JAKKS Pacific Inc (JAKK) 2009 Q3 法說會逐字稿

Good afternoon ladies and gentlemen, welcome to the JAKKS Pacific third quarter results teleconference. At this time, all the lines are in listen only mode. Later, we will conduct a question-and-answer session. Please note that this conference is being recorded. I would like to turn the call over to Ms. Genna Rosenberg. Ms. Rosenberg, you may begin.

Thank you, operator. Good afternoon, ladies and gentlemen. This is Genna Rosenberg. We apologize for the delay in getting this call started. Thank you for joining our teleconference with management of JAKKS Pacific today to review the results of our third quarter and first nine months ended of September 30, 2009. On the call today are Jack Friedman, Chairman and co-Chief Executive Officer of JAKKS Pacific, Stephen Berman, our President and co-CEO, Joel Bennett, Executive Vice President and CFO. Mr. Friedman will first provide an overview of the quarter and our operational results and then Mr. Bennett will provide detailed comments regarding our financial results. Mr. Friedman will then conclude the prepared portion of the call with highlights and current business trends prior to opening up the call for your one-on-one questions.

Before we begin, I would like to point out that any comments made about our future performance, events or circumstances including the estimates of sales and earnings per share for 2009 as well as any other forward-looking statements are subject to safe harbor protection under the federal security laws. These statements reflect our 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 our forward-looking statements. For details concerning these and other such risks and uncertainties, you should consult our most recent 10-K and 10-Q filings with the SEC as well as our Company's other reports subsequently filed with the SEC from time to time. And with that, I will turn the call over to Mr. Friedman.

Good afternoon, ladies and gentlemen. This is Jack Friedman. Thank you for joining us this afternoon. Today we announced our results for the third quarter and first nine months of 2009 for JAKKS Pacific. While this year has been extremely challenging on many levels, sales for the third quarter met our expectations. Last quarter, we announced we would be implementing a company-wide restructuring plan and comprehensive cost savings initiatives in light of lower than expected sales and we have been diligently working on this implementation process. We have been working closely with key management in every area of our business around the world to implement changes that confront these obstacles affecting our top and bottom lines and turn to our outlook for 2010 in a very positive direction.

On a nonGAAP basis third quarter 2009 net sales were $351.4 million compared with sales of $357.8 million for the third quarter of 2008. And for the first nine months of 2009, sales on a nonGAAP basis were $605 million compared with $634.1 million for the first nine months of 2008. These nonGAAP net sales figures exclude one-time charges related to the recall of one of our products. On a nonGAAP basis we had earnings for the third quarter of $35.9 million or $1.13 per share and net income on an nonGAAP basis of $24.3 million or $0.83 per share for the first nine months.

We began shipping many of our new items in the third quarter, including Halloween products from our disguise division and continue shipping reorders and spring orders in the fourth quarter. Our Halloween portfolio is doing quite well is items based on popular licenses including Transformers, model characters, Sesame Street and Toy Story leading the way, and we have many value driven toy items that have good placement at retail including a myriad of products based on Disney princess and fairies, our UFC action figures that are just hitting shelves and look extremely well so far. Girl Gourmet food play products, new Plug It & Play TV game products including our big buck hunter which has been a bit of an upswing surprise for us. But, as I mentioned, we are seeing under performance of several lines that have been strong contributors in the past, particularly Hannah Montana toys and both WWE and Pokeman action figures and accessories.

Given all that, we have been very focused analyzing every area of our business executing on our restructuring plan, shipping our fall line in to retail and shaping our portfolio for 2010. We previewed next year's lines to many of our customers at the JAKKS 2010 fall toy preview during held at our new Santa Monica show room during the past two weeks, a line which was very well received from our retail partners from every sales channel. Several new initiatives resonated as favorites based on our early reads including our robust Disney range, some new internally brand JAKKS brands, a number of key line extensions and other areas of our diverse portfolio. Our commitment to product coupled with our commitment to running a lean and profitable business along with our strong balance sheet, excellent relationships and a seasoned team should position us well for future growth.

