of $694,000,000 to $700,000,000 and diluted earnings per share in the range of $0.63 to $0.68 per diluted share excluding financial and legal advisory fees relating to the twenty eleven unsolicited indication of interest. In addition, due to current business conditions, our Board of Directors has suspended the company's quarterly dividend, which it will reevaluate upon a return to profitability. Lastly, we will commence a restructuring plan in the third quarter to substantially reduce lease space, employees and other overhead expenses. Despite the reported loss this year, JAX is expecting to return to profitability in 2014.

And with that, I will return the call back to Stephen Berman.

Speaker 1

Thank you, Joel. Although technology is becoming more and more prevalent in children's play habits, parents and caregivers are still looking for a balance in the toy box. The top contributors for the quarter were centered on many of our evergreen core brands and categories such as dolls, dress up, role play and preschool toys, which continue to be the foundation of our business. Toys for the Disney animated show, Sofia the First, have exceeded initial sales expectation for the second quarter. Ads and end caps and catalogs have been secured across accounts to maximize this brand throughout fall this year and beyond.

Disney Princess Dolls dress up and role play continue to be a big segment of our portfolio with our Little Mermaid product line launching at all key accounts this fall. And excitement is picking up for our first Disney Frozen line of dolls, dress up and role play launching later this year. Sales have met or exceeded expectations this quarter at our major retail partners for our Fisher Price foot to floor ride ons and ball pits and arcade games. And the trade excitement is starting to pick up for the launch of our Duck Commander Deluxe TV games based on A and E's hit show Duck Dynasty. And although the boys properties are down overall within the industry, we are staying optimistic with the launch of our 31 inches Darth Vader figure line this fall.

New items we introduced at our spring previews have caught a lot of interest with the trade and we are optimistic for spring twenty fourteen mainline launches for Kid Fiti in line of sprayable washable chalk art and My World is a line of many play boutiques and environments based on young girls' favorite brands including Claire's Fashion Boutiques, Sweet Factory Candy Shop, Dairy Queen Food Store, Opie Nail Salon and Sprinkles Bakery to name a few. This will also be enhanced with our DreamPlay technology and innovation. The future of the industry clearly lies in the marriage of technology and toys as increasingly to where children are turning more and more to smart devices for additional entertainment. For that reason, we are developing a very large segment of our portfolio and integrating gadgets, technology and interactive elements to new toy offerings to entice the children of the digital age. We are in the midst of developing some really amazing products for 2014 under the Dream Play umbrella with Jack's own brand and other licenses.

Maximizing digital play is integral to our strategy to compete in this changing landscape and our Dreamplay line will bring us to the forefront of digital play and innovation. The industry as a whole, toy makers, retailers and content owners need to view digital now and in the future as complementary to the traditional toy place. Beyond the strength of our evergreen core brands, core business and core categories, our new Dreamplay portfolio, we believe there is a lot of value in Jack's. We have licensing relationships with top kids entertainment companies and our diverse product portfolio combines popular licenses and proprietary brands. We have products across multiple categories with value driven and strategic pricing.

We have retail customers in virtually every sales channel and an experienced management team to drive our business forward. We continue to expand upon our international opportunities and we believe the joint venture we entered in with Natworks to produce Dreamplay technology enhanced with toys will bring countless new opportunities for our business. Thank you for your time. And with that, we will wrap up the prepared portion of the call and open up the call to Q and A. Thank you very much.

Speaker 0

Thank you. We will now begin the question and answer session. Our first question comes from Steph Wissink from Piper Jaffray. Please go ahead.

Speaker 3

Hi. Good afternoon, everyone. Just a couple of questions from us guys. First and foremost, Joel, if you could just give us some insight into how we should pace the back two quarters of the year from a sales and earnings perspective, I think that would be really helpful. Full year looks like right around $620,000,000 but how should we think about the balance between Q3 and Q4?

Is it consistent with prior years or slightly different just given the comments that you made around the industry buying patterns? And then secondly, if we could just get some insight into the restructuring plan, what's the timeline? How sizable? Kind of where are you at in that evaluation process? Thank you.

