JAKKS Pacific, Inc. (JAKK) Q3 2013 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen. Thank you for joining today's JAKKS Pacific Third Quarter 2013 Earnings Call with management. Today, JAKKS will review the results for the third quarter ended September 30, 2013, 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 product lines and current business trends prior to opening up the call for your questions. [Operator Instructions] Before we begin, the company would like to point out that any comments made about JAKKS Pacific's future performance, events or circumstances, including the estimates of sales and earnings per share for 2013, as well as any other forward-looking statements concerning 2013 and beyond are subject to Safe Harbor protection under federal security laws. These statements reflect the company's best judgment based on current market trends and conditions today and are subject to certain risks and uncertainties, which could cause actual results to differ materially from those projected in forward-looking statements. For details concerning these and other such risks and uncertainties, you should consult JAKKS' most recent 10-K and 10-Q filings with the SEC, as well as the company's other reports subsequently filed with the SEC from time to time. With that, I will turn the call over to Mr. Berman.

Good morning, and thank you, everyone, for joining us today. We are pleased with our third quarter results and believe we're on track to achieving our full year 2013 guidance. Highlights of our third quarter sales include Disney Princess dolls, dress-up and role play, Sofia the First dress-up and role play items, 31-inch Giant Action Figures, Disguise Halloween costumes, Black & Decker boy role play and our Pre-School Ride On and activity tables. These are great examples of our core evergreen brands and categories that are the foundation of our business. We recently completed our Fall Toy preview meetings and are excited about the enthusiastic response from retailers, license owners and other industry partners to our 2014 product line including our DreamPlay Toys and products and technologies. We launched the Ariel’s Musical Surprise app this month which we are promoting to our customers through TV commercials, call-outs on product packaging and PR and social media activities. The Toys"R"Us big brand catalog dropped into 1.5 million homes this month and features our DreamPlay enhanced Little Mermaid products with a call to action to download the app. Third quarter was a strong quarter for JAKKS International driven by our 31-inch Action Figures, Spy Net, Smurfs and Sofia the First products. I will provide more highlights on our International business later in the call. We, along with our retailers, are focused on managing risks on new product launches, but for JAKKS, we believe with our strong basic categories, where we are leaders in and are a major competitor, we have an extremely strong core business now and going forward. It is a challenging retail environment but with our previously announced restructuring, our strong basic core business, our DreamPlay and technology initiatives, we believe we will lay groundwork for a more profitable 2014 and beyond. Looking ahead to 2014, we are optimistic about future opportunities including the launch of our licensed and non-licensed DreamPlay and technology kid products and the solid performance of our core category business lines which spans a wide spectrum that includes Action Figures, Dolls, Dress-up and Role Play, Halloween costumes from Disguise, kids furniture and seasonal products from Kids Only!, infant and pre-school products from Tollytots, ride-on vehicles and wagons from Moose Mountain and outdoor and junior sports products and Impulse Toys from Maui toys. In addition, we have an aggressive international plan of expansion and growth going forward in 2014 and beyond. I would now like to turn the call over to Mr. Joel Bennett to review our financial results for the third quarter of 2013. And then I will give a further update of our business this year and beyond. Joel?

Thank you, Stephen, and good morning, everyone. Net sales for the third quarter of 2013 were $310.9 million compared to net sales of $314.5 million reported in the comparable period in 2012. Net income for the third quarter was $36.6 million or $1.11 per diluted share, which reflects the net dilutive impact of $0.21 per share associated with the common shares underlying the convertible senior notes recently issued and repurchased in July 2013. This compares to net income of $30.4 million, or $1.10 per diluted share reported in the comparable period in 2012. Net sales for the 9 months ending September 30, 2013 were $495.2 million compared to $533.3 million in 2012. The net loss for the 9-month period was $37.8 million or $1.73 per diluted share, which includes second quarter charges for license minimum guarantee shortfalls of $14.4 million and inventory impairments of $14.9 million. This compares to net income for the first 9 months of 2012 of $14.7 million, or $0.59 per diluted share, which included $4.1 million, or $0.10 per diluted share, of pretax financial and legal advisory fees and expenses related to that 2011 indication of interest. Worldwide sales of products in our Traditional Toys and Electronics segment, which includes dolls, action figures, vehicles, electronics, plush and pet products were $156.9 million for the third quarter of 2013 compared to $172.8 million for the third quarter of 2012. And sales for Traditional Toys were $243.9 million for the first 9 months of 2013 versus $286.6 million for the first 9 months of 2012. Sales this quarter in this segment were led by our Disney Princess Dolls, Disney Fairies, Cabbage Patch Kids, TV games and 31-inch Giant Action Figures. Those sales overall was down this quarter due to declines in Monsuno and Winx Club. Worldwide sales from…