In addition, we believe the cost savings initiatives we set in motion will help JAKKS improve profitability for the next year and beyond. This month we began consolidating offices in Hong Kong and New York where we had excess office space and overlapping operations from previously acquired businesses and also carried out headcount reductions company-wide. Our goal is to stream line processes, reduce costs and lower capital expenditures doing more with less for future enhanced profitability and growth.

We continue to anticipate sales over our core JAKKS products to be lower for this year and are navigating through these considerable challenges. While there is still uncertainty as how sales for JAKKS will be this holiday season, with a healthy contribution coming from our disguise Halloween costume division, at this point we still believe we are on track to achieve our revised guidance. For the 2009 fiscal year the Company is expecting GAAP net sales of approximately $810 with a net loss on a GAAP basis of $375.6 million or $13.54 per share. Wow, that doesn't found very good, and is expecting nonGAAP sales of approximately $810.7 million with a net income on a nonGAAP was of $30 million, or $1.01 per share.

Our financial position remains extremely strong with working capital of approximately $322.5 million, including cash and equivalents and marketable securities of $154 million as of September 30, 2009, enabling us to continue to execute on our acquisition strategy and internal product development without interruption. I would like at this point to turn the call over to Joel Bennett for a review of our financial performance for the third quarter and first nine months.

Thank you, Jack, and good afternoon, everyone. Net sales for the third quarter were $351.4 compared to $357.8 million reported in the third quarter of 2008. Net sales for the first nine months of 2009 were $604.9 million compared to $634.1 million for the first nine months of 2008. Net income for the third quarter of 2009 was $33.7 million or $1.06 per diluted share compared to net income of $54.1 million or $1.70 per diluted share reported in third quarter of 2008.

For the nine-month period we reported a net loss of $383.7 million or $14.11 per share compared to earnings in the first nine months of 2008 of $59.2 million or $1.88 per diluted share, the loss primarily related to the writeoff of good will and noncash basis in the second quarter in the amounts of $415 million. On a nonGAAP basis, 2009 net sales for the third quarter were $351.4 million and $605.5 million for the nine-month period compared to nonGAAP net sales of $357.8 and $634.1 million for the third quarter and nine months of 2008 respectively. On a nonGAAP basis, JAKKS reported net income for the third quarter of $35.9 million or $1.13 per diluted share compared to nonGAAP net income of $46.6 million or $1.47 diluted share in the third quarter 2008. NonGAAP net income for the first nine months of 2009 was $24.3 million or $0.83 per diluted share compared to nonGAAP net income of $53.4 million or $1.70 per diluted share for the first nine months of 2008.

2009 GAAP results including the following which were excluded from the nonGAAP results I just spoke of. Pretax noncash goodwill impairment charge of $407.1 million due to the sustained decline in the Company's market capitalization taken in the second 2nd quarter of 2009, pretax noncash impairment charge of $8.2 million related to underutilized trademarks also taken in the second quarter of 2009. Pretax charge of $33.2 million taken in the second quarter related to abandoned or underperforming licenses and $19.7 million noncash and $13.7 million -- I'm sorry, of the $33.2, $19.7 million is noncash, $13.7 is expected to be paid out to third parties through 2011.

A pretax charge to cost of goods of $23.3 million was taken in the second quarter of 2009 and $2.9 million in the third quarter of 2009 related to the impairment of inventory of which $17.4 million is noncash and $8.8 million is expected to be paid out to third parties during the remainder of 2009. Pretax noncash charge of $2.3 million related to the writeoff of obsolete tools and molds. Pretax charge of $1.3 million related to the recall of one of Company's products taken in the second quarter of 2009. And finally for 2009, pretax noncash charge of $23.5 million related to the reduction of the receivable from our video game joint venture with THQ as a result of the recent arbitration decision which reduced our preferred return payment rate from 10% to 6% to the joint ventures net sales of which $22.5 million was taken in the second quarter of 2009 and $1 million was taken in the third quarter of 2009. The good will impairment charge taken during the nine-month period does not affect the Company's liquidity and operations and does not change our ability to continue to generate positive future cash flows from these intangible assets.