Speaker 2

Sure. The back half will be consistent between '3 and four as we've been historically, third quarter being our highest volume quarter.

Speaker 3

And then on the restructuring plan guys any comments there in terms of size or pacing around timing when we can anticipate that in the model?

Speaker 2

It will start in the third quarter and roll into fourth quarter. We have a number of different operations that have different seasonality. So it's deep in general. But as far as the specific timing, again, it will be pretty balanced over the third and fourth quarter, again managing the ongoing needs of the business.

Speaker 3

Okay. Then maybe just one follow-up. Joel, with respect to the model again, looking at the first half, looks like the sales were down kind of mid teens. The second half the guidance would imply down low single digits. Can you just give us some insight into your confidence and acceleration at that pace from kind of down mid teams to down low single digits here in the second half?

Speaker 2

Sure. Percentage wise, it's going to be much higher in the front half, is proportionately lower in sales overall. And at this point, more of the sales are on an FOB basis. I mean historically on the back half they're more on an FOB basis. And at this point we're booked at 6% higher than we were at this time last year.

Also with FOB sales, we have purchase orders well in advance compared to when we have sales and orders on a domestic basis. So we're very comfortable about the numbers.

Speaker 3

All right. Thank you, guys. Best of luck.

Speaker 4

Thank you.

Speaker 0

Our next question comes from Ted Woo from Ascendiant Capital. Please go ahead.

Speaker 1

Yeah. I had a question. When is

Speaker 4

your DreamPlay product being launched? And what is your patient and retailer anticipation of the product?

Speaker 1

The retail product is actually starting to ship it off August. It will be on shelf the September. The app launches September 1. The receptiveness from the retailers that we had our initial plans with is extremely strong not just on the product but on the advertising and signage. And going forward into 2014, one of the biggest areas that we are expecting from what we've gone through over the last six months with retailers is the Dreamplay product offering both being rolled out both in domestic and U.

S. And having quite a nice growth that we see going forward.

Speaker 4

Was your change guidance related to Dreamplay at all?

Speaker 1

I'm sorry?

Speaker 4

Was the change in guidance related to your Dreamplay expectations at all? No. Okay. Thank you and good luck. Thank you.

Speaker 0

Our next question comes from Sean McGowan from Needham. Please go ahead.

Speaker 5

Thank you. Hi, have a couple of questions probably with the simplest. Should we infer from this proposed convert that there is no bank line? Or did you get a bank line? What's the status of that?

Speaker 2

That is correct. The convert is one of our or has been one of our options and it was decided to go with that. Having said that, we're limited to what we can say because it's currently being marketed. So we'll just refer you to the press release.

Speaker 5

Okay. I just didn't know if there had been an extension of the other bank line or you've been operating with that one since didn't it expire in April?

Speaker 2

Yes. That one expired in April and we had been working on a new one with a similar structure and asset baseline.

Speaker 5

Okay. All right. So we'll just see as long as this gets done then that's a moot point. Yes. Second question, this isn't the first time by any means that minimum license guarantees have been a source of some reduction in it.

I'm surprised at this point that there would be the magnitude of $14,000,000 What does this say about the viability of those underlying licenses? I mean, got this must be some pretty big properties if there's $14,000,000 of guarantees being written off?

Speaker 1

They come from several different licensee content licensor content holders. Some of them were previous deals done back with previous management and specific divisions. So the deals that were done and set forth were quite rich and due to the environment and the call it the shrinkage of retail space, The minimum guarantees were not met with the decline in sales. The other license shortfall is from a property that was no longer put on air as we had expectations that this property was being on air for quite a few years of obligation and on strip. So based off of what we see those two areas of businesses we ended up having to take the write off of the shortfalls.

