JAKKS Pacific - Earnings Call - Q2 2014
July 23, 2014
Transcript
Speaker 0
Good morning, and gentlemen. Thank you for joining the JAKKS Pacific Second Quarter twenty fourteen Earnings Call with Management. Today, JAKKS will review the results for the second quarter ended June 3034, 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 the detailed comments regarding JAKKS Pacific's financial and operational results. Mr. Berman will then conclude the prepared portion of the call with highlights of product lines and current business trends prior to opening up the call for questions.
Your line will be placed 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 2014 as well as other forward looking statements concerning 2014 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 and such risks and uncertainties, you should consult JAKKS' most recent 10 ks and 10 Q filings with the SEC as well as the company's other reports subsequently filed with the SEC from time to time. With that, I will turn the call over to Mr.
Berman.
Speaker 1
Good morning, everyone, and thank you for joining us today. We are pleased with our sales and earnings results for the second quarter of twenty fourteen as we continue with the positive momentum generated from the first quarter of the year. We have exceeded our sales forecast for the quarter and are upbeat about the outlook for 2014, increasing our previously announced sales and earnings forecast on a comparative basis for the full year. Highlights of our second quarter sales include Dolls, Dress Up and Role Play in our Frozen line, Disney Princess Dolls and Dress Up, seasonal outdoor and water toys from Maui Toys, foot to floor ride ons and ball prints from Moose Mountain and disguised Halloween costumes among others. Our fall lines are proceeding as planned with excitement around our new Frozen offerings, Disney licensed dress up and role play including Princess, Fairies and Sofia the First, Disguise Halloween costumes and our preschool foot to floor ride ons and ball trips from Moose Mountain.
For boys, we are strongly looking forward to launching the large scale figures such as Teenage Mutant Ninja Turtles and Star Wars Rebels, our new Hero Porter plug it in and play TV games, titles based on Power Rangers, Teenage Mutant Ninja Turtles and DC Comics, Nintendo Plush and figurines and Max Tow Truck vehicles with our Dreamplay app technology. In addition, the expansion of our MyWorld physical play sets products with the Dreamplay digital enhancement and our first in app purchase component, which is just the beginning with many more to follow. Now I'd like to turn the call over to Mr. Joel Bennett to review our financial results for the second quarter of twenty fourteen and then I will give a further update of our business this year and beyond. Joel?
Thank you, Stephen, good morning, everyone. We're very pleased to report that net sales for the second quarter of twenty fourteen increased 16.9 to $124,200,000 up from net sales of $106,200,000 reported in 2013. The reported net loss for the second quarter was $9,100,000 or $0.43 per diluted share, which includes pretax restructuring charges of $1,200,000 or $05 per diluted share, higher than anticipated product testing and development costs of $2,100,000 or $0.10 per diluted share due to higher sales in the quarter and to support new products being developed in response to increasing consumer demand for some of our licensed product lines and the dilutive impact of both increased interest expense on the recently completed convertible note issuance and the reduction to the share count for the 3,100,000.0 shares repurchased of an aggregate of $03 per diluted share. This compares to the 2013 reported net loss of $46,900,000 or $2.14 per diluted share, which included charges for license minimum guarantee shortfalls of $14,100,000 and inventory impairment of $12,200,000 Net sales for the six months ending June 3034 increased 12.1% to $206,700,000 compared to $184,300,000 in 2013. The reported net loss for the six month period was $25,400,000 or $1.17 per diluted share, which included the restructuring charges, higher than anticipated product development and testing charges and the impact of the stock buyback and convertible note issuance.
This compares to a net loss for the first six months of twenty thirteen of $74,400,000 or $3.4 per diluted share, which included charges for license minimum guarantee shortfalls of $14,400,000 and inventory impairment of $14,900,000 Worldwide sales of products in our traditional toys and electronics segment, which includes dolls, action figures, vehicles, electronics, plush and pet products were $49,500,000 for the second quarter of twenty fourteen compared to $48,600,000 for the second quarter in twenty thirteen. And sales for traditional toys were $85,200,000 for the first six months of twenty fourteen versus $87,000,000 for the first six months of twenty thirteen. Sales this quarter in this segment were led by our Frozen and Disney Princess Dolls, Fanoodle water toys and licensed foot to floor ride ons and wagons. 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 $74,700,000 in the second quarter of twenty fourteen compared to $57,700,000 in 2013. And sales for role play, novelty and seasonal toys were $121,500,000 for the first six months of twenty fourteen versus $97,300,000 for the first six months of twenty thirteen.
Disney Princess dress up and role play including Frozen and Sofia the First, Maui Toys outdoor seasonal products and disguised Halloween costumes dominated sales in the category this quarter, driving the category to an overall increase this quarter. Included in the category numbers are international sales of approximately $17,700,000 for the second quarter of twenty fourteen compared to $19,900,000 in 2013. International sales for the first six months of twenty fourteen and 2013 were $35,200,000 and $36,600,000 respectively. Disney Princess Dolls including Frozen, Slugterra and Nintendo products drove second quarter sales in the international market. Gross margin for the second quarter of twenty fourteen and 2013 was 30.52.1% of net sales respectively.