Now for our sales by-product categories, worldwide sales of toy products which is basically everything other than craft activities and writing instruments, was $328 million for the third quarter of 2009 compared to $337.2 million for the third quarter of 2008. Traditional toy sales for the first nine months of 2009 were $551.1 million compared to $596.8 million for the first nine months of 2008. Sales in the quarter were driven by Halloween costumes, pretend play products, electronic toys and action figures. However, we did see year over year declines in some of these products based on WWE, Hannah Montana, Pokeman, Neopets and several others. Worldwide sales of craft activity and writing instruments amounted to $23.4 million in the third quarter of 2009 compared to $37.3 million in the comparable period in 2008. For the nine-month period we had sales of $45.8 million compared to $37.3 million for the comparable period in 2008. Sales of our Girl Gourmet line of activity items drove sales in this category this year.

Included in the numbers are international sales of $63.1 million for the third quarter and $106.1 million for the first nine months of 2009 down from $77.3 million and $133 million for the same period respectively for 2008. On a nonGAAP basis, gross margin for the third quarter of 2009 was 33.6% as compared to 36.1% in the third quarter of last year. Gross margin for the first nine months of 2009 was 34.1% as compared to 36% for the first nine months of last year. The 190 basis point decrease in gross margin is due primarily to the change in product mix which included more lower margin sales, closeouts and we also experienced lower than expected sales of our higher margin products.

SG&A in the third quarter of 2009 was $63.4 million or 17.8% of net sales as compared to $62.7 million or 17.5% of net sales in the same period last year. SG&A expenses for the first nine months of 2009 were $171.7 million or 28.4% of net sales as compared to $157.5 million or 24.8% of net sales for the first nine months of last year. This increase is due primarily to the addition of overhead related to our recent acquisitions and higher legal costs related to various litigation now not being reimbursed by the insurance company as well as product testing costs.

As Jack mentioned, we've begun executing on our restructuring plans and cost savings initiatives that we set in motion to improve profitability in the next year and beyond. These cost saving efforts are intended to reduce spending given the lower than expected sales forecast and lower gross margin. Going forward, our operations will be focused on fewer SKUs but basic everyday, every season products. Depreciation and amortization, excluding the disposal of obsolete tools and molds in the amount of $2.3 million was approximately $13.2 million in the third quarter and $24.2 million for the first nine months of 2009. This compares to $6.9 million and $18.9 million for the comparable periods in 2008.

Stock-based compensation for the third quarter was a credit of $700,000 and $2 million dollars for 2008 and $3.3 million for the first nine months of 2009 and $6 million for the comparable period in 2008. For the quarter, we posted a loss of $1.9 million from the video game joint venture with THQ as a result of increased legal fees and the final adjustment to our preferred return rate compared to profit of $700,000 for the comparable period last year. For the nine-month period we posted a loss of $21.9 million after the adjustment of the cumulative receivable of $23.5 million compared to profit of $4.5 million in 2008.

Operations provided cash in the third quarter of 2009 of approximately $35.9 million compared to using cash of $39 million in Q3 2008. Our financial position remains very strong. Accounts receivable at the end of third quarter were $251.6 million compared to $230 million at the end of the third quarter 2008. DSOs were 64 days compared to 58 days in the same period of 2008.

Inventory was $71.1 million at the end of quarter down from $110.8 million at the end of comparable 2008. The decrease is due to the selloff of close-out inventory after writedowns in the second quarter of 2009 as well as tighter inventory management. DSI has decreased to 33 days from 53 days at the end of third quarter of 2008. And finally capital expenditures for the quarter were $5.3 million and we expect CapEx to be approximately $18 million for the full year of 2009 down from $23 million in 2008. With that, I'll return the call back to Jack.