Thank you, Joel. We could not be more pleased with the performance of our Sofia the First products. The brand is building to be a powerhouse license with amazing products. We are currently chasing the upside of retail and have increased our forecast for our Dress-Up and Role Play lines. Our Sofia the First royal talking vanity was included on the Toys "R" Us hot list and our Sofia the First transforming dress and trunk on K-Mart's fabulous 15 list. We have secured rights in Latin America, Australia, China, Taiwan and Hong Kong for our Sofia large doll line under our Tollytots division. This will begin shifting in the spring 2014 and this has a potential to have significant growth of our doll business in 2014 and beyond. The Little Mermaid Diamond Edition Blu-ray DVD launched this month and the sell-through of our light-up dress and Under the Sea! Ariel feature doll is doing exceptionally well. Our Under the Sea! Ariel was featured recently by Disney on their Disney Dozen top choice for holidays. Products for the new Disney animated feature film, Frozen, began shipping this quarter and we have promotional plans in place at each key retailer. We are looking forward to a solid performance of our Frozen dolls, dress-up and role play products for the holidays with a strong spike expected around spring 2014 during the DVD release. Our Disney Fairy products are starting to pick up momentum at retail. Sales for Cabbage Patch Kids continue to be a solid contributor. Looking ahead, we are extremely excited about the anticipated launch in December of our My World line of mini play environments, based on top growth brands like Claire's, Sprinkles and LPI, just to name a few. This will also feature the compatibility with our My World DreamPlay…

[Operator Instructions] And on the line, we have Scott Hamann from KeyBanc.

Joel, could you help us quantify the impact of the restructuring actions that you've taken and maybe some of the timing associated with some of those decisions and how it's going to flow-through going forward?

Sure. We actually commenced them, that third week in July after we had announced earnings and the financing. It includes headcount approximately 100 people, or 12% of the workforce, which equates to about $8 million and other items, including leases, travel outside services and so forth, all of these actions are phased in over that period of time -- through the end of the year so as to not impact adversely into the operations. So, we expect to have a full year impact in '14.

Okay. And you alluded to having what you call normal margins in the fourth quarter. Can you kind of help us understand what you mean by normal margins and as we move into '14 and you guys have talked about a return to profitability, what we should expect as kind of an ongoing margin structure for this business?

North of 30%. Basically, that eliminates or significantly reduces the inventory impairment as well as license guarantee shortfalls. Some of the new products from DreamPlay will actually expand our overall margins as we're developing products, essentially from the ground up with the technology. So we will be establishing the retail price points and the value and within that construct, we'll be able to enhance our gross margin.

What about on an operating margin basis?

In the short term, we're shooting for north of 5%. It's still well early in the process. We just completed Toy Fair, but once we get all the line listings and the 2014 product solidified, we'll be able to give more color on that but in that range, is our short-term goal.

From Piper Jaffray, we have Steph Wissink online.

Just a couple of questions for us. First guys, it sounds like the third quarter came in a bit of ahead of how you have planned it. Yet you maintained the full year guidance so, how should we think about that? Is that conservatism on the fourth quarter? Is that a shift in the flow of business from -- or this year versus last year? And then second question, just a follow-up to the earlier question related to DreamPlay, can you talk a little bit about the relative side of that business potential in 2014 and the product margin versus the company average?

For the third quarter and the remaining part of the year, we're comfortable with our estimate that we gave out during second quarter and reaffirmed during third quarter. We are taking a cautious approach to ensure that the retail sell-throughs and buy-ins stay consistent. At the same time, the sell-throughs that we have currently on our products throughout the segmentation from Halloween to our evergreen toy products are doing extremely well. So we are just taking a approach looking forward and ensuring that we have a good holiday season. Our goal is we had a rough past and we want to be conservative and ensure that we have a steady business going forward. And that's the approach we are taking. There's the business going forward is a lot of evergreen singles and doubles. We have some very strong products moving ahead, such as Sofia the First line, both in the U.S. and abroad. Daniel the Tiger, but we are looking at things and taking a cautious approach. On the DreamPlay initiatives and the technology initiatives, at this time we're not breaking out what those sales or segmentation of businesses will be for 2014 until we give a outlook for 2014 at a later date.