And gross margin for the first quarter of twenty fourteen was 29.7% of net sales compared to 13.9% of net sales in the first half of last year. The increase as a percentage of net sales in 2014 is primarily due to license minimum guarantee shortfalls and inventory impairment charges incurred in the second quarter of twenty thirteen offset in part to higher competitively priced Disguise sales in 2014. SG and A expenses in the second quarter of twenty fourteen were $42,600,000 or 34.4 percent of net sales as compared to $46,500,000 or 43.8% of net sales in 2013. SG and A for the first half of twenty fourteen was $81,100,000 or 39.2% of net sales compared to $93,700,000 percent of net sales. The decrease in SG and A in dollars and as a percentage of net sales is the result of the benefits achieved as part of the restructuring and cost saving initiatives that commenced in the second half of twenty thirteen, though offset in the second quarter of twenty fourteen in part by shift in media buys due to Easter falling later in the year, higher testing due to higher disguise sales in the quarter, higher product development
Speaker 0
associated with many new products like Frozen and the restructuring charges taken. Higher
Speaker 1
Consistent with the seasonality of our business, operations used cash of $21,600,000 for the second quarter of twenty fourteen compared to using cash of $34,900,000 in 2013. As of June 3034, the company's working capital was $198,500,000 including cash and equivalents and marketable securities of approximately $162,900,000 Depreciation and amortization was approximately $4,500,000 in the second quarter of twenty fourteen compared to $5,000,000 in 2013. As for our tax rate, the effective tax rate for 2014 is expected to
Speaker 2
be
Speaker 1
approximately 22.6% before any FIN 48 or other adjustments, which could change if there's a shift in sales and therefore taxable income between The U. S. And Hong Kong entities. Capital expenditures were $5,700,000 for the second quarter of twenty fourteen compared to $3,900,000 for the second quarter of twenty thirteen. For the full year, we expect capital expenditures to be in the range of 12,000,000 to $13,000,000 Accounts receivable as of June 3034 were $109,300,000 up from the $94,900,000 at the end of the second quarter of twenty thirteen due to higher sales in 2014 resulting in DSOs of seventy nine days, a slight decrease of one day from the eighty days in 2013.
Inventory as of June 3034 was $66,200,000 up from $56,700,000 in Q2 twenty thirteen due to higher sales and continuing high demand for our products resulting in higher six days in 2014, up from sixty nine days in 2013 as we head into our peak selling season. Based on first half results and the increased demand for our products, we've increased our 2014 guidance and now expect net sales for the full year of 2014 to be in the range of $660,000,000 to $670,000,000 an increase from the previously announced guidance of net sales in the range of $633,000,000 to $640,000,000 Giving effect to the full year impact of the net dilution of $0.15 per share relating to the recent convertible note issuance and stock buyback, previous earnings guidance would have been in the range of $0.15 to $0.25 per diluted share. And now with the dilution from the convert and stock buyback, earnings guidance is in the range of $0.20 to $0.30 per diluted share. The company's previous reported earnings guidance was in the range of $0.30 to $0.40 per diluted share and excluding the impact of the convertible note issuance, stock buyback and restructuring charges, revised guidance for earnings per share would have been in the range of $0.40 to $0.45 per diluted share.
And EBITDA is now expected to be in the range of $42,000,000 to $44,000,000 an increase from the previous EBITDA guidance in the range of $41,000,000 to $43,000,000 Lastly, we completed the issuance at par of $115,000,000 principal amount of 4.875 percent convertible senior notes due 20. The notes which mature on 06/01/2020 are initially convertible at $9.64 per share. The company received net proceeds of approximately $110,000,000 from the offering of which $24,000,000 was used to repurchase 3,100,000.0 shares of the company's common stock under a prepaid forward purchase contract and $39,000,000 will be used to retire at par the company's 14 convertible notes maturing on 11/01/2014. The remainder of the net proceeds will be used for working capital and general corporate purposes. This opportunistic offering served to derisk and otherwise strengthen the balance sheet by refinancing the upcoming note maturity and provide additional liquidity which with cash on hand and availability under our GE credit facility will enable the company to continue to execute on its strategies.
And with that, I will return the call back to Stephen Berman. Thank you, Joel. We are extremely pleased with our performance in the second quarter of twenty fourteen despite the continued challenging retail environment. Let's begin with the highlights in our Disney Girls division this quarter, which includes Disney Dolls, Dress Up and Role Play categories including Frozen, Disney Princess, Sofia the First and Disney Fairies. The Frozen craze continues and our product sell through as quickly as they hit store shelves.
We have aggressively across the board ramped production and demand still exceeds supply. We expect our fall Frozen lineup to continue to drive significant sales through the remainder of the year and include the magical lineup dresses and our feature doll, Snow Glow Elsa, both of which play the award winning song from the movie, Let It Go. Snow Glow Elsa will be bilingual in The U. S, U. K.
And Canada with international versions in 25 different languages to maximize its global potential. We have also added new products that play on the popularity of the breakout character Olaf, including a snow cone machine and a tea set just to name a few. During a recent earnings call, Disney identified Frozen as one of the company's top five franchises from music videos, live sing along stage shows to Frozen on iShows and to interstitials on the Disney Channel. We are excited and pleased of all the promotional support from Disney for the franchise, making Frozen one of our evergreen licenses in our Disney portfolio for this year and many years to come. As consumers flock to buy Frozen products, we continue to focus on Disney's core Princess with promotional plans for fall to drive Eyes.