Thank you, Joel. We are approaching the most crucial shopping season of the year for the toy business and so far things are looking pretty good. We expect to benefit from some strategic value pricing initiatives as consumers are increasingly cost conscious. We are trending higher on items like our line of novelty toys and are looking for items -- have been looking to such of our low cost electronic products, Girl Gourmet and pretend play products to drive sales in the portfolio.

With the restructuring and cost saving initiatives we are implementing we expecting to see normal benefits by the end of this year. These cost savings efforts are intended to reduce spending given the lower than expected sales forecast across a number of product lines in the portfolio and lower gross margins overall and will include headcount reductions, a consolidation of office spaces and other efficiencies that will be implemented during the remainder of 2009. The annual savings are expected to be in the vicinity or upwards of $40 million on an ongoing basis. While there is no certainty about the level of sales for the holiday season, at this point we still believe that our previously announced guidance is achievable.

For the 2009 fiscal year, the Company is expecting GAAP net sales of approximately $810 million with a net loss on a GAAP basis of $378 million or $13.72 a share and is expecting nonGAAP net sales of approximately $810.7 million with net income on a nonGAAP basis of $30 million or $1.01 per diluted share. Despite the uncertainties related to the US recession, we remain committed to running a profitable JAKKS Pacific and are working hard to execute on a strategy on behalf of our shareholders for 2009 and beyond. With that, I will open the call to questions.

Thank you. We will now begin the question-and-answer session. (Operator Instructions). Our first question comes from Edward Woo of Wedbush Securities.

Yes, good quarter. I had a question. Was there any impact from foreign exchange?

No. Our FOB sales are done in US dollars and our international operations have not gotten to the point of any significant local currency sales.

This is Jack. For 2010 we are going to be doing a great deal more of direct selling through offices in the UK and we will have to get savvy in terms of exchange after this year.

I guess Joel has a lot of work cut out for him.

We all do.

Another question about the $40 million annual savings, do you ever disclose what the split out would be between maybe operating costs and product cost savings?

It doesn't reflect product cost.

No, it's primarily operating costs.

The product costs would come out in margin, Edward.

Okay. Thanks a lot.

You're welcome.

Our next question comes from Drew Crum of Stifel Nicolaus.

Good afternoon, everyone. I wonder if you could spend a minute on the revenue contributions from the acquisitions in the quarter or year to date if you have that available?

We'll come back to that.

Okay. Joel just a question on the crafts and activities segment. I know you guys have anniversaried Girl Gourmet and Spa Factory. If I heard you correctly, it looks like that segment was down about 37% year on year. Can you touch on that, what drove the decline?

We may have on the year to date we may have flip flopped the numbers. It should have been $45.8 million for 2009 compared to $37.3, so we were up about $8.5 million.

Okay. All right. And didn't see any restructuring charges in the quarter. Are you still anticipating $0.25 to $0.30 for 2009?

Yes. We're looking at when we take the charge when we actually exit the premises on the leases and so forth. The dollar range was about $12 million to $15 million. So since the people were notified, you know in the last couple of weeks, all of those charges will hit in Q4.

Okay. And one last question, your expectations on legal costs for the balance of the year?

We've been running in the $3 million to $5 million range historically and it's all reliant upon how the activity runs and it's based on the timing of judges' decisions and requests, so we've pretty much allotted for in that range for Q4.

Okay.

Again, that's subject to change as discovery and other activities related to the ongoing cases go on.

Okay. Thanks, guys.

Your next question comes from Sean McGowan of Needham and Company.

I have a couple of questions as well. Can you give us -- if you look at your guidance for the year, it implies another year on year decline in the fourth quarter. Can you give us a sense of when we might be able to look for a year on year increase in sales? Not getting into a specific number, but when would you expect the quarterly sales to show an increase?

Just in terms of the comp, Q4 2008 was huge for Hannah Montana and also for wrestling. What we're looking for and now with the addition of disguise, which about 85% of their sales is in the third quarter, which is of a higher seasonality than the lines that had replaced on the core line. So our expectation is certainly in 2010, although we're not prepared to give that guidance yet, but certainly within the next year or so we would certainly be on track to build the business which would then imply ongoing year over year growth.

