JAKKS Pacific (NASDAQ:JAKK) Q2 2020 Earnings Call

0:00 Good afternoon, everyone. Welcome to the Jax Pacific's second quarter earnings conference call with management, who will review financial results for the quarter ended June 30th, 2020. Jax issued its earnings press release early today. The earnings release and presentation slides for today's call are available on the company's website in the investor section. On the call this afternoon 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 and the discussion of the impact of COVID-19. Then Mr. Kimble will provide detailed comments regarding that specific financial and operational results.

0:51 Mr. Berman will then return with additional comments and some closing remarks prior to opening up the call for questions. Your line will be placed on mute for the first portion of the call. If you would like to be placed in the question queue, please press star then one on your telephone keypad. Before we begin, the company would like to point out that any comments made about Jax Pacific's future performance, events, or circumstances included estimates of sales and of 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 ASHA results to differ materially from those projected in forward-looking statements.

1:48 For details concerning these and other such risks and uncertainties, you should contact JAC's most recent 10-K and 10-Q filings with the SEC as well as the company of the report subsequently filed with the SEC from time to time. In addition, today's comments by management will refer to non-GAAP financial measures such as adjusted EBITDA. Unless stated otherwise, the most direct comparable GAAP financial metric has been reconciled to the associated non-GAAP financial measures with the company's earnings press release issued today or previously. As a reminder, this conference is being recorded. With that, I would now like to turn the call over to Stephen Berman.

2:45 Thank you and good afternoon, everyone, and thank you for joining us today. We are pleased with the results we were able to post for the second quarter, and not just because they were better than we had expected internally, but because I believe underneath the reported numbers there are very promising signs that we believe point to better performance in the future. Like almost every company in the world, we faced considerable challenges in the quarter from the ongoing pandemic. These challenges started in the first quarter, but in some ways they were different from the ones we faced in the first quarter. Our priority remains the health and safety of our employees and their families, our customers, and our suppliers. In some ways, our business is back to normal, and in other ways, it still has a way to go.

3:32 We continue to operate with limited staff coming into the offices worldwide, and many, if not most of our employees, are working from home. Our manufacturing partners are back online, but they are facing production challenges that are limiting access to some of our products that are selling very well. Our major retail partners stayed open for most of the worst days and have picked up a lot of the slack from those that were closed, but many of our smaller retail partners continue to struggle. Sales through online channels have thrived through this time and continue to grow. We are slowly opening our facilities following federal and state guidelines in an attempt to resume full and normal operations. Our reported sales in the second quarter were down 17% from the results we posted a year ago, but we are encouraged by the composition of those sales.

4:25 In our toy segment, our sales were down approximately 4%. This was due to the fact that we consciously exited certain low growth, low margin lines of business, notably Fun Noodles at the end of 2019. Excluding the discontinuation of Fun Noodles, our toy segment sales were actually up approximately 3% compared to last year and roughly flat for the first half of the year. The main driver of the sales decline was Disguise, our Halloween division, but even there we think the story is better than it looks. John will go over the details in this section, but the main point is last year Disguise was unusually strong and this year we are being more cautious in who we ship to, even as retailers are being more cautious regarding their Halloween expectations.

5:15 In other words, we don't just want sales, we want sales that are profitable and where we see sustainable growth potential and are more willing to sacrifice volume in the name of increasing profitability. We are very encouraged by our retail POS and our retail inventory levels. Through the end of June, POS at our top three customers was up mid-single digits and retail inventory at these retailers is down mid to high teens. We are pleased with this position as we move into the second half. We know we have some difficult comps in Q4 against the launch of Frozen 2, but we're satisfied with how clean our inventory levels are at retail. Even more encouraging than the sales trends and POS is how much we have reduced costs compared to last year and the year before.

6:06 We have been diligently working to reduce our fixed costs, taking dramatic steps to reduce costs in both 2019 and earlier this year. John will review shortly, but we have taken millions of dollars in expenses out of our cost structure, such that despite the reduction in sales, our EBITDA loss is actually considerably lower. These cost reductions lower our break-even and leave us better positions to leverage our costs in higher volume quarters. So we are pleased with how our results are in the quarter, reflect our efforts to be more disciplined and more focused on profits, and we look forward to reaping the benefits of these efforts. Jon will now review financials, and I will return to discuss what we see for the rest of the year. Jon.