The latest ratings indicate Sofia the First is still holding the number one cable program slot with girls two to five years, seen by almost 54,000,000 viewers in The U. S. We have a strong push planned for fall with more retail promotion support than ever before for Sofia the First dolls, dress up and role play items. The DVD release of The Pirate Fairy boosted sell through in our Disney Fairy line this spring and we have a treasure hunt promotion planned for this fall along with TV advertising to continue the momentum. Turning to our non Disney Girl business, My World Dream Play products continues to grow.
We expect to see significant growth as full distribution rolls out to all retailers, including Target, Kmart, Justice Stores, Claire's, Myers, Amazon and many more. Justice is doing a special promotion this fall and starting in August, SKECHERS bag stuffers and inserts will be packed into Twinkle Toes shoe boxes as well. We are gearing up for a promising third quarter with our SKECHERS Twinkle Toes Cabbage Patch Kids that will hit shelves at all retailers this fall. Skechers is helping promote the line with bag stuffers and box inserts in all kids' purchases at Skechers stores and a shoe box insert at all their retailers that sell Twinkle Toes sneakers. Skechers will also be tagging one of their fall Twinkle Toes TV commercials with a Cabbage Patch Twinkle Toes line.
We are also extremely excited to launch our Jack's Own Animal Babies line of collectible and cuddly plush baby animals, which plays upon the huge popularity of baby animal videos on YouTube and is placed at all retailers this fall, including Costco and QVC. For 2015, this line has many additions including the enhancement of DreamPlay technology. Now for highlights in our boys business in the second quarter. Our Nintendo items had a solid performance at retail, especially for our international business. There has been a lot of buzz around Nintendo with the successful release of Mario Kart eight video game and we are hoping this will help to drive sales at retail for the toy line through this fall and beyond, which will have expanded retail distribution this fall both in The U.
S. And internationally. For our large scale figures, our 24 Godzilla figure was a big surprise this year and it was nearly sold out before the theatrical release in May. Even more retailers will be on board for the DVD release with incremental unit sales in this fall. We also are expecting our Star Wars Rebel 18 inches to 20 inches figures and our 48.5 inches Teenage Mutant Ninja Turtle figure to perform well as a result of strong entertainment recognition.
One of our strong evergreen lines Black and Deckard continued its success at Target for its second straight year with placement on springtime end caps. We are looking forward to a December end cap program at Walmart to continue the brand into the holiday season. In addition, we are pleased with the expanded distribution being achieved for this evergreen line. For fall, we are looking forward to the launch of our new line of HeroPortal plug it in and play game consoles, which capitalizes on the huge interest in interactive figure play with video gaming at a great compelling price point. There will be a big launch at almost all accounts.
We have an exciting fourth quarter promotion at Walmart for How to Train Your Dragon and we're also in the electronics department at Target just to name a few. We have extremely strong VOID licenses built with great gameplay and figure play, which is perfect for the low price point and targeted age range that has made Plugged It and Play games successful, leading the way as Teenage Mutant Ninja Turtles, Power Rangers and DC comics such as Batman and Superman. Max Toe is on its way to being one of the top toys for boys this fall with support from all top four major retailers amongst others. This item will get an even bigger boost this fall with TV support and interactive in store displays at select retail accounts. The corresponding Dreamplay app will launch on iOS and Android devices on August 1.
This will allow people to play with the amazing physical toy and have a great digital experience as well, kind of like Max Toe at home and the digital part is Max Toe on the go. Turning to preschool, our Moose Mountain division is having another banner year for ride ons, solidifying our dominance and market share in North America in this category. Sales of our new convertible ride on line have boosted sales and provided diversification at retail and our Fisher Price ride ons continue to post impressive growth in sales year over year. In our ball pit category, we continue to dominate retail with perennial programs at Toys R Us, Walmart and Kmart. In our kids furniture business, our activity tables continued strong sales in spring with the inclusion of new and fresh brands and styles.
And our licensed kids chairs have really driven the overall kids only business in the second quarter. Patio chairs, fold and go and Adirondack chairs have become ubiquitous at mass, value and drug channels this spring. In seasonal, despite challenging weather, our Maui division did well with Wave Hoops and Sky Bouncers performing as the top sellers. Sky Bouncers was the sleeper success in the first six months with a successful feature placement at Walmart that we are continuing to chase sales. Our Fun Noodle business also did very well in the second quarter.
Selling for our disguised costumes in second quarter solid. We saw a slight increase in our Maleficent orders due to the success of the movie and of course Frozen orders continue to go through the roof with Elsa, Anna and Olaf costumes and accessories. With the success of The Movie, anticipation of possible additional orders are expected to be forthcoming as well. Now I'd like to turn to our international business. Highlights for the second quarter include Disney Princess Toller Dolls and of course Frozen Dolls are hot almost everywhere around the world.
All that we can ship in every market sells as soon as it hits the shelf. So our numbers continue to increase as we chase additional capacity to fulfill the demand. We started shipping our Sofia the First large America in spring for Children's Day in advance of the North American launch this fall. Through in Latin America has been very strong so far, which makes us optimistic about the potential in The U. S.
