JAKKS Pacific, Inc. (NASDAQ:JAKK) Q2 2022 Earnings Conference Call July 27, 2022 5:00 PM ET
Company Participants
John Kimble – Executive Vice President & Chief Financial Officer
Stephen Berman – Chairman & Chief Executive Officer
Conference Call Participants
Stephanie Wissink – Jefferies
Operator
Good afternoon everyone and welcome to the JAKKS Pacific Second Quarter of 2022 Earnings Conference Call with management, who will review financial results for the quarter ended June 30, 2022. JAKKS issued its earnings press release earlier today. The earnings release and presentation slides for today’s call are available on the company’s website in the Investors 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, then Mr. Kimble will provide detailed comments regarding JAKKS Pacific’s financial and operational results. Mr. Berman will then return with additional comments and some closing remarks prior to opening of the call for 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, margins and/or adjusted EBITDA in 2022, as well as any other forward-looking statements concerning 2022 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 certain risks and uncertainties which could cause the 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 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 and adjusted earnings per share. Unless stated otherwise, the most directly comparable GAAP financial metric has been reconciled to the associated non-GAAP financial measures within the company’s earnings press release issued today or previously. As a reminder, this conference call is being recorded.
With that, I would now like to turn the call over to Stephen Berman. Please go ahead.
Stephen Berman
Good afternoon and thank you for joining us as we discuss our most recent quarter and what we see coming for the balance of the year and some thoughts about 2023 as well.
It’s not often you get to report quarterly year-over-year sales growth of 96%, so you can hopefully forgive our enthusiasm around our latest results. With $220 million in net sales in Q2, we were finishing the first half of the year with $341 million shipped year-to-date. That is the highest year-to-date shipped total through June in the history of the company dating back to 1995. I have been strongly passionate all throughout the pandemic about the team working together across offices and collaborating to deliver amazing results. And this past quarter is just another example of what I’ve been talking about but taken to a new level.
As we have said before, years ago, we implemented a new philosophy and approach to running our company. Within each of our divisions, we seek out a mix of strong and opportunistic licenses to build stable, growth-orientated categories. By focusing on methodically building and refreshing our product lines annually, we create the brick-by-brick foundation of our evergreen business, delivering the singles and doubles that generate our results year after year. Within those categories, we further develop items for each class of trade in which we see opportunities. In mass for customers like Target, Walmart, Amazon, Tesco, Carrefour and more for specialty channel customers such as Smith’s, Kohl’s, GameStop, Barnes & Noble; and for value drug and grocery customers like Kroger, dollar stores, Walgreens, CVS, Ross, Big Rock, Five Below as well as many others.
In addition, with all these class of trade retailers, we look to be creative at retail with our out-of-aisle product placements such as check lanes, pallet programs, 2×2 displays, clip strips and more. By redeveloping items annually, we ensure to the best of our ability, margin expansion and we always look for new opportunities in product innovation and licenses.
With that foundation, there will sometimes be unique opportunities to exceed our expectations which we are seeing this year with many areas of the company performing extremely well and contributing to tremendous performance against our plan. To name a few, toys developed for the Disney animated film Encanto and the live action and CGI film, Sonic The Hedgehog 2 are having exceptional years. Beyond those 2, we are seeing amazing, continued expansion of the evergreen Nintendo IP, very strong demand for Disney Princess products as well as our Perfectly Cute Baby line. And for Halloween, we have a plethora of new licenses and newly developed really creative product costumes and related accessories.
Lastly, with the international initiatives we have embarked on over the years on opening up offices to sell direct to retail in more markets, we are seeing tremendous growth, details of which I will highlight shortly.
As we discussed last quarter, we have been seeing exceptional demand for our current product lineup. We’ve applied tremendous focus to enabling our FOB customers to secure product with enough lead time to avoid the supply chain bottlenecks that negatively impacted everyone in the second half of last year. And at the same time, we’ve done everything we could to take advantage of off-peak shipping windows to secure the manufacturing and inventories we plan to sell domestically in the second half of this year.
Our quarter end inventory level is $124 million, of which $36 million is in transit to our warehouses. Although this is a high level for Q2, it is reflective of our planning to mitigate potential exposure to our higher second half spot container rates and extended transit times. Given our strong sell-in and sell-throughs to date and reviewing the insights into retail demand for the second half of the year, we are quickly pivoting our attention to ensuring that we exit the year with tight inventories at retail and within our own warehouse infrastructure worldwide. There has been a lot of discussion around the outlook for the economy, retail inventories and the mindset and spending power of the average consumer. There are several areas of business we’ve been focusing on. It is well known that the toy industry often shows higher resilience than other consumer areas when spending power is challenged.
