Q2 2019 Earnings Call
All participants please standby your call will begin momentarily once again please standby.
Good morning, and welcome to the track specific second quarter 2019 earnings Conference call with management will review financial results for the quarter ended June Thirtyth 2019.
Your next issued its earnings press release earlier today.
The presentation slides containing information covered in both today's earnings press release and call are available on our website in the investors section.
This presentation includes video showing some of our key products and on the call. This morning are Stephen Berman, Chairman and Chief Executive Officer, and Brent Novak.
Chief Financial Officer.
Mr. Berman will first provide an overview of the quarter and provide highlights of product lines and current business trends and Mr. Novak will provide detailed comments regarding Jack's pacific's financial and operational results prior to the 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 queue to ask a question. Please press Star then one on your telephone keypad.
Before we begin the company would like to point out that any comments made about JAKKS pacific's future performance events or circumstances, including the estimates of sales and or adjusted EBITDA in 2019 as well as any other forward looking statements concerning 2019 and beyond are subject to safe Harbor protection under Federal Securities laws.
These statements reflect the company's best judgment based on current market trends and conditions today.
And are subject to risks 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 Jack's most recent 10-K and 10-Q filings with the SEC.
As well as the company's other reports subsequently filed with the SEC from time to time.
In addition, today's comments by management will refer to non-GAAP financial measures such as adjusted EBITDA.
Unless otherwise stated the most directly comparable GAAP financial metric has been reconciled to the associated non-GAAP financial measure within the Companys 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.
Good morning, everyone and thank you for joining us today.
This morning, we are going to review our performance during the second quarter of 2019.
I'll start with some general comments about the recently completed recapitalization transaction, which we announced this morning.
And then talk generally about our second quarter performance.
After my comments, Brent will discuss our financial performance after which I will come back with some additional comments.
I am very pleased that we have executed a comprehensive recapitalization transaction and we can finally move forward with a keen focus on the business without the overhang and uncertainty of needing to complete some type of transaction. We are grateful to have sets grade business partners and friends supporting us, including our customers Licensors suppliers shareholders and other stakeholders advisers and of course our employees.
Moving onto our results the quarter ended June Thirtyth was the first quarter, which we had no sales to toys R. Us in the us either this year or the prior year.
Even with no sales in the us to toys R. US in Q2 2018, the industry still saw considerable disruption from the liquidation sales and the response of other retailers to those sales. Therefore, the clean comparisons are just beginning.
Some of the highlights in the quarter, where we saw strong growth in the quarter and our disguise division, which was up almost 50% even ahead of its peak quarter.
We also saw strong sales contributions from new license properties, notably Aladdin Godzilla toy story, four and Nintendo.
Pos of our Dizzy products was up over 50% in Q2, setting us up well for the second half with the key licenses ship.
Our evergreen seasonal business performed well in the quarter with introduction of our plate tense added to strong sales of activity tables and ball pits.
These areas of strength were more than offset by the declines in Incredibles, two and square still this both of which were particularly strong in the second quarter of last year with above average gross margins.
As a result net sales in Q2 declined approximately 10% compared to last year.
Essentially all of the decline can be accounted for by the decline in Incredibles. Two however, we achieved our expected gross sales target in the first half of the year of approximately 27% of our expected full year sales.
As we said on our 2018 year end first quarter calls, we expected sales in 2019 to be skewed much more to the second half due to the timing of key entertainment content and related product launches, notably frozen too which is launching in November but also a toy story four which was released late in Q2 and should drive sales into Q4 seller of our most important disguised licenses such as Lion King live action.
Hope you mine Lego movie to descendants three Kim possible and top rating to name a few also skewed to the second half the increase sales of close out goods, coupled with the shift in product mix reduced our gross margins further than expected in 2019 second quarter, though we do expect our gross margins to return to more normal levels in 2019 third quarter based on her bookings to date.
As was the case in first quarter, we were able to partially offset the effects of lower sales. Our gross margin in 2019 second quarter due to the steps taken last year to reduce our assay in a car.