Overall, American business is up significantly year over year. For boys, Slugterra continues to lead the way and is the number two boys action property in Spain. Nintendo sales have been strong in the second quarter. Our U. K.
Business continues to grow and our business and new Disney business in Mexico has grown sales in that market exponentially. We also started working with two new retailers in China, including Walmart with more to come by year's end. Lastly, our Dreamplay offerings are continuing on plan with updates to our MyWorld Mall app to include our new playsets and our new Max Tow Truck app launching this fall in conjunction with the product hitting shelves. Our newest item, Selfie Booth, is the ultimate photo booth experience right in your own home and plays on the popular social media trend of uploading customized photos. The pop up photo booth will feature a green screen and an app to choose from customized backgrounds and digital stamps.
Consumers can also upload and share their photos online. We are looking forward to launching the selfie booth late in the fourth quarter. We have also updated our successful Aerials Music Surprise line of Dreamplay experiences with additional levels added. We appreciate everyone's time today for the prepared portion of the call. With that, we will open it up to Q and A.
We are optimistic about our future and we are looking forward to a profitable and successful JAKKS Pacific for our shareholders and employees. Thank you for your time.
Speaker 0
Thank you. We will now begin the question Our first question comes from Scott Hammond from KeyBanc Capital. Please go ahead.
Speaker 3
Hey, thanks. Good morning, Good morning, Scott. In terms of some of the cannibalization you had talked about in the release that Frozen was taking away from some of the other lines. Can you kind of elaborate on that? And if that's something that potentially is a concern in your planning with the other lines for the balance of the year?
Speaker 4
No. What it is, is we also want to be clearly transparent. So it's not just taken away from I'd say just specific areas in our line which is moderate, but it's taken away business from other competitive doll brands in the market. So for us it's just it's taken away from certain parts of our business, but not dramatic. But it is it's such a big property and the focus that Disney has put behind it, there has to be some type of drop off in certain areas.
But it's not just in our Jack's business, it's actually affecting other grill brands. But it's part of what we expected. It's just doing it a little more because Frozen has become such a big brand around the
Speaker 3
world. And then just
Speaker 4
Also Scott, it's also offsetting when we look at the orders coming in for fall, we see it did affect the spring part, but it's not affecting the fall part as much.
Speaker 3
Okay. Makes sense. And then just in terms of the guidance, the revenue lift was nice, but EBITDA is only up about $1,000,000 on like a $28,000,000 increase in sales. So I'm not sure exactly if you reconcile what some of the givebacks. It just didn't look like the flow through would have been as strong as you would have thought.
Speaker 1
Yes. The EBITDA was inclusive of the restructuring charge. So if you were to as you may have read in the release, it got a little convoluted in terms of trying to be clear and showing apples to apples. And in general, it's just overall conservatism. We've provided for a number of different things that we don't know if will happen.
We're certainly very optimistic about going forward, but it just gives us a little cushion in that. But anyway adjusted it would be 42,000,000 to 44,000,000
Speaker 5
So the restructuring charge was a
Speaker 3
little bit over $1,000,000 in the quarter. Is there anything else from the first quarter? Are there anything in the third and fourth quarter that you're anticipating that would be in there?
Speaker 1
No. That was pretty much the last of it and it primarily relates to our Hong Kong showroom that because Toy Fair in Hong Kong occurred in January, it wasn't included in the charge from last year. We tried to get everything done in 2013, but that was the last piece and we're not expecting any going forward.
Speaker 2
Okay. Thank you.
Speaker 4
Thank you, Scott.
Speaker 0
Thank you. Our next question comes from Derek Johnston from BMO Capital. Please go ahead.
Speaker 6
Hey, good morning.
Speaker 4
Hey, Derek.
Speaker 6
Good morning. Can you just talk about the restructuring charge specifically what that was for? And then in your guidance to be totally clear what does it include and exclude in terms of restructuring and the other items you talked about in your press release?
Speaker 1
Sure. Basically it was the buyout of a lease in Hong Kong basically by paying an amount we got out of the next two years of rent. So we have savings beginning in Q3 twenty fourteen to mid-twenty sixteen. What was the other part of your question?
Speaker 6
Well then as it pertains to guidance does that include or exclude restructuring product testing all of the other things you talked about in the press release?
Speaker 1
Yeah. Everything is included in those numbers except for the EBIT well no the EBITDA included and then the EPS we were reflecting it both ways in terms of the financing and the restructuring. So I think that part was pretty clear. The only thing that we didn't specify was the EBITDA was after the reorg.
Speaker 6
Okay. And then taxes, can you talk about taxes? There's a $1,300,000 hit to earnings. But if you put it at a 20% rate, looked like it should have been a benefit and that would have been like a swing of $0.13 So if you could explain what's going on there, so we understand
Speaker 1
Sure. The actual tax provision is based off of where we have taxable income and in which quarters. In The U. S, we're still not a taxpayer. In The U.
K, Canada and Hong Kong, they have taxable income and the provision basically flows with their income. So it has more to do with that than the group results. With the loss you would either expect the benefit or no tax provision, but it has to do with the territories that have taxable income.