Current data also suggests that accumulated household savings are at higher levels than they were when entering past slowdowns as the employment levels remain robust. Although it’s true that there has been a lot of spending in the toy space over the past couple of years, it is also true that a 3-year-old is now a couple of years older too. To our way of thinking, both the younger children entering the toy market as well as the older children entering different phases of development, need new and different toys to engage with. And when you layer in basic play and play patterns that are healthy for children and the surge of new content reaching households at theaters and via streaming, we believe it’s still a very good time in the toy kids consumer business.
At JAKKS, we’ve been extremely focused over the years to try to ensure a large portion of our product SKU retail price points are lower than $30. We are proud that over half of our revenue comes from items that traditionally retail for $25 or less. And when you move that threshold to under $50, you’re closing in on 90% of our sales. That reality of affordable price points in combination with the current popularity of our classic and topical brands leaves us mindful of the current market conditions, yet optimistic that we will finish the year with the right kind of momentum heading into 2023.
At retail, broadly speaking, our largest segments of business are performing best and our sense of the market is our velocity is as good or better than any other company in our space. Of course, we did see some point of sales that slowed down compared with some of the strong numbers we saw earlier in the year but we are certainly growing faster than the market in total.
Our Q2 Toys/Consumer Products segment grew 83% with North America up 92% and international up 38%. All of our international regions and nearly all of our top 10 markets were up double digits during the quarter. We are also on track for a tremendous year in our costume business. Q2 represented the biggest Q2 ever for the business since JAKKS acquired Disguise back in 2008. Last year, some customers were late setting planograms for the Halloween season. This year, we are stretched the industry standard timelines to work with our customers and factories to reduce that likelihood as much as we could.
And our international expansion led to most markets shipping a multiple of the level shipped last year. In total, we shipped $72 million in the quarter, more than double what we shipped in the quarter last year. Container cost continued to be a drag on the product margins compared to prior years. We have been relatively pleased so far not seen a repeat of the costs and delays we were dealing with in the second half of 2021.
As mentioned, we were doing everything we could and can to keep these costs in check, inclusive of trying different routings and carriers to import the product. So far, so good but of course, the next 6 months will be critical to how our year finishes. Some of our outdoor seasonal items continue to struggle from a margin perspective, given the continued challenges of tariffs and the container cost impact on the larger cube items. This remains one of the toughest parts of our business this year. There is no magical solution but we know this is a solid segment for us and we continue to explore all angles to get this business on a better trajectory.
Shipping in this business was down 25% in the quarter year-over-year. We are keeping shelf space for these categories of business but shipping less than normal due to the margin impact. Retailers are also negative about big items in general given their inventory issues outside of the toy and their general need for space for other goods and categories of goods.
As I said in April, with each passing quarter, our balance sheet gets stronger. Given our recent performance and outlook for the next 6 to 12 months, before the second quarter close, we decided to make an optional $10 million pay down towards our long-term debt. This will save us meaningful cash interest expense in the second half and gives you some sense of how we’re thinking about our performance and liquidity between now and the end of the year.
I will now pass the call over to John for some further discussions around our financials, after which, I will come back with some more thoughts about the balance of the year and how we are starting to think about 2023.
John?
John Kimble
Thank you, Stephen and hi, everybody. Sticking with the idea from last quarter, I will skip reading through the various financial details included in our release today, even if they are pretty good. But I’ll try to touch upon what are hopefully some more insightful thoughts and observations as we mark the halfway point in the fiscal calendar. Even if there’s not a lot to add, I’m not going to pass any opportunity to say something about sales. Singles and doubles generally isn’t supposed to meet nearly doubling last year’s sales number in a quarter but we’ll take it.
What I think you see in these results are execution against what we’ve been talking about the last couple of quarters, a longer and more expensive supply chain for us translates to or wanting to do even more FOB business and to reaffirm our focus on our biggest and most popular brands and segments. It also increases the urgency to be thoughtful about inventory purchasing and to similarly prioritize our best-selling items. We’ve also been talking about great consumer demand for our product lines and customer enthusiasm for our current lineup as everyone gets ready for the all-important second half. Add all those factors together and layer in the great momentum of our costume business, that leads you to types of sales numbers we’ve seen in the first half of the year when supported by the team’s relentless execution.