6:54 Thank you, Stephen, and good afternoon, everyone. As I discuss our results for the second quarter of 2020, please note that the company executed a 1 for 10 reverse stock split after the close of trading on July the 9th. and all per share figures discussed here reflect that reverse split. Net sales for the 2020 second quarter were $78.8 million, down 17% compared to $95.2 million last year. Reported net loss attributable to common stockholders for the second quarter was $23.6 million or $7.70 per basic and diluted share compared to a net loss of $22.5 million or $9.55 per basic and diluted share in the second quarter of last year. As a reminder, certain elements of our capital structure are marked to market quarterly based on a few factors inclusive of our share price.

7:45 The net loss in Q2 of 2020 includes non-cash charges totaling $7.7 million, reflecting changes in the fair value of our convertible senior notes and the derivative liability associated with our preferred stock. By comparison, these charges in Q2 of 2019 totaled $0.1 million. The second quarter of 2020 also included restructuring charges and COVID pandemic-related charges of $1.9 million compared to a negligible amount in Q2 of last year for restructuring charges. Conversely, Q2 of last year included $2.5 million in acquisition and recapitalization-related expenses compared to no comparable spending in Q2 of this year. Excluding the impact of such charges as well as stock compensation expense, our adjusted net loss attributable to common stockholders in the second quarter of 2020 was Thank you for watching.

9:04 Our girls-targeted businesses showed growth for the quarter, inclusive of dolls, role-play, and dress-up toys, preschool plush, as well as same-walk cosmetics. Girls' products were $32.8 million in Q2, up 5% compared to $31.3 million in the second quarter of last year. As was the case in the fourth quarter of 2019 and the first quarter of this year, the big driver was Frozen 2, which was released in theaters late in Q4 of 2019. Other products that contributed to growth were Disney Princess, Perfectly Cute Baby, our exclusive baby doll line with Target, and Kitten Cat Fae, our own aspirational doll and collectible world of Cat Fae-inspired surprises, which continued to build nicely during the quarter. These sales more than offset some of the anticipated declines in various other product lines, particularly those related to older entertainment properties such as Disney's Aladdin, the original Frozen, Squish Delish, and assorted other older lines.

9:59 Sales of action figures, vehicles, roleplay, and electronic products in our Boys category for the 2020 second quarter were $10.7 million, up 2% compared to $10.5 million last year. Positive contributions from our Flywheels line of proprietary action vehicles, Sonic the Hedgehog and Nintendo Super Mario toys, and Black & Decker roleplay more than offset declines in entertainment-driven properties such as Godzilla, Incredibles 2, and Harry Potter. Sales of seasonal products, including licensed ball pits and play structures, were $12.7 million in the 2020 second quarter, down 26% from $17.1 million in the second quarter of 2019, primarily due to our discontinuation of Fun Noodles, a low-margin product line we exited last year and referenced in Q4 when we took an impairment charge against the intangibles associated with that acquisition.

10:50 Strong sales of Minnie Mouse and Frozen 2 ride-ons, as well as sales of our Redo skateboards, offset declines in Morphboard. Broadly speaking, we are seeing strong retail sell-through with our activity tables and many more. as well as a shift in some shipments from Q1 to Q2 led to unusually strong sales growth in the second quarter. This year, not only do we not have the same entertainment lineup or the timing shift, but the pandemic is clearly cutting into some of our sales.

11:39 This business sells disproportionately to smaller specialty retailers, and some of them are struggling. In addition, we have been more cautious and disciplined in our shipments, not wanting to turn good inventory into bad debt. and even the healthiest retailers are uncertain as to how the ongoing pandemic will affect demand for Halloween products, even though Halloween falls on a Saturday this year, which often leads to higher than normal sales. Looking at sales by business segment, sales in our toys consumer product segment, which includes all markets around the world, were down 4% to $56.2 million compared to $58.8 million in the second quarter of last year. The decrease was driven by the same factors noted above in the product discussion. Latin America and Australia and New Zealand were up year over year, whereas the U.S., Canada, Europe, Asia, and the Middle East and Africa were lower.

12:26 And as we already noted above, our Halloween segment was down 38%. Looking at the rest of the P&L, reported gross margin in the 2020 second quarter was 21.3% compared to 18.6% in the 2019 second quarter. Steady improvements in our product margins and lower obsolescence expense outpaced higher royalty charges incurred in the quarter. The increase in royalty expenses as a percentage of sales was driven partly by a mixed shift towards products with higher royalty rates, but also reflects a more disciplined approach to accruing for royalty costs earlier in the product selling cycle. Sharply lower spend for SG&A expenses, including direct selling expenses and depreciation and amortization in the 2020 second quarter, totaled $24.7 million or 31.3% of net sales compared to $33.9 million or 35.6% of net sales in the second quarter of 2019.