Speaker 6
Okay. So that makes it a little bit more difficult for us to model going forward. I had my taxes at basically a 20% rate or so. So is that appropriate going forward? Or should I or should we get
Speaker 5
some guidance as to what earnings are going to
Speaker 6
be in what jurisdiction so we can better model
Speaker 1
I think we can give more color on what because through transfer pricing there's a lot of moving pieces, so it would be difficult for you to model. So we'll probably give more information and give actually what we'll do is we'll give quarterly effective rates which will have everything blended. Actually I'll come back to that later in the call maybe when Stephen is answering a question. If not, we can do it offline and I can get it to whoever has the question. But I'll look at it during the call.
Speaker 6
Okay. I'll let a few other guys ask some questions, but I'll be back.
Speaker 4
Okay.
Speaker 0
Thank you. Our next question comes from Steph Wissink from Piper Jaffray. Please go ahead.
Speaker 7
Hi. Good morning, everyone. Thanks for taking our questions.
Speaker 4
Thank you, Steph.
Speaker 7
Stephen, if we could I want to just rephrase Scott's earlier question because I think it's a good one on the cannibalization factor. Is that based on the way retailers are booking orders for back half? Or are you seeing something in the POS data that would
Speaker 4
half is the POS data. So I'll use an example. This is a simple one. If a child is going out to buy an Elsa dress, they may not go out and buy a Cinderella dress or whether it's a Barbie role play or Monster High dress up. So we've seen it in the spring, but then for the first half, but the bookings for fall are extremely strong on our core Disney products.
So while the craze was happening and still is happening with Frozen, it did hit certain parts of our girls area, but not just ours, it hit a lot of part of retail girls area, but our bookings for fall are right on track to what we expected. But there was some slip off of some cannibalization in certain areas of our core business, call it dress up and some dolls.
Speaker 7
Okay. That's really helpful. And then Joel, if I could on the incremental R and D spend, was that spend planned in your original full year guidance and it was pulled forward into the quarter? Is that additive spend that we should think about for the full year? And what categories or product lines will be benefiting from that incremental testing and development spend?
Speaker 1
Yes. It was additive because originally we didn't expect Frozen to actually expand. But with the prominence of Olaf and some of these others, we've got I think I mean those analysts that came out and certainly the trade saw the huge expansion to the frozen line, which otherwise would have been just selling out what we had originally sold in at the end of last year. So it's additive. And the other thing is it's going to be something that's going to benefit into 2015 because the sales for a
Speaker 4
lot of those items aren't occurring until third and fourth quarter. Stefan, let me add to addition that we while frozen has expanded, we expanded into the correct areas and I think as we mentioned it into the press release, you would remember a Snoopy snow cone maker that was done years ago. We came out with an Olaf snow cone maker that will be a perennial and it was a new category. We came up with a whole line of switch them up Olafs almost like a Mr. Potato Head, but for today's children that they understand Olaf.
So we expanded our rights with Disney and at the same time we had to do quick R and D to get these going for fall and spring twenty fourteen and spring twenty fifteen.
Speaker 7
That's really helpful. Thanks. And then Joel if I could just throw one more out there on the international sales that you went through the numbers really quickly, but did I hear that the sales were actually down in the quarter? And how should we think about the acceleration in that trajectory as you get back into stock and some of the frozen items going into the back half?
Speaker 1
Yes. International was down about $2,000,000 year over year. Last year we had Smurfs, but with frozen and some of the other licenses in our proprietary product like MaxToe that will be accelerating in the back half and into 2016. As Steve had mentioned all the other initiatives in his portion of the call. But I think one of the big takeaway is in The U.
S. Market where we've seen some challenges in the past in some of our peers more currently. It's been a big increase for us.
Speaker 0
Okay. Thanks guys. Best of luck.
Speaker 1
Thank you.
Speaker 0
Thank you. Our next question comes from Linda Bolton Weiser from B. Riley. Please go ahead.
Speaker 8
Hi. I was just wondering if you could explain a little bit more about the special product development costs that were in the quarter. And was that related to kind of like development of Dreamplay technology? Or what exactly? And I guess I'm wondering in the future if you have strong sales growth as you did this quarter, are we to expect that there would be sort of these special costs that come up each quarter?
So I'm just kind of wondering how we should think about the earnings power even with strong sales growth because it's not really coming through to the bottom line. So if you could explain what those costs were and the likelihood that that type of thing might recur? Thank you.
Speaker 1
Sure. It's well for starters again with Frozen, we reacted very quickly and that's one of our competitive advantages and it reflects the broad expansion of the rights in Frozen in particular. As I just mentioned before, the sales for a lot of those items will occur in the third and fourth quarter as a launch, but all of the R and D costs are preloaded. So in terms of the current period that we're scrambling essentially to get the goods developed, we'll have actually expanded profitability in 2015 since the essentially the startup costs for those initial items are already in the P and L from the prior year. So it's not a headwind per se in terms of fundamental change in the business.
It's just our reacting to a huge opportunity.
Speaker 8
Okay, great. And then I kind of missed what you said the operating cash flow was for the six months of the quarter. Could you repeat that number?
Speaker 4
Yes.