On the tear front, we are in the process of evaluating the impact that the tears proposed to go into effect on September Onest would have on our business generally there are a number of levers we can pull to mitigate the impact including changing in sourcing modified logistics.
And price increases where possible.
These steps in the past had been effective at offsetting the negative effect of terrorists.
Given how close to peak shipping periods. These recently announced heres would take effect and how broad. They are there may be some negative impacted near term results. We are currently evaluating the impact that this could have in the third quarter and fourth quarters. We will continue to work with our suppliers and retail partners to find an optimal path.
Before I hand, the call over to Brent I want to summarize some of the aspects of the recapitalization transaction.
We had outstanding convertible debt with a face amount of approximately 140 million due next year and 2020.
Approximately 140 million of that debt has been extended maturity to 2023.
Our credit facility with Wells Fargo has been amended and extended and now matures three years in August 2022.
The 20 million term loan from Great American will be prepaid.
The collateral used to support the great American term loan is now included in the Wells Fargo credit facility, which we believe will increase our ability to borrow under the facility. We issued 30 billion of new secured debt maturing in January 2023, which will help to fund the pay off of the great American term loan.
As part of the extension of our convertible debt approximately 104 million of the convertible debt held by the AD hoc group was essentially converted to secured debt.
We issued 19.9% of our outstanding common stock and issued preferred stock with a face about a $20 million to the AD hoc group. The preferred stock is not convertible into common stock and the preferred stock does not include a mandatory redemption provision at the option of the holders. We also adjusted the conversion price to one dollar or the convertible debt that remains outstanding of roughly 38 million, which is held by Oasis.
This is just a summary of some of the features of the recapitalization transaction.
For all of the details please refer to the form 8-K and related supporting exhibit that were filed with the FCC today.
With the recapitalization transaction complete we can pursue our business objectives through the near term and beyond with new vigor and resolve.
One final point.
While we did not complete a transaction with Beijing machine continues to be a strategic supplier of jacks and a large shareholder.
I will now turn the call over to Brent Novak Brent.
Thank you Steven and good morning, everyone.
I'll first review the financial highlights from the piano and then provide more color on the sales composition before finishing up with some balance sheet commentary.
Net sales for the 2019 second quarter were $95.2 million down, 10% compared to 105.8 million last year.
As Steven said the decline was essentially due to the fact that our Q2 2018 sales benefited significantly from Incredibles, two that declined year over year as expected with other notable declines from the prior year, including Squished delicious.
All of which were partially offset by newer properties.
As Steven noted our 2019 first half gross sales approximated 27% of our full year target with increased growth driven by licensed product expected in the 2019 second half compared to 2018 gross margin in the quarter was 18.6% down from 26.4% in Q2 of last year. The main driver of the decrease was a substantial shift in sales away from certain higher margin licensed and owned IP products toward some of our lower margin evergreen products as well as closing out some older products at lower margins.
Product mix also drove royalty cost higher as a percentage of net sales impacting our gross margin.
Our direct selling expenses declined 19% in Q2 on a year over year basis.
The result of lower co op advertising expenses and other costs.
Total SG gaming expenses declined by approximately 9% in Q2 on a year over year basis in line with the reduction in net sales.
Excluding acquisition related and other costs associated with the strategic transaction and refinancing process total SG nay costs were lower by approximately 15% compared to the second quarter of 2018 due in part to the 2018 fourth quarter cost savings initiatives.
Net interest expense was 2.9 million in Q2 up from 2.2 million last year as a result of higher borrowings and a higher average borrowing rate.
The provision for income taxes for the second quarter of 2019 was approximately 600000 compared to 2.1 million in Q2 of last year. The variability of the income tax provision is based on changes in taxable income levels in various tax jurisdictions in which we operate.
Reported net income attributable to jacks shareholders was a loss of 22.5 million in the 2019 second quarter or 96 cents per diluted share compared to a net loss of 18.6 million or 80 cents per diluted share in Q2 of last year.