As we’ve also said before, we really do manage the business with a full year view, given our seasonality, so although we love being able to deliver quarterly results like these, we really are focused on finishing strong on 12/31 and then starting all over again.
I will point out as a reminder that we had about $30 million worth of Q3 sales shipped out of the quarter into Q4 last year due to customer pickup delays in Asia contributing to a much higher Q4 than we would have expected. Those dynamics are always in play given current events. But beyond that, there’s not a lot more to be said about seasonality than what we’ve already covered. The sales performance to date has been exceptional, along with the timing of when it’s happened, given that increased freight costs have eroded some of the progress we were making in gross margins in 2020 and early 2021.
That said, we’re pleased to only be down less than 80 basis points in gross margin percentage compared to last year. Our product margins are holding up well, thanks to a combination of designing for improved margins and pricing. Royalty expense is tracking a bit higher as some older agreements charge a higher rate for FOB sales versus domestic sales and there’s a product mix element in play as well.
As Stephen pointed out, the narrative on ocean freight in Q2 was along the lines of, so far, so good, still unfavorable versus prior year but it certainly could have been worse. Where this topic ends up 6 months from now, we’ll have a meaningful impact on our full year results as well as our ability to drive bottom line margin percentage improvements in 2023. Great sales volume clearly is especially good when it leverages the fixed elements of our cost base. Operating margin for the quarter was positive and our trailing 12-month operating margin increased to 8.2%.
As Stephen also mentioned, we took the opportunity to make a fee-free pay down of our long-term debt at the end of Q2. With LIBOR increasing, this represents at least $400,000 in cash interest avoidance between now and the end of the calendar year based upon projected rates.
Interest expense in the quarter was $2.3 million, down from $4.4 million in the same quarter last year. And the marking to market of our preferred stock liability resulted in a noncash gain of $6 million primarily due to rising interest rates. We backed that gain out of our non-GAAP calculations of adjusted EBITDA and adjusted EPS. In aggregate, our adjusted EBITDA for the quarter was $27.1 million versus $5 million last year. Our trailing 12-month adjusted EBITDA is now $75.7 million or 9.9% of net sales which was $49.1 million and 8.7% of net sales at this time in 2021.
Moving on to the balance sheet. You’ll note with the surge in sales and our going forward of inventory, our midyear noncash working capital is very high compared to historical loans. We’ve generally been able to self-fund that and would expect that number to work itself down a bit by the end of the year or early next in part driven by timing and levels of 2023 shipments. Our cash balance at the end of the quarter was $62.3 million. Our total debt was $84.9 million and we had no draw on our credit line. We like where that puts us but we still have the bigger half of the year ahead of us which isn’t lost on everyone here. So plenty of work left to do.
Finally, some of you noted that we filed an S-3, more commonly referred to as a shelf registration with the SEC earlier in the month. Broadly speaking, we’ve intended for quite some time to get a shelf in place in case the situation arises in the next couple of years, where management and the Board feel offering some more shares would be the right thing to do. We consider having this flexibility to act quickly to seize upon opportunistic scenarios, another positive for the company. So we are happy to get around to getting it filed.
And with that, I will now hand the call back over to Stephen for some additional remarks.
Stephen Berman
Thank you, John. I want to call out some second half retail highlights and focused areas in addition to some very early thoughts about 2023.
Leading off clearly, a remarkable quarter in our costumes business and congratulations to everyone who works under the Sky’s business. Building on last Halloween success and sell-through, we saw most customers this year wanting to both go a bit deeper into the Sky zone with a couple in particular making bigger bets. We consistently at Sky’s have a robust market-leading business here with an ever-expanding lineup. A return of confidence in the box office is creating additional demand as our 2022 offering is anchored by theatrical releases like Jurassic World, Minions, Disney Pixar’s Lightyear in addition to Disney’s Encanto and Sonic 2.
I’m also happy to say that our first quarter of shipping the Disney business in Europe is going extremely well and we are having a lot of great discussions with new customers and distributors as we expand our network there.
Moving to our Doll and Role-Play business, as a result of ongoing year-over-year growth we have been securing extended shelf’s presence and incremental distribution for the Disney Princess franchises, generating meaningful incremental volume. That placement has been well earned and is delivering for our customers with solid sell-throughs. Disney’s Ultimate Princess Celebration is continuing and providing promotional support and attention to this important evergreen business.