Speaker 1
And used cash of $21,600,000 versus $34,900,000 last year. And going back to the tax rate, the effective rate for Q3 is expected to be around 3% and about 15% in Q4.
Speaker 8
Joel, could you also just to make everything really clear, could you also give us a little bit of direction on the interest expense and diluted share count for the third quarter and full year?
Speaker 1
Sure. Diluted share count for Q3 and that will only be for the third quarter not for the year to date September 30 is about 45,000,000 shares, 18,900,000.0 shares for Q4 and 20,200,000.0 for the full year.
Speaker 2
Interest
Speaker 1
Q3, 3,800,000.0 Q4, 3,300,000.0. And the big difference there is the payoff of the November maturities on November 1.
Speaker 8
Great. Thanks. And can you just clarify also, I mean, you actually meet your credit facility covenant requirements in the quarter? And if so, what was the EBITDA that you earned in the quarter? And did the covenant facility allow the restructuring charge?
Or could you exclude that from that?
Speaker 1
It's all in. We did meet it. There are certain other add backs like foreign exchange, other non cash charges like
Speaker 4
stock based
Speaker 1
comp. The EBITDA covenant is only for Q2 and Q3 I'm sorry Q1 and Q2. Beginning in Q3, it reverts to a leverage ratio.
Speaker 8
Okay, great. Thanks a lot.
Speaker 4
Thank you. Thank you.
Speaker 0
Thank you. Our next question comes from Sean McGowan from Needham and Company. Please go ahead.
Speaker 5
Good morning. Hi, guys. I have a couple of questions and some of them are follow ups. So on the product testing, with product testing cost, is that a period cost or does that get put into inventory?
Speaker 1
We do defer it on the disguise because a lot of the testing is front loaded. So with the increase in disguise sales in the quarter, we had a lot more testing costs. But generally, it's pay as you go because you have a normal flow of product. But with disguise and the time that it takes to build up the inventory because they're such a seasonal business, it's essentially deferred and matched to those sales. Well, sounds like
Speaker 5
you're saying two different things though. If it's deferred and matched to the sale then it wouldn't be upfront.
Speaker 1
No, on that line. No, we pay for it upfront.
Speaker 5
We pay
Speaker 1
for The it, but increase this quarter is due to the higher sales of Disguise. So it was in that sense it was a shift in product mix.
Speaker 5
Okay. But for other test so how much of this testing and product development cost, how much of that was testing and how much of it was other development cost?
Speaker 1
It was about $1,000,000
Speaker 5
Was it primarily other development costs?
Speaker 1
No. Was about $1,000,000 apiece.
Speaker 5
Okay. And so those expenses have been taken. So back to earlier questions, should we expect not to see that magnitude of higher expected expenses in subsequent periods or will we see that?
Speaker 1
Correct, because we've already developed the frozen. So on the R and D side, we've already expensed the development on what we're going to ship. And on the testing, it's essentially a shift part of it is a shift from well two things. One is based on increased SKUs that we've developed we'll have more testing and there'll be less testing associated with the earlier ship of certain disguise orders. Does that make sense?
Speaker 5
Well, I was asking A or B and you said correct. So it sounds like what you're saying is we won't see these unusually high expenses Is in the that the right way to read it?
Speaker 1
Yes, correct. I was just trying to describe we have things moving in both directions. Okay.
Speaker 5
Another question is also a follow-up. So on international, I would be surprised that you would have a hit like Frozen and still have a decline Was it just the comparison on Smurfs?
Speaker 1
It's actually it's the time to roll it out. I mean we're still responding to the popularity. So we have I think 25 or 26 different languages that we'll be doing the doll in. I think that The U. S.
Markets tend to get the goods first.
Speaker 5
When did the movie open in the markets that you have the rights in?
Speaker 4
I'm sorry, Sean? When did the movie open in the markets that you're selling in? It opened during last year October throughout the latter part of 2013. All
Speaker 5
right. So it's just you're still chasing the demand is the end.
Speaker 4
And also Smurfs opened last year and Smurfs is a real European property. It's called Stronts. It's from Belgium and it had a very successful second quarter and there was no movie content from it. So that was really the drop off of international in second quarter. Okay.
Speaker 5
And earlier in the call Joel, I think you said that the restructuring charge would have been something you would have liked to have taken last year, but because Hong Kong Toy Fair happened this year you couldn't. Why would that charge not have been taken in the first quarter then?
Speaker 1
Because we were still in the property. So you can't take the charge until you're actually out of the Okay. That makes sense.
Speaker 5
And I think that's it. I'll leave it at that. Thank you.
Speaker 0
Thank you. Our next question comes from Ed Woo from Ascendant Capital. Please go ahead.
Speaker 2
Yes. I had a question about some of your POS, your sell in versus your sell through. It looks like Frozen was very strong, but what about for all your other products?
Speaker 4
If I we take kind of by category on our foot to floor area business, which is Moose Mountain and our called Spring business of kids only, we've had exceptional sell through. Halloween, we've had exceptional sell in, but it's not the time for the sell throughs to occur for the Halloween component of our business. Going through the Nintendo, going through MyWorld, all the areas that we have been shipping continuously, the sell throughs are continuing. It's not just based off of just Frozen Godzilla. I think I mentioned earlier in the call, we sold out even prior to the movie launch.