Adjusted EBITDA for the second quarter of 2019 was negative $11.5 million compared to negative 8.5 million in the second quarter of 2018.
The sales drivers in the second quarter of 2019 by category were as follows.
Sales of dolls role, playing dress up plush and activity products in our girls category amounted to $30.3 million for the 2019 second quarter down 31% compared to 43.6 million in the comparable quarter last year.
We saw positive contributions from frozen Aladdin toy story four in Who's your Lama.
These brands were more than offset by the expected declines in a number of girls lines, including several entertainment content driven lines, such as Incredibles, two fancy Nancy in Milan, as well as our slow rising boom product Squished English.
Sales of action figures vehicles role play and electronic products in our boys category for the 2019 second quarter were $10.5 million down 50% compared to 21.2 million last year positive contributions from God Cilla, Harry Potter, Nintendo and TP Blaster sheet storm.
Were more than offset by declines in Incredibles two.
Sales of seasonal products, including license to ride ons ball pits kids' furniture, Maui outdoor activity products and more boards were 17 million in the 2019 second quarter up 9% from 15.6 million in 2018.
Despite unfavorable weather conditions in many markets, we saw strong growth in kids outdoor furniture ball pits intense and our Flywheels brand, which were partially offset by a decline in more forward sales.
Sales in our Halloween category, which is also one of our business segments increased 49% to 36.4 million in the second quarter of 2019 compared to 24.4 million in 2018.
As we said previously we showed a year over year decline in disguise sales in the first quarter due in part to a shift in the timing of orders and shipments.
For the first six months disguise sales were up 36% year over year ahead of the third quarter, which is typically the quarter with the highest sales of disguise.
The sales increase in the second quarter was led by toy story four in various other products.
Sales of baby dolls accessories figures plush and games in our preschool and activity category were essentially flat year over year at approximately 1 million in the second quarter.
Declines in our pull my finger game in Daniel Tiger's neighborhood were offset by strong initial sales of jacana source.
Looking at sales by business segment Us and Canada net sales for the second quarter of 2019 were 48.5 million.
Down, 18% compared to $59.4 million last year, primarily due to a decline in incredibles two products.
International sales for the 2019 second quarter.
Were 10.3 million down 53% compared to 22 million in 2018, driven by declines in Incredibles, two and squished Polish products.
And we already mentioned Halloween sales in the category breakdown earlier.
Net cash used in operating activities was $7 million for the second quarter of 2019 compared to net cash provided by operating activities of $2.7 million in the second quarter of 2018 due to changes in working capital.
For the first six months of 2019 and 2018 net cash used in operations was roughly the same at just under 9 million.
Free cash flow was negative $9.7 million in the 2019 second quarter compared to negative $1.3 million in the 2018 second quarter.
As of June Thirtyth, 2019, our cash and cash equivalents.
<unk> million as of June Thirtyth, 2018, and $47.4 million last quarter. The decline in cash from last quarter was primarily due to operating cash outflows and capital expenditures.
Accounts receivable as of June 32019 was $85.1 million down from 100.3 million as of June 32018.
Dsos improved in the 2019 second quarter to 81 days from 86 days reported in the 2018 second quarter.
Inventory as of June Thirtyth, 2019 was $53.5 million versus $62.2 million as of June 32018.
Dsos eyes in the 2019 second quarter were 80 days compared with 93 days in the 2018 second quarter.
As of June Thirtyth, the company's debt includes principal amounts of $113 million for convertible notes due June 2020 $29.5 million for previously exchanged convertible notes due November 2020, and $19.8 million in a term loan with great American.
When taking into account the recapitalization transaction.
All of the above debt is long term.
With the exception of approximately 2 million of the convertible notes due June 2020.
And is classified as long term on the balance sheet at June Thirtyth 2019.
Capital expenditures during the second quarter of 2019 were $2.7 million.
Compared to $3.9 million in the second quarter of 2018.
The diluted loss per share calculation for the second quarter is based on a weighted average 23.6 million common shares outstanding compared to $23.1 million for the second quarter of 2018.