From BMO Capital Markets, we have Gerrick Johnson online.

Couple of product questions for you. DreamPlay retail, can you tell us where that is? We're out in stores just a couple of days ago, we didn't see it anywhere. So what retailers, what aisle should I be -- should I be looking in to find it?

You could look at both Toys"R"Us, Target and Walmart were the initial launches. And you would look under the girls category where Little Mermaid is. It's been set in the sell-throughs that we're getting currently are going beyond our expectations, but it is out there and it is set, so if you're not seeing it, it is either sold through and not pulled back from either the back room of a retailer or back at the DCs. So, it is out at retail, at those 3 major retailers. The My World DreamPlay product launches at Walmart, 12/1, with the app launching 12/1 at the same time.

Okay. We'll go with the assumption that it sold-through and I'm sorry, we didn't see it. So how about that Daniel, will you expand that retail beyond Toys"R"Us next year?

Yes. Actually, we just had all of our major retailers and -- not just major retailers, all of our retailers from the drug trades to the big-box stores and our line has expanded dramatically on an SKU basis. And as we've had such amazing results with Daniel the Tiger as Sofia the First is outpacing everyone's expectation and at the same time, Daniel the Tiger's sell-through is equal or more to Sofia the First, so retailers are backing it very strongly and we expect that to be a nice part of our business for next year.

Yes, it looks like a good license. Last question, what's your #1 selling Halloween costume this year?

I can't tell you that because I don't know what it is. Our sell -- because the sell-in is different than sell-through, Gerrick, and we don't -- right now, this is the biggest sell-through period at -- for Halloween, it's the last 2 weeks. I don't have the answer so I don't want to give you a guess but you could call back and I can get the answer within the next day from our President of that division.

From Stifel, Nicolaus, we have Drew Crum online. Andrew E. Crum - Stifel, Nicolaus & Co., Inc., Research Division: Guys, you seem to have an increased focus on international. Can you talk about how you're thinking about what this could comprise of the percent of the total, is it intermediate to longer-term? And then you also mentioned, increased usage or utilization of the Disney properties. What is the margin profile on that business?

On the International business, we've had it undertaken for over a year or a year and a half of true expansion. In fact, we're showing, and at Mumbai Toy Fair in India and we're in the process of making a strong distribution deal in India. I think, even the Toy Association expressed that the Indian market as well as the Chinese, are one of the fastest-growing markets internationally. But we have been majorly focused in China, Latin America, Eastern Europe, and now that we have more of our own content as well as a lot of our licenses now we have international territories, that gives us a very strong boost to really penetrate these markets and in fact, the Nordic and Russia, we've seen extremely strong growth in our international segmentation. So, we believe the business should get to 40% of our business going forward in the next couple of years. It's a very fast-growing business. We have a great team and in addition to the great team, we have the great product that's necessary to go abroad outside of North America. Andrew E. Crum - Stifel, Nicolaus & Co., Inc., Research Division: Okay, got it. And then, I understand there was some change to the relationship with Disney under DreamPlay. Can you talk about what the pipeline of products or content looks like for DreamPlay with Disney going forward?

Well, we work very closely with Disney. In fact, the app is doing excessively well for Disney. They gave us a quick update, we're not allowed to give stats on it, but they are well more pleased than expected of how many downloads has occurred. And our relationship with Disney has been -- is very broad but what we're focusing on is the technology and appropriate areas. So for both boy and girl, with our launches with Disney for DreamPlay next year are under wraps while we are working with them, and then when the time comes, when we do the announcement of our categories under DreamPlay, we will certainly talk about what we're doing with Disney. Andrew E. Crum - Stifel, Nicolaus & Co., Inc., Research Division: Okay. So Stephen, just to confirm, there will be new Disney properties associated with DreamPlay in 2014?

Yes. Andrew E. Crum - Stifel, Nicolaus & Co., Inc., Research Division: Okay. Last question, just some accounting questions. Joel, can you quantify what the impact of the tax deferral was in the quarter? And then also, you mentioned that the day sales outstanding were higher due to greater sales domestically and I guess, I would have thought it would have been higher with internationals sales being greater, just wanted to get some qualification on that?