MyWorld forecast and orders are increasing more than expected. A good example, our large figure of Teenage Mutant Ninja Turtle has the it's increased dramatically in the sense of the forecast. Our hero portals are shipping right now, which is the three properties. So we're getting really great sell through, better sell throughs than what we had last year. At the same time, the order flows and our bookings are stronger than they were over the past couple of years.
So we're getting the sell throughs that we need to continue the ordering that occurs throughout the year. But we're well ahead of our bookings and we expect it even for third quarter and for fourth. So without the sell throughs, we wouldn't be where we're at in bookings and that's why we're very confident with our increasing guidance. And we're still taking a look to see of just the marketplace itself because even though if our sell throughs are great and competitors' items are not selling well that does affect the open to buys by retailers, but they still need items to drive consumers in and our mix of diversification in all the different segments we're in has really helped us to bode well going forward and we're not really relying on one segmentation to help our business.
Speaker 2
Great. And there's been a lot of asking on the call about the special charges that you guys have with product development costs. But how do you qualify overall profitability for some of your brands? I know, obviously, your internal brands you should be higher profits, you don't pay licensing. But other brands such as your Disney property have much higher licensing costs.
But on the other hand, do you get any leverage by having much higher sales? And how should we really see, I guess, of like looking at gross margin going forward, are we going to see improvement? Is it going to be weaker? How should we look at that for the rest of the year?
Speaker 1
Yeah. I mean, lot of the headwinds are really out of the business at this juncture. Based off of product mix, it will have some variability, but overall it's expanding. And as we add new items where we're not tied to legacy pricing, we do take advantage of opportunities to expand margins. We also look at some of the legacy items where we don't have pricing power necessarily, but we look at ways to cost reduce.
That and with the restructuring now essentially complete, we expect to leverage on the infrastructure as we achieve upside. Again, guidance that we provided it does it is a conservative forecast since there are a lot of moving targets. But the underlying tone is that we're very optimistic about the business Profitability on the items that we're selling is improving. And as we continue to grow the business is where we'll experience the leverage.
Speaker 2
Have you provided any update to your gross margin outlook for this year? And has it changed at all with the mix of products towards frozen?
Speaker 1
No. They are new items and certainly as hot items, we do have some pricing power. But as a percentage of the business, we still have a lot of legacy items. So the expansion in gross margin is a little slower going, but we expect each of the quarters to be north of 30%, which is a big positive sign considering the last the more recent history.
Speaker 2
Great. And one last housekeeping item. What is your cash balance? And how much of it is offshore? And how much would you be subject to taxes if you do bring it back to The U.
S?
Speaker 1
We have about $163,000,000.90 approximately 90,000,000 or so is in The U. S. We do have the maturity coming up in November of the twenty fourteen notes of $39,000,000 but we can bring back 100,000,000 no it was $60,000,000 in the $60,000,000 range on the Hong Kong cash on a book and cash tax free basis, but we don't expect to have to do that. But we do have the GE line, which will help us manage any needs should they come up. Q3 is our big, big selling season.
It's just under half of the annual volume. So that fourth quarter will throw off tremendous cash going into Q4 and into 2015.
Speaker 2
Great. Well, thank you and good luck. And definitely waiting for my princess dresses. I hope you make it into extra large size. Thank you.
Speaker 0
Thank you. Our next question comes from Drew Crum from Stifel. Please go ahead.
Speaker 4
Okay. Thanks. Good morning, everyone. Good morning, Drew.
Speaker 2
I had a question
Speaker 4
about the Disguise business. Was there any anomalies with this quarter relative to shipping? Did you ship earlier this year than last year? So that's the first question. And then secondly, I didn't hear any discussion or anything in the press release on the Marvel properties.
Can you comment on how they performed during the quarter and just expectations for the balance of the year given you've got three film properties for Marvel in 2014? Thanks. Okay. On Disguise, we actually ramped up the we had an internal forecast that we believed in and actually there was upside that came out of that forecast in so many various segments from Mario to Marvel to Frozen and other Disney properties, core Disney Princess. So what happened was a lot of the orders came in earlier in second quarter and what we wanted to do is to make sure we got more product out earlier, so we can get an extra turn or a turn and a half on sell throughs and many retailers placed orders earlier and we ship it FOB.
So that was what happened with Disguise. On Marvel, we have it in different segmentations of our business. So we have it in our kids only area of business. We have it in our boys role play. I'm trying to go through and some segments we have it in disguise.
And the Marvel boys properties and I'll even use transformers that we have in both our Halloween area of business and foot to floor. Those boys' properties are doing extremely strong. They've held their own, but they're in various segmentations of our business. So we don't have the core property rights of the action figures for the Marvel, but we do have some great ancillary rights that have performed and continue to perform going forward. And Stephen just going back to the topic of disguise, would that detract from third quarter shipments or demand strong enough where you don't see any impact?
We don't see any impact for the year. I don't have the total year forecast, but we do have growth in disguise for the total year and it may be either flat or detract a little bit, but it's offset by other areas of growth. So for the year, Disguise will be up year over year. Got it. Okay.
Thanks guys. Thank you.