The 2019 second quarter diluted share count excludes 23.4 million shares underlying our outstanding convertible senior notes at June Thirtyth 2019.
Before I pass the call back over to Steve and I would like to discuss our expectations for the remainder of 2019.
We are off to a great start to the 2019 second half and the third quarter.
We continue to estimate that our net sales in 2019 will increase year over year by approximately 5% or two $596 million give or take a few percentage points.
While our 2019 topline expectations remain unchanged and our 2019 second quarter adjusted EBITDA met our previous expectations. We believe that some of the gross margin pressures we experienced in the first half of the year may persist into the second half of 2019.
As a result, we believe that our adjusted EBITDA. This year, we will show significant improvement over last year, but our prior estimate of adjusted EBITDA for 2019 year of roughly $22 million would be the top end of a range of possible outcomes.
Adjusted EBITDA excludes significant nonrecurring and noncash items, including stock based compensation expense acquisition related costs and restructuring charges, many of which pertain to future events.
And are not currently estimable with a reasonable degree of accuracy.
Therefore, no reconciliation to GAAP amounts can be provided.
And with that I will turn the call back over to Steven.
Thank you Brian .
Before we get to Q, a day I will share some thoughts on the properties and trends, we think will be important in the second half of 2019.
As you all know for the past 18 months and addition to dealing with the liquidation of toys R us and its effect on our sales our financial condition. We have also been working extremely hard to consummate a strategic transaction with Beijing or other interested parties as well as a recapitalization transaction with our bondholders and banking partners.
This effort has been disruptive and distracting and we are pleased that we have an agreement in place.
And can now focus on our efforts solely on running the business.
Near term, we continue to be optimistic about the second half of 2019 for a number of reasons.
2019 continues to be a great year for entertainment content and the second half we have such a strong licenses.
We expect frozen too.
Toy story, four Nintendo pulp coupon Lion, King gigantic source and others to drive our holiday sales.
We continue to expand our owned IP consistent with our strategic goal or having our own IP constitute a higher portion of our total sales.
The X. power Dozer, TP Blaster sheets storm slap Ninja and the chocolate maker to name a few our retailer favorites.
Our disguise business has been very strong it typically sees the best sales and third quarter and is looking solid at the year over year growth in 2019.
Same law, which we haven't spoken much about lately as showing strong growth while the base is still very small we continue to be optimistic about the brand's potential.
Our seasonal business has rebounded nicely and has several segments that are either new or are showing good growth versus last year, including plate tense.
From Disney the Thirtyth anniversary release of the little Mermaid should lead to a renewed interest in this line.
Frozen too will be out in time for Thanksgiving, we have a broad array of products shipping ahead of the box office release, including special feature dolls dress up and role play.
We expect the frozen brand to be a significant factor in both the second half of 2019 and well into 2020.
Video game related toys continue to sell well for us and other companies.
In addition to Nintendo which continues to perform well, we have Mega man and Sonic the Hedgehog benefiting from new entertainment content.
More forward are excited activity system continues to see distribution broaden. The addition of an electric motor has been pushed into next year, which should allow the system to grow into 2020.
In conclusion, while we are focused on improving our disappointing first half gross margins. Our first half sales came in as we expected and we believe we are well positioned for sales growth and gross margin improvement in the second half. This coupled with our continued fiscal discipline puts us in a good position to improve our profitability and 2019.
The recapitalization transaction is that the dawn of a new day for Jacks, we're invigorated and look forward to taking advantage of our many opportunities.
With that we will now take questions operator.
Thank you we will now begin the question and answer session. If you have a question press Star then one on your Touchtone phone if you wish to be removed from the queue. Please press the pound sign or the hash key.
If you are using a speakerphone you may need to pick up the handset first before pressing the numbers. Once again, if you have a question press Star then one on your Touchtone phone.
Okay.
And our first question is from Steph Wissink from Jefferies.