But what we in addition to what you're asking, Sean, there's about 85% to 90% of our business is extremely constant, solid and evergreen, which goes from our kids only outdoor furniture product to our foot to floor right on moose product to our Talitots preschool division to Maui to so on. What we've realized in this new environment is we need to enhance that play pattern with the call it ID technology which is enhancing the call it physical world with the digital world. You can play with the physical world without the digital component. You can play with the digital component without the physical. But when you combine them both when a child wants to, it just is a magical experience.

And we've seen it from working with Lego with our technology and they do a lot of testing. They have their feedback and their focus groups was truly breathtaking. With our core business is where we're really solid. What we realize now industry is and we've seen it, the likes and days of launching an item and I will use as we launched four years ago our night vision goggles that did 50,000,000 $90,000,000 in sales and a Furby call it that has done those days of the euphoric items of marketing and TV advertising and looking for these euphoric items to take off is few and far between because retailers won't bet on the inventory. There is not the top 20 retailers anymore where Our segmentation of retail, which we're very proud of, spans throughout the mass retailers that we all know about, the Target, the Walmart, the Toys R Us, the Sears, but it goes to Sports Authority, Dick's Sporting Goods, Sports Chalet, Big five, Kohl's, Spencer's, Ross, Party City.

So while we're diversifying the customer base, we're focusing on the basic play pattern, which is primarily we see around under six is where the key play pattern for children are with playing with toys, but at the same time they're utilizing smart devices. So the enhancement of what we're doing and we've seen it is a magical combination.

Speaker 5

I can't disagree. This actually dovetails into my final question. I can't disagree that kids are certainly interested in these technology products. But this isn't like it happened overnight and yet your sales shortfalls go back several years and you say 80%, 90% of it is rock solid. The sales decline suggests that maybe even there's weakness there.

But my question is how much confidence can you have that you're making the right bet when there's still going to be a lot of business that needs to be done in basic traditional toys that don't have a technology element? I'm

Speaker 1

sorry, Sean. Go on that. I'm saying

Speaker 5

that other companies are not seeing their business decline as much as your business is declining. LEGO couldn't be lower tech and they just keep crushing it year after year. So somebody else is doing something that you guys aren't doing it to generate sales of traditional nontechnical toys. I'm not disagreeing that there needs to be some technology component to toys, but you can't abandon the nontechnical part either and you got to get that right.

Speaker 1

By the way, I would say on our basic evergreen singles and doubles business, which is probably about 85% to 90%, we do have it right. We're the category leaders. What we also have had to do address is some of our major customers, both international and The U. S, the credit facilities that we've had or insurance were discontinued and we also at that time don't want to take a financial risk as we've had in the past when Woolworths claimed bankruptcy or years ago when Kmart claimed bankruptcy or KB. So we are taking a very prudent step of not taking that type of risk factor.

So when we're looking forward, we are taking that in consideration. But when you take our non tech area of business, Halloween is an extremely solid area of business for us, our kids only, our moose, our TALI. But that area of business, Sean, is an area of business that primarily is, I'll use six and under where we've seen that's where kids are truly still continuing to play. We're very close with Lego and we understand what they're doing and from their sales in both U. S.

And abroad, they've had a great job in managing their businesses and diversifying with their hotels, with their parks and so on. So they're an anomaly and I think they're a terrific company as well. But we are also looking at the retail environment and not we won't allow ourselves to get caught where we were years ago with any of the retailers that are maybe less with strength in their balance sheet and less able to pay us in the future. So we're also taking that in consideration.

Speaker 5

Okay. Thank you.

Speaker 0

And we have no further questions in queue at this time. I'll now turn the call back over to Stephen Berman for closing remarks.

Speaker 1

Firstly, thank you everyone for joining the call. We are getting ready for our fourth quarter second half of the year fourth quarter, but more primarily with the restructuring and consolidating the offerings of the core Jack's business. And at the same time, we are very aggressively engaging with the launch of our DreamPlay technology with our current application in toys and future. And to the parties that have seen it from some of the top Fortune 100 companies, the receptiveness from them has been tremendous and from our trade. So with that, we appreciate the time and effort of everyone taking this call.

Thank you.

Speaker 0

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