The Disney Style Collection line which continues to bring new items to market continues to perform well as early releases in the segment have. Later this fall, we’re building on our popular 15-inch large doll range with a talking and singing feature doll segment. Our launch of assortment includes Ariel, Moana and Tiana, among others, from the Disney Princess franchise and from the Frozen franchise versions of Elsa from Frozen 1 and Frozen 2. This new segment will be supported by a 360-degree marketing initiatives, driving sales this upcoming holiday season.
Although nearly 3 years removed from our most recent film, Elsa remains one of the most popular Disney characters. And while as anticipated, Frozen sales are down versus last year, they have been selling above planned expectations. Finally, I also wanted to mention our promoted Playdate 32-inch doll segment will include our new version of our popular Rapunzel along with a new, really innovative, really fun, many moods Maximus.
Outside of Disney Princess and Frozen, we continue to be excited about our support, the Disney ILY 4EVER brand with new dolls launching in October, inspired by Bell, Rapunzel and Minnie Mouse. The line launch at Smiths in the U.K. earlier this month and is off to a solid start. As we mentioned last quarter, international expansion is happening with this business across a number of markets.
When it comes to Disney’s Encanto, we have been scrambling since January to keep up with demand and make sure that this will be a magical holiday season when it comes to Encanto toys. The Magical Madrigal House has been the hot hard-to-find toy and we’re on track to ship nearly 0.5 million units. Our largest customers are planning meaningful out-of-aisle real estate in Q3 and Q4 as much anticipated Encanto inventory makes its way to retail shelves.
Supporting Encanto, last week, Disney kicked off a 32 city tour of a one-of-a-kind concert event featuring the entire length film and an on-stage band celebrating all the record-breaking hit songs from the beloved soundtrack. The tour runs through the end of August, so look forward in a city near you. And the teams are also working on several new Disney initiatives for 2023 that we will look forward to telling you about in the future quarters to come.
Our Perfectly Cute line of baby doll, toys and accessories have continued to perform really well to date. And looking into the second half of the year, we see momentum continuing.
In terms of box office and toy sales. For Sonic The Hedgehog 2 movie and product line, we have exceeded our internal original forecast this year. A new wave of 4-inch figures and Sonic Speed RC will drive sales through the holidays for the movie line and more new items for the core Sonic line are coming this fall.
The Egg Mobile Battle play set is a feature set in the 2.5-inch figure world, allowing fans to recreate the Epic Boss Fight matchups of Sonic versus Dr. Eggman. And to customize the Egg Mobile into 5 different looking vehicles. You can also count down to the holidays with the newly unveiled Sonic The Hedgehog Advent calendar with 4 exclusive holiday 2.5-inch figures and a total of 24 figures and accessories. It’s a perfect way to kick off the holidays for every Sonic fan.
And the items that I might personally even most excited about or at least in my top 3, we just announced at San Diego Comic-Con last weekend. It’s a new entry to our Nintendo Super Mario product line. We brought together the expertise from our Moose Mountain Ride-on business to the world of Super Mario, creating our Mario Kart 24-volt Ride-on Racer, a child-sized power ride on version of iconic Super Mario Kart Racer.
With 24 volts of power, it has 3 exciting forward driving speeds setting to go up to 8 miles per hour as well as reverse. It features authentic sounds from the Mario Kart video games and an adjustable seat that grows with the driver. The ratio should be on shelf in Q4 of this year.
Now, let me talk a bit more about 2023. One of the exciting things about this industry is despite the fact that we normally have a long planning cycle, with our teams currently deep in refining our fall 2023 introductions with new licenses and rights in the works, in addition to securing new rights for 2024 opportunities at the same time, we always have to stay in the moment, track and react to what is currently working at retail.
As much as on January 1, this year, we felt we had a strong lineup for calendar year 2022, none of us would have predicted with high confidence that would all come together to the levels of success we are now looking to achieve for the full year. The core performance of our evergreen categories and product lines continues to be supported by 4 defining elements that I know we discussed last year but I wanted to take a moment to repeat.
First, innovation within categories to maintain freshness and relevance; second, in addition to being relevant brands, new and exciting IP and licensed store relationships; third, geographic expansion to reach a rapidly expanded global market; and four, migration into adjacent categories to fulfill the needs of our consumers and our retail buyers. Those guideposts are both contributing to our results this year, while we also benefit from the additional pop of some breakout successes and creating the momentum, we have heading into the second half of the year and beyond. But looking beyond the top line, we remain very focused on continuing to improve margins and bottom line profitability as we have consistently done since our 2019 recapitalization.