Speaker 0
Thank you. We have a follow-up question from Derek Johnston from BMO Capital. Please go ahead. Hey
Speaker 6
there. Told you I'd be back. How long does the Frozen license last? And do you have rights? Should there be a sequel?
Speaker 4
A, we cannot discuss the period of licenses that we have just because of confidentiality with our licensors and also for competitive reasons. But we have it for a very good period of time. And the sequel I believe from what we gather, again this is just not confirmed at all from Disney. Promoted it for the years to come through Disney on Ice and through Interstitials, but I think there will be a Frozen in 'seventeen. I don't know, again, don't want to speak for Disney, but they've also included in their TV show, which they have Once Upon a Time, they immediately included Elsa in that Sunday evening TV show.
So they are promoting Frozen and Elsa throughout the year. So we have a broad license and for a good period of time. So Frozen is now actually going to be compelled to the core Disney property. So Frozen now is Elsa and Anna are now part going into next year as core Disney princesses and that's how Disney is looking at Frozen going forward.
Speaker 0
Thank you. Our next question comes from Sean McCallan with a follow-up from Needham and Company. Please go ahead.
Speaker 5
Hi. I also have some follow ups. Sure. So Joel, did I hear you right that your share count for the fourth quarter is 18.9? Yes.
Does that imply then that the level of profitability is below that threshold that would give rise to the dilution? And how does that square with the tax rate of 15%? It's 15%
Speaker 1
of the pretax, which we're actually projecting a loss for Q4.
Speaker 5
So you would have
Speaker 1
a benefit? No. Would actually be it's call it well, we have a tax rate. So there is a provision not a benefit. So it's the it's 15% it's about 15% of the loss.
Speaker 5
It's Is it a benefit or provision? So it's a provision
Speaker 1
that's It's 15% of the At the group level there's a loss, but at the Hong Kong, U. K. And Canada levels there's taxable income. That's why there's the provision.
Speaker 5
We would see a pretax loss but a positive tax number like an actual tax?
Speaker 1
Yes. Like in Q2. We have a pretax loss at the group level. I guess I should have not said 15%, but it's 15% of the pretax, but it's the Negative 15%.
Speaker 6
15%.
Speaker 5
Okay. Thank you for clarifying that. Anything in the inventory build that's related to concern over work stoppage or slowdown in the docks in LA? From what we got right now that was an issue that was during the first quarter
Speaker 4
and second quarter, but we shipped early preparing for it. But as we see today, there's no issue with the docks and the LA ports. But we did prepare for it because there was a lot of talk going on. So those issues with the ports seem like all the issues have been agreed upon with the unions. We're very close to the ports here.
So we did prepare by bringing in goods early on. But now we actually are shipping as normal. Right.
Speaker 5
I just yes, didn't know if the inventory build still at the end
Speaker 4
of the second quarter reflects any of that anticipated issue? Yes, did without a doubt. We were preparing early on because it was such extreme talks of the ports being closed. We've dealt with it before. So but we actually then now since it's resolved are just planning as normal.
In fact, I'm leaving to Hong Kong and China next week because of just the demand and it's not just for frozen, we're seeing which is a positive at least in our industry is as there's less competition, there's more demand for good product at retail and not just at retail call it even online. So we're seeing a lot of growth whether it's nominal in so many areas of our business that it's a great effect that there's a lot of less competition out there and retailers are we're seeing a healthy retail environment for good product not for just basic. So it's an exciting time and Frozen is terrific and it's a wonderful run and it will be a wonderful run next year. But we're also seeing really great traction across the board. That even shows in our Disguise division, our Moose Mountain division, our Boys division from the Hero Portal and the Dreamplay.
It's our first in app purchases starting in fall that we actually have a component going forward. So it's really exciting. Okay. Thanks. And then the last question I have,
Speaker 5
it goes back to the dynamics within Disguise. I think Joel you mentioned competitive pricing dynamics. So what's that about? And is that part of why you're not seeing better gross margin leverage and expansion?
Speaker 1
Well, in general, I mean that's part of it. I mean disguise is about 15%, 16% of the business and just the competitive landscape in that area. With a one use Garmin if you will, there's just a lot of competition. We have a lot of moving pieces.
Speaker 5
Okay. So then I guess I'm still wondering why in a time when you have some decent momentum you're not seeing a greater expansion in gross profit. I mean I know last year there were lot of
Speaker 1
Well in terms of Q2, proportionately it made up more. So it has lower margin than some of our other areas of business. In the second quarter, their sales were up pretty dramatic. We did about $30,000,000 last year and it was $42 ish million year. So it was more related to mix, but for the pricing I mean going into the year we're expecting a lot of competition.
And so as Stephen mentioned, it will be up year over year. But there was kind of a push in terms of the margin expansion. In Q3, where the sales for Disguise will be a smaller percentage, one, because the overall business will be up that's our peak season, but also the earlier ship on in general through Q2.
Speaker 5
Okay. Thank you.
Speaker 4
That is it for the Q and A portion of our calls. We have no more questions and we appreciate everybody's time. We'll be doing calls to analysts and investors after the call today. So if anyone has any further questions or updates, please give us a call directly and we have calls already scheduled. So thank you very much for your time.
Bye bye.
Speaker 0
Thank you. And thank you ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.