Actually, it's domestic versus FOB shipping. The proportion to international accounts didn't change much. The FOB sales are done on a letter of credit and they are generally collected within 2 or 3 weeks versus 60 days plus extended dating on a lot of the Disguise accounts because of the high seasonality of that business. Andrew E. Crum - Stifel, Nicolaus & Co., Inc., Research Division: Okay, that makes sense.

What was the first part? Oh, the tax. What were you referring to actually on the tax? Andrew E. Crum - Stifel, Nicolaus & Co., Inc., Research Division: There was a tax benefit, I just wanted to know if you could quantify the impact on the quarter?

Actually, there are no tax benefits. What the provision is that we recently completed our transfer pricing which allocates the taxable income between Hong Kong and the U.S. So it's more reflective of the loss in the U.S. which has no benefit or provision and so it's essentially the income tax on the Hong Kong earnings for what they'll keep through the transfer pricing analysis.

From Ascendiant Capital, we have Edward Woo online.

About the retail environment. As -- how do you characterize it as we're about a month away from the beginning of Black Friday? And has it changed much since last quarter?

So, I could give you a better understanding as we just got through listening to a lot of our customers, both the U.S. and abroad. They are, I would say, more optimistic in the sense of its back to the basics and products that are more evergreen. I think, retailers are staying away from hit driven properties and not taking big inventory positions on items. They are taking good inventory positions online. What we've seen in our own personal sell-through has been really across the board because we're in so many different segments from -- Halloween is currently now, our spring summer shipments are over. Our Moose Mountain to our girls division to our Pre-School division, it's so diverse in the different segmentations at retail. I mean, we sell to over 15 different buyers at 1 retailer. So we're seeing really nice traction. Again, that's just currently what we see as of today. And very similar abroad, there's -- we had a problem what we discussed second quarter with one of our international customers and that customer, we believe, will be back to a somewhat stronger strength for next year and outside of the areas of businesses that we were highly driven in the sense of marketing and advertising called Winx and Monsuno, that were really based off of being placed on strong TV strip and daily which didn't occur on the network that we were working with. Everything else in our line is really streamlined and selling well and we're not hearing anything truly negative at retail, we're hearing that this is just nothing really, really, really amazing. Our Sofia the First line is probably the hottest property in our toy industry right now. The ratings, we only launched it for, I think, the last 4 or 5 months at a retailer and the numbers have grown well outside of our expectation. But, it's a long build, I think retail looks solid for the remaining part of this year.

From B. Riley, we have Linda Bolton-Weiser online.

So, in terms of a cash flow performance in the quarter, I mean, it was kind of negative, more negative than I would have expected maybe with the operating cash flow and I know it will be stronger in the fourth quarter, but is there anything unusual in that number? And also, can you tell us what your peak working capital need will be in the first half of 2014? Like I'm guessing it's around $90 million to $100 million but I don't know. And in what months does that peak working capital occur?

The cash flow for this quarter, definitely met our expectations. The biggest draw in the cash was the growth in receivables. And as you said, we go into a heavy collection period and in fact, throw off most of our cash over the next couple of months. In terms of peak needs, it would probably be mid-second quarter but it's somewhere south of the $90 million, we -- we don't have much working capital needs. Most of the sales of the business still on an FOB basis, so we're able to grow without much use of capital.

Okay. And then in the near-term, you had referred to trying to get a bank revolving credit facility. Do you think that these results being on target here in the third quarter are going to help that process? Or do you think you actually don't need that in order to get through 2014? Or can you give some color on that?

Yes, we actually don't need it but certainly, Q3 was an inflection point for us. One is it's showing the world at large that we still have a substantial business that can be very profitable. What we would look to do is implement the lines for a couple of reasons. One, dry powder for acquisitions. Also, we have a $39 million of our 4.5% convert due in November. So to the extent that the...

November.

November of 2014 and to the extent that we can opportunistically buy some of that back at a discount, I know it's been trading a little bit all over the place. So, we'll evaluate that but we do have that liquidity event coming up. We believe that the cash on hand and cash flow we'd be equipped to take that out but we'd certainly like to have a little backstop with a revolving line of credit. We think it's a good non-dilutive layer to our capital structure.

Great. And then, can you just give me the year-to-date depreciation and amortization number? I just missed that, for the 9 months.