13:20 Our interest expense in Q2 of this year was $5.5 million compared to $2.9 million last year, reflecting higher borrowings under our term loan and a higher average interest rate. Net cash provided by operating activities was $7 million for the second quarter of 2020 compared to a net cash used in operating activities of $7 million in the second quarter of 2019, primarily due to cost savings measures. Free cash flow is positive $4.2 million in the 2020 second quarter and negative $9.7 million in the 2019 second quarter. As of June 30, 2020, our cash and cash equivalents, including restricted cash, total $52.7 million compared to $66.3 million at the end of 2019 and $37 million as of June 30, 2019. Accounts receivable as of June 30, 2020 were $69 million, down from $117.9 million as of December 31, 2019, and $85.1 million as of June 30, 2019.

14:16 DSOs for the 2020 second quarter decreased to 80 days from 81 days reported in the 2019 second quarter. Inventory as of June 30, 2020 was $57.7 million versus $54.3 million at December 31, 2019. and $53.5 million as of June 30th, 2019. DSIs in the 2020 second quarter were 85 days compared to 80 days in the 2019 second quarter. And looking at DSIs on a trailing 12-month basis, we were at 62 days for 2020 and 63 days for 2019. During the quarter, the company applied for and was granted a Paycheck Protection Program or PPP loan under the Federal CARES Act program.

15:07 Those proceeds of $6.2 million will be utilized to cash flow payroll and rent payments over the next six months as per the program's intention. At the end of the time period allotted to utilize the funds, it is the company's intention to file for forgiveness for a portion of the debt. In the absence of knowing whether any funds will be forgiven and how the program may change as the year continues, the company has taken a conservative approach and presumed a two-year loan period with interest beginning to accrue in December of 2020. As a result, we now reflect an additional $1.8 million in short-term and $4.4 million in long-term debt on our balance sheet. As a result, as of June 30, 2020, the company's debt at face value included a $6.2 million PPP loan due June of 2020 to $30.4 million of recapitalized convertible senior notes due July 2023 and $134.8 million owed under our term loan due February of 2023.

16:02 During the quarter, $7.1 million of the July 2023 convertible senior notes were converted to common shares at $1 per share. The $1.9 million worth of 4.875% convertible senior notes was paid off during Q2 on schedule. We currently have no outstanding balance under our credit facility. Capital expenditures during the second quarter of 2020 were $2.8 million compared to $2.7 million in the second quarter of 2019. Thank you, John. Right now, we are usually at the peak of our Halloween shipping season.

17:01 Halloween falls on a Saturday this year. And in a normal year, we would expect to get a lift from that timing. And this typically leads to more trick or treaters and people dressing up for parties. But this is not a normal year. We know that kids and adult fans of Halloween will want to celebrate in some form. But we are expecting COVID to have a negative impact on sales of Halloween merchandise this year. Even the healthiest retailers are taking a more cautious approach to their overall Halloween buying, with orders down double digits for most of them. Less healthy retailers, of course, are more worried. And so are we with these retailers, and we are taking a more prudent approach to credit risk by turning down some orders if we feel there is too much risk for Jack's.

17:51 We do not want to turn good inventory into bad debt. We recognize that COVID has caused a near complete shutdown of live action film production and caused films that were completed to have their theatrical debuts delayed because theaters are closed. This will affect not only Jack's, but any company making products tied to films that were expected to come out this year. One example that affects us is Disney's Mulan, which is supposed to open in fall and then got pushed to next March and now has no current scheduled release date for this year. Another is Raya and the Last Dragon, which was moved from November 2020 to March 2021. But we still have expectations that some of our girl product lines will do well and will benefit us this year. Frozen 2 continues to be a big contributor and for the holidays we expect our animatronic Magic in Motion Elsa doll and our Playdate Nook water horse to sell very well.

18:55 We have two products in the Disney style collection that we believe will perform well. One is a gourmet smart kitchen set and the other is a light up and style vanity. Both are proven play patterns and benefit from being part of the strong Disney sub-segment. Kitten Cafe, which is based on our own internal IP, has been selling very well and we expect that to continue in the second half with new exciting releases. Our Cute Girls Hairstyles product line, which is based on the number one hair channel on YouTube with more than 5.5 million subscribers and over 13 million video views per month, shows girls how to make elaborate hairstyles at home. Perfectly Cute Our baby doll line sold exclusively at Target continues to be a very solid seller and we expect good sales in the second half.

19:49 In our boys division we have several strong launches in addition to the strong evergreen base of business of some of our existing strong brands. Our toys based on video games continue to sell very well including Sonic the Hedgehog and Nintendo. For the holiday season we will be launching It's a Mii Mario, an oversized feature action figure with an integrated voice and sounds. This is the first time in the history of Nintendo that talking Mario toy has been introduced into the market. Another new video game related line we are launching this fall is based on Apex Legends, a highly successful battle royale video game from Electronic Arts. We have broad rights for Apex toys, and are optimistic our product line will sell well given the continued success of the game.