Thanks, Good morning, everyone and Stephen I wanted to ask your question about the Sky is this has been a perennial outperformer and really strong in the first half Im curious if you can talk about the evolution of that platform into more of a year round business versus just a purely Halloween business.
Sure Good morning Steph.
Firstly I think as we expressed before disguised as seen a very strong growth year, and we have quite a few new properties compared to last year and Halloween is actually seeing growth year over year as an industry. So since that we have a tremendous amount of new properties.
Which allowed us to ship more in Q2 than in the past and has allowed us to build a stronger Q3 due to the growth of disguise.
Okay and are you seeing retailers, taking that merchandise earlier and placing it on the floors earlier or is that a build up in advance of what they expect to be a stronger Halloween.
It's actually simply just a build up for Halloween is for them to actually order remember were strong fob business. So they need to order on the fob basis earlier than on a domestic AD since there is.
Quite a large percentage of growth year over year, we shipped more in Q2 than our our normal past years and going forward into Q3, it's an extremely strong Q3 of this four disguise.
Okay. So we should expect that.
That segment to contribute to growth in Q3 as well, it's not a pull forward into Q2.
Correct and also we have a newer licenses that are internationally base or shipping more disguise international than we have in the past year.
Yes for the full year, we are expecting good growth for for disguise.
Year over year.
Hi, good growth you mean over indexing. Your your total company should we think about it that way kind of above or below company average.
Yes.
Okay.
And then Stephen another one for you a lot of exciting things coming through the pipeline for the second half, but I'm wondering if we can talk a little bit more about frozen to just given that that was such a meaningful driver for you a few years ago.
How should we think about the scale of that property. This year, both domestically, but also internationally. How are you looking at the international market opportunity this time around.
Well, we have worldwide rights are frozen too and we actually since we had it in the past in 2013, you've actually figured out what SK use performed better from the experience we had in the past so expectations are extremely strong worldwide. In addition, Disney Princess sell throughs for the first half of the year, our extremely strong which is giving retailers even additional strength for more placement of frozen too and the build up both in both brick and mortar and as well as online retailers has continued to add to it has increased over the past few months placement and expectations and excitement is extremely strong.
That's encouraging great to hear and Brent last one for you is just on the gross margin is going to make sure. We understand the drag that came from the close out.
I know you expect some of that growth margin data persist then would you be willing to quantify of that.
And declined from 26 to 18 and a half what portion of that was Closeouts and we can at least model a phasing out of that portion of the drag.
Yet modeling out or quantify.
I would say that it was smaller than the overall I would say mix had a bigger contribution than the Closeouts closeouts was still.
I would just in terms of quantification qualitatively or it would have been meaningful.
So really the big driver was that for example, you had high volume products like Incredibles, two and Squish last year that were sold at high margins. This year.
We sold them at lower volume and unfortunately, the the margins were much lower than than we expected for those two lines.
So I had.
Say the largest contributor was was mix.
Flash pricing and then we did have closeout sales.
As well.
The other impact you on margins was.
Because of the mix issue so as more licensed products versus owned IP that negatively impacted our margins as well just a higher royalty percentages as a percentage of revenue. So as we mentioned on the call. We do believe that.
That the pressures may persist into the second half, but but we are off to a good start in the third quarter and we do expect margins to be more normal levels in the in the third quarter. So you can look at at last year, we came in at.
But even with that that disappointing gross margin in Q2, we were able to hold cost down.
And achieve higher than expected sales that brought our adjusted EBITDA number in line with our previous expectations. So that was certainly a positive.
Okay. That's great and then just two housekeeping if I could from a modeling perspective.
The interest expense for the back half and then on a full year basis, and then with the new capitalization structure, what's going to be the new share count on a fully diluted basis.
So the the common stock that we issued is is roughly five 5.8 million 5.9 million. So it's about 20%.
Of the.
Our outstanding shares so that will be that will be added to the account.
Where the stock price is right now it doesn't look like we'll be any impact from the.
From the outstanding convertible notes.
And then from an interest perspective, you can see the details when we file the.