Oh, sure. $9.3 million for the third quarter and $16.9 million for the year-to-date.

And a question on the DreamPlay. You sound really optimistic about it for 2014? Do you have any sense for how many items or SKUs there will be in the line? Or what percentage of your total sales -- I'm still thinking even with really good growth it will still be relatively small percentage of your sales next year? Can you put some numbers around it?

We cannot give numbers in the sense of what it equates to for 2014. It's too early for us to give guidance or information for '14. But there'll be well over 20 SKUs in that area. Licensed and unlicensed and also -- it will also -- be launched internationally in 2014.

From Needham & Company, we have Sean McGowan online. Sean P. McGowan - Needham & Company, LLC, Research Division: Most of my questions are housekeeping nature. Joel, can you just confirm that the share calculation for the fourth quarter is essentially whatever your basic number is, plus the 11.4 minus 4.2?

No. Actually, because in periods of loss, you use the basic, so you don't show the converts as converted. There's also some quarters where there is modest income but we have to run that calculation each quarter. So, in the fourth quarter, we would use basic for both the quarter and the year-to-date because of the loss. Sean P. McGowan - Needham & Company, LLC, Research Division: Okay. And in terms of Maui, can you just comment on whether Maui was a contributor to growth in the quarter and like what's the year -- I know you didn't have it for the full year last year, so for the 9 months, how much of the sales in the 9-month period were Maui?

Maui was actually up in the third. We acquired them in the third quarter of last year and they were actually up year-over-year and their business is in the $20 million -- between $20 million and $30 million and they're on track to achieve that. Sean P. McGowan - Needham & Company, LLC, Research Division: That's for the full year, you mean?

Yes. Sean P. McGowan - Needham & Company, LLC, Research Division: Okay. And it's -- but it's much more of the first half business because of the nature of the product?

Correct, yes. Seasonal and Outdoor. Sean P. McGowan - Needham & Company, LLC, Research Division: Okay. And why -- you commented on why the gross margin -- in your prepared remarks, you commented on why the gross margin was lower. I think, you were commenting on the first 9 months and while it's not down a lot, in the third quarter, why is it down at all in the third quarter?

Actually, Accounting 101. We capitalized a certain amount of our warehousing cost and it's a function of how much inventory we purchased. With a carryover inventory from 2012 and the lower inventory purchases in general, a higher percentage of our -- of the direct selling was allocated to cost of goods, so we had -- but overall other direct selling was down. It's just a higher amount was allocated to cost of goods through that mechanism. Sean P. McGowan - Needham & Company, LLC, Research Division: Just so I understand it, you mean that because the inventory is lower, the allocation of expenses is higher or something like?

Because inventory purchases were lower, the allocation -- it changes the percentage allocated to cost of goods. So, if we had purchased a lot more, you would actually see margin expansion. Sean P. McGowan - Needham & Company, LLC, Research Division: Okay. So just go with the 30%-ish plus, is what you consider normal, not this quarter?

Correct. Sean P. McGowan - Needham & Company, LLC, Research Division: Okay. Can you remind us of, has there been any major change and what percentage of the cash is U.S. versus outside the U.S.?

With the issuance of the new convert, it added the $35 million of liquidity to the U.S. Right now, it's $20 million here and the balance in Hong Kong. Sean P. McGowan - Needham & Company, LLC, Research Division: Okay, I didn't know if there was any transfers back and forth.

No, we have ongoing transactions between the companies we buy inventory from Hong Kong, we charge them a management fee, so there's a continuous flow of activity between the entities in the ordinary course. But no borrowings per say. These are just trade receivables between the companies. Sean P. McGowan - Needham & Company, LLC, Research Division: Okay. And what do you expect to be the effect of tax rate for the whole year?

We're looking at about 3% which basically reflects the tax on the Hong Kong income since we don't have any income in the U.S. So, it will be aberrational in that respect but we expect to be fully taxed for financial reporting next year in the 18% to 20% range.

Thank you. This concludes our question-and-answer session. I will now turn it back over to Mr. Stephen Berman for closing remarks.

Thank you, everyone for the call. We had a lot of people attending this call and we have actually had a good chance to meet with investors and analysts throughout the few weeks and we're excited to complete this year and move forward into 2014. So thank you very much. Bye-bye.

And this concludes today's conference. Thank you for joining. You may now disconnect.