20:40 Also in Boys, we are following up with the success of last year's Extreme Power Dozer with this year's introduction of Extreme Power Dump Truck. This new release has a powerful drive mechanism that allows users to haul, push and pull all types of items with a beautifully designed construction play toy. Redo, our very cool proprietary line of skateboards, has performed well for us this year and we expect continued success going into the holidays with our current customer base and the expansive reach into new retail distribution channels. And we are relaunching a reimagined version of the iCops, a powerful new toy that allows kids to explore the unseen world around them with high magnification imagery that can be captured and shared for use in both indoor and outdoor settings.

21:33 This is just some of the products we expect to do well this holiday season. Before we finish up, I would like to talk more broadly about our expectations for the industry and how we all need to evolve and adapt to these changes being caused by COVID-19, some of which may last well into the future. We in the toy industry have often pointed out that toy sales hold up relatively well in recessions and during times of uncertainty, and this has been mostly true. People like to give their children toys even if they can't take vacations, buy a new car, dine out, and various other restrictions. During the early phase of the pandemic, we saw the added boost that retail toy sales got from the fact that kids were stuck at home and parents were looking for something to keep their kids occupied. Activity toys, puzzles, games, role play, plus indoor environments sold very well.

22:32 We are not sure that this demand surge will sustain. If schools remain closed, there will still be kids at home needing to be occupied, but they may already have purchased the activity toys and games and may not need to purchase more. When unemployment benefits run out or are greatly diminished, there is going to be some impact on consumer spending. Consumers have accelerated their shift to online shopping, most probably already had Amazon accounts, but those consumers who shopped at Target.com or Walmart.com to name a few for the first time have now set up accounts and they continue to buy on those sites more than they did before. Entertainment landscape may also be altered for some time. We are already seeing a reduction in frequency of events like birthday parties or other gift giving occasions where people get together.

23:24 What will the holidays look like this year? Will fewer family members get together and not seeing nieces and nephews reduce the need to purchase gifts? Or will family members still spend on gifts but just have them sent? With all this in mind, we are expecting consumers to be cautious this holiday season. At Jack's, our plan is to focus on making basic evergreen toys with proven appeal and proven play patterns. selling them through our strong retail networks around the globe and keeping our operational costs lower as we prepare for when the effects of the pandemic are reduced. This bodes well for Jack's continue its focus on growth and profitability now and for the future. In closing, I want to thank our incredible team for all their hard work in the challenging environment we have today. We continue to take the steps needed to position the company for profitability growth, and we couldn't do it without the dedicated team.

24:21 With that, we will now take questions. Thank you. To ask a question at this time, please press star then 1 on your telephone. To withdraw your question, please press the pound key. Our first question comes from the line of Seth Wissink with Jefferies, Your line is now open.

24:44 Good afternoon, everyone. A few questions for you, both of you actually, Stephen and John. So the first one, Stephen, is just as you're concluding your remarks, you're talking about this pretty direct shift to online, and it sounds like you expect some of that to be permanent. So how have you adjusted your marketing programs, your digital assets, for particularly your owned brands, to ensure that your landing on pages for consumers when they're searching that you're easily found in the digital environment relative to the physical experience that we've seen in the past.

25:21 Well, firstly, hello, Steph. I hope everything's well for you and everything's healthy and safe. For Jax, what we've been working on, and it's bode well for this, call it environment, is we've been working on doing videos internally with all of our products that go online. So you actually have We believe actually a better experience when you go online to search for a product because you're actually looking at 3D renderings, you're looking at videos, and you're getting a much more descriptive overview of the product. So you're really much more engulfed in actually the product when you see it online. In addition that all the online customers that we mentioned and some of which we haven't mentioned in the call, we're doing specific advertising on their online sites and we drive them to their online sites with regards to Thank you for joining us.

26:38 A lot less expensive digitally than what we do on TV. We're getting a little bit more benefit out of our own dollars spent for digital advertising versus the traditional TV advertising. But that being said, during the second half of the year, traditional TV advertising is one of the strong catapults for us worldwide and throughout the North American, Western and Eastern territories, that it actually benefits us to do it more TV based at the second half of the year.

27:08 Okay, that's helpful. And then just a second question on the disguise business. Recognizing that COVID is hopefully transitory, you're one of the best positioned and well positioned brand vendors in that space, but not all of your peers are as well positioned and even seeing one of your largest peers go through a bankruptcy process. So talk a little bit about the opportunity to actually enhance and upsize that business, not for 2020, but into the future years. where you could actually become even a larger player within Halloween role-playing costumes and even maybe some cosplay areas.