The overview of the of the 8-K later today.
That will have all the interest rates in there, but you're going to see probably an annualized interest expense actually that thats, just a cash interest expense of about.
3 million ish, maybe three three and a half million something in that in that range.
But those will be some gold there will be some amortization costs as well for that the financing cost, but all of that is noncash.
Very helpful. Thank you guys.
Yes, Thank you Steph thanks.
Once again, if you do have a question press Star then one on your Touchtone phone.
And our next question is from Gerrick Johnson from BMO capital markets.
All right. Thank you.
So you mentioned changes in sourcing or potential changes in sourcing to get around Tara.
Easier difficult is that to do and how quickly can that be done.
Good morning, Gary.
How quickly it can get done to move to move a material amount of the manufacturing.
Out of China would take.
A couple of years, but we have moved and have been traveling to Vietnam and other areas with regards to cut and sew and also injection molding. In addition to Mexico. So we have different areas that we've been working with and preparing for but we also have been hit with the terrorists before and our kids only furniture business underpinned the previous.
Call it tear fours and what we ended up doing is.
Increasing prices to various retailers, which have accepted the increase prices, which actually increase the retail price slightly but at the same time, what we've seen in our.
Our outdoor furniture indoor furniture, the sell throughs havent changed.
A bit they've actually states extremely strong so.
For the most part we've seen an increase that we've done and retailers at the same time.
And going through the different areas of businesses, we will be moving some of our manufacturing to other areas, but generally majority of it will still be in China for the next at least two years and we have been speaking very closely with our retail partners worldwide of where price increases.
We will be achieved in addition, we have also done that doing continuously cost reductions where possible.
On areas of business to allow a lower price.
For us to sell our continue keep our pricing and the same but just lowering the mount of spray ops or amount of stitching in different areas of our businesses.
Okay, great and.
You guys are traditionally in Fob shop, how is that mix of fob versus domestic changing this year and how do you see that playing out say over the next couple of years.
We have been because we've been consistent year over year, it's anywhere from 56%, a fob, 43% domestic or 60, 40, and thats been our split for years.
It seems based off even with the tariffs that it will stay very similar to what we've had in the past we prefer to be like at Fob business, what it's less use of capital.
We get to benefit from it as well as well as our retailers worldwide as they get to add their own loads to it. So our goal would be to increase it as time goes on.
Okay, and lastly are you able to comment on 2020 projections you know last quarter. We saw your projection for $640 million in sales $46 million and adjusted EBITDA can you comment on that.
Not at this time, it's too early based on the holiday season coming up but we feel very strong with this year going forward as well as we have a strong lineup for 2020 and if you remember in the past with frozen the second year was actually the highest and strongest share.
We're expecting that the same.
You're expecting that to be the theme.
Even as we weren't expecting that to be the same.
A very similar growth as what we had in the past okay. Okay. Well last time was a complete surprise. This time everyone's prepared for it so I would assume that we'd be a little bit more shifted towards this year would that be a correct assumption.
No.
It's a stronger year because people have had experience it experienced in the past and the way Disney is promoting it and the expectations of the movie we're definitely because it was an unknown before we definitely have a stronger first part, but the second part remember its only on air for five weeks prior to Christmas and the second half.
In 2020, we will have a full year of of sales. In addition, we'll have the skies that will partake very strong it because the skies as a very minor.
Forecast for frozen Twoq is there is no real awareness of it so the lines that we have going into next year like our interactive doll, which was our number one performer in the past ship. The following year. So we have a lot of new apps can use for spring and going into fall in the retailers' expectations are still strong for 2020, okay. Great. Thank you Stephen.
Okay.
And we have no further questions at this time.
Well, please ladies and gentlemen, thank you for the call today, we appreciate the time and apologize at the earnings announcement was done at a later date, but we're very happy with the closing of our financing and looking forward to this coming year and the years to come. Thank you very much.
Thank you, ladies and gentlemen that concludes today's call. Thank you for participating and you may now disconnect.