Our plans anticipate improved supply chain economics and continued thoughtful overhead cost management to cushion softening and some of the exceptional success areas we’re seeing this year. And the windfalls from this year and any potential reductions in working capital can be reinvested in improving our balance sheet, reducing our borrowing costs and are enabling thoughtful additive acquisitions consistent to what we have done and been saying for a long time.
In summary, we remain extremely excited about where we are and the outlook for what’s ahead. We have worked extremely hard to seize the opportunities which have presented themselves in 2022 and we remain laser-focused on finishing the year strong while we uncover and develop new businesses for the years ahead.
With that, we will now take questions. Thank you.
Question-and-Answer Session
Operator
[Operator Instructions] And our first question comes from the line of Stephanie Wissink here from Jefferies.
Stephanie Wissink
Stephen, the first question for you is just to help us compartmentalize the drivers of the business. Can you separate out the growth from Encanto and Sonic from the underlying evergreen categories and product lines? Just to help us think about the underlying stability in the business.
Stephen Berman
Sure. Thank you, Steph. So if we take Encanto, Encanto on its own had a successful launch in last year in fall and also continues this year from first quarter onward. But Encanto has also, I believe, helped the enhancement of the overall Princess business as Princess, the Doll Role Play and Dress Up category, inclusive of Encanto has grown tremendously, with the overall just general Princess properties as well as our Style Collection. And the same goes for the Sonic and Sonic to the movie. That has also increased more dramatically based off the content that came out. And with Nintendo and the gaming licenses, the hot gaming license are performing extremely well and continue and Encanto has been growing double-digit for years. So those both enhanced each of the boy’s category.
And then we’ve had a tremendous year, almost overall in the majority of our evergreen stable businesses. As I mentioned earlier, Halloween, we more than doubled — or doubled shipments in the second quarter and we have a as I mentioned, a pressure of new licenses as well as continuous licenses that have helped the growth in addition to building international that has actually helped drive growth and we’re just starting this year. But overall, excluding our table and chairs, there’s been some real market drivers but the basic business and the business that we’ve mentioned earlier that over 50% is under $24 has really helped during this time of unique periods in the economy.
Stephanie Wissink
Okay. That’s helpful. And John, one for you. Just thinking through the full year and kind of as Stephen has mentioned some things about 2023, cushioning the softening from strong trends in ’22. How much do you want us to pass through of the second quarter beat to the year? If you could just give us some sense of — how much of this is timing related? How much is momentum related? And then how do you want us to model into the back half to give you the best chance to kind of outperform as you go through the balance of the year?
John Kimble
Thanks. I think most of the year, we’ve been talking about how we see the front half of the year would be much bigger for us on a percentage basis than it has been in recent years. So I don’t know that I have a real clear sense to steer on that front. It’s certainly the case that with some of the really hot breakout properties that those are performing exceptionally well on a year-to-year basis. The comment I made about kind of shipping early and often in so many words, certainly kind of holds true. But at the same time, we still have plenty of shipping left to do this year.
Stephen Berman
Steph, if I can add one thing to John’s comments. The goal for Jack, so what we have been doing is focusing on is bringing more in early and making sure and ensuring that our inventory levels both at retail, worldwide and our in-transit and distribution centers worldwide have a lesser amount of inventory going into ’23 and we’ve been managing that at the start of this year. So it’s something that we’re focusing on. So even if we could have a tremendous year which we believe we’re having a tremendous year and we’ll continue. We will be very cognizant of making sure that we build on this year for 2023 with the appropriate growth strategies and enhancement of margin and profitability.
Stephanie Wissink
Okay. Just final clarification. So I think you had given us some direction on the year prior to this quarter. Has the full year changed for you in terms of your expectation for the level of growth and it’s just the timing? Or do you anticipate that some of the Q2 momentum continues and your full year outlook now is higher than what it was when we spoke last coming off of Q1?
John Kimble
Yes, I think it’s fair to say that our expectation for the full year is higher now than what we thought it was 3 or 4 months ago.
Operator
This does conclude the question-and-answer session of today’s program. I’d like to hand the program back to Stephen Berman for any further remarks.
Stephen Berman
Appreciate everyone on the call. We have a tremendous amount of follow-up calls after this. So thank you very much and we’re excited to have our upcoming third quarter call in October. Thank you very much.
Operator
Thank you, ladies and gentlemen, for your participation in today’s conference. This does conclude the program. You may now disconnect. Good day.
Be the first to comment