27:44 So that is a case. One of our real competitors has actually went to Chapter 11, and we'll see what goes on with that process. That being said, we've also, during the ill fate for that manufacturer, we have been in the process of obtaining new licenses and many new licenses going into 2021. for the Halloween period, which is a good sign because Halloween next year will be on Sunday, which actually gives us the most benefit of a lift normally in a non-pandemic year. But with our major retailers, we have been very, very close with them working methodically and meticulously on the correct cutbacks of the unknowns of what Halloween will be this year. That just doesn't mean that Costumes will be purchased in a different way this year, but it means candy, home decorations, indoor and outdoor is going to be a change because retailers saw Easter having a big lull down year over year and back to school starting out that way as well.

28:47 So for us, we have garnished the majority of the top video game licenses. So we're the leader in video game license costumes. We have a plethora of new licenses that we will look forward to announce shortly. Thank you for joining us.

29:29 All right, that's great. And then just the last one is on the break-even point. I think on your script you mentioned, you know, an agenda really to reduce the overall sales level to break even on your costs. I'm wondering if you can just articulate what you see as your, whether it's monthly or quarterly sales level to really cover your cost structure. And as we look out into the next couple of years, see a pathway towards really starting to generate incrementality in your overall operating margin structure.

29:58 Yeah, I don't know if a break-even point of view, if that was something that was in my part or Stephen's part, but I think to be fair, consistent with what we've been talking about for the past several months, you see our specific focus on bringing G&A down to both a smaller level and while at the same time we're trying to attack growth margins as well. So without getting into specifics as to where we're going to go, and the balance of the year. We're happy with what ended up happening with Q2 from a results perspective. We're mindful about the challenges of the year as we've kind of talked about the past and talked about today and looking at Halloween in particular and are hoping to be able to end the year with not going backwards on that front in terms of looking at cost as a percentage of sales.

30:51 Certainly when it comes to areas like G&A, there's always a degree of unexpected activity impacting that line, but some of the changes we've been making in the front half of the year are intended to be kind of changes for the long term.

31:06 Okay, that's great. Thanks a lot, guys.

31:09 Thank you. Thank you. Our next question comes from the line of Derek Johnson with BMO Capital Markets. Your line is now open.

31:19 All right, thank you. Good afternoon. Hello, Derek. Hi, I hope you're good. How have your discussions lately been going with retailers? What are their expectations in terms of planograms and set dates? Are they still when they're supposed to be, or are we thinking about pushing anything back? And then maybe part B of that is, are you fully able to hit all those dates? Are you still seeing some lingering issues anywhere from any of your manufacturing partners? Thanks.

31:53 So on the manufacturing side, we are pretty well working with the majority of the manufacturers, both in China, in the southern part and the northern part. The southern part was the hardest, and we had problems in the first quarter getting plush, some of the cut and sew done, which was in Shenzhen, but we're all back to normal production. And in different areas like Cambodia and India and Indonesia, it's back to normal business now. So I believe the majority of the platforms, in manufacturing, assuming there's no major pandemic, will go extremely well this year, assuming nothing extremely goes out of the control. In addition, the planograms and the set dates are being set, I believe it's a week after next, for the North American retailers, the first, second week of August.

32:42 In fact, I am going out later this week or next week to some retailers to meet with them and also walk some of the planograms and just some of the retail outlets, because There are some companies, manufacturer-wise, that are having difficult times to ship during this period due to whether it's financial issues or how impacted they were from COVID. So for Jaxx, as we've been very nimble and entrepreneurial throughout our inception, we're looking to garnish some of that shelf space now and for the future. So I believe the retailers are keeping the set dates for the majority of ones that we spoke to, called the big mass retailers. and not shifting their dates. So, so far, everything that we see on the set dates and what we're shipping for these set dates as we need to have product exactly on those set dates in order for us to make sure that we have the line occurring for the rest of the year have not changed. They were up in the air up until about six weeks ago, but everything has been settled and it looks like it's the first week of August, second week of August, so we have some media planned behind those initial set dates on some of our product lines.

33:52 Great. Thank you very much, Stephen. It's all I have. Thanks. Thank you, Gary. Thank you. We have no further questions in the queue at this time. I would now like to turn the call back to Stephen Berman for closing remarks.

34:05 Thank you, everybody. We appreciate the time today for everyone on the call, and we look forward to having our follow-up calls later today and tomorrow as scheduled. Thank you, and everyone stay healthy. All the best. Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.