Okay. Can you just give us color why there was an additional adjustment to the accounts receivable related to the joint venture. Why wasn't everything captured in the second quarter?

We would get -- we were getting limited sales information from THQ during the period of the arbitration and related disputes, so we had basically our best guess and when they gave us the final accounting of the sales, it came up lighter than we'd expected. We got the cash after we reported second quarter, so otherwise we would have -- everything would have flushed through that second quarter.

So there's nothing left from that chunk, but doesn't sound like you guys have the coziest of relationships now, so what do you think the ongoing impact would be from future payments that you're expecting?

The payments were withheld only because we had not settled on a -- now that the rate is settled and they paid the -- as an example, they paid the second quarter preferred return very timely if not early, so the adjustment was related to the period through March 31, 2009, which was during the dispute. So we have expectation that they'll report timely and we've had better communication since then.

Okay. So the loss taken in the joint venture then in the quarter is really related to that piece, primarily, right?

That was about $1 million and also we have the ongoing dispute in Connecticut and those legal fees are reflected in that line as well.

Okay. So from an operating actual business of selling games, would you expect the fourth quarter to be a lot better?

Yes. We've got a new game coming out across the platforms and that's typically the largest quarter.

Okay. Looking at the balance sheet also the -- how much of the increase in accounts receivable year over year was due to the inclusion of disguise which wasn't there a year ago?

Sales year over year were somewhat comparable but with Halloween they have a little bit longer dating so where they started shipping in the second quarter, those sales or the terms are typically longer on the costume side, so part of it is not so much the dollars that they've contributed, but the terms associated with those sales.

Okay. Well there wasn't any disguise in the numbers in 2008, right?

My point is sales are comparable both at about $350 million for the quarter.

Right.

I pointed that the terms are longer on their sales than they were on the sales that they replaced on the JAKKS side.

So how much of the inclusion -- in addition to that, isn't there also the fact that those receivables weren't there at all a year ago?

Correct.

Now, what happens when -- regarding the inventory charge that's been taken so far this year, what happens to this -- these goods when you sell them from an accounting standpoint?

When they're sold, the inventory is relieved and the related reserve a relieved, so basically the losses are taken when the inventory is impaired, so when it's sold we make either a nominal gain or nominal loss, depending on what the final sales price is.

So they're not written down and then sold at a normal margin? It's sort of like implies no margin?

They're written down basically to cover any royalties, the selling costs that we might have, but they're not written down to get to normal profit.

Okay. Final question is more of a philosophical one and probably also better for you, Joel. In an ongoing basis -- this was an unusual year, but when you talk about things like inventory impairment and licenses that maybe didn't work out, that's clearly an ongoing normal part of every toy company's business. Do you plan to exclude those types of expenses and charges forever going forward?

We called them out because of the magnitude and they were related to the licenses. Again, you're right, on an on going basis we review these things but we're in sort of an uncharted territory in terms of competition, the closeout space, and the general economy that it was more the magnitude as opposed to the charges.

Again, I don't want to put words in your mouth, but assuming we get to the point next year where we've anniversaried these at least on a year on year basis do you expect this time next year calling out relatively small inventory impairment?

Only if it's something that doesn't relate to the fundamental business on a go-forward basis.

Okay.

Again, because of the magnitude.

Right.

Our -- the products we're selling are generating and we hope to improve margins on the new products that we're selling, so we don't want those types of things to mask, I guess what I'll call our successes, selling the product at good margin.

Okay. Thank you.

Our next question is from Scott Hamann of KeyBanc Market.

Good afternoon. On the gross margins drivers for the quarter, can you kind of give us a magnitude of what some of those big buckets were? I believe in the last quarter you thought margins would be kind of flattish for the back half of the year and I'm just curious what your maybe updated assumptions are going to be?

Excluding the closeout, it was 190 basis point difference all in year over year and excluding close outs it would probably be a 100, 110 basis points. Disguise has average margins in the low 30s and as the quarter played out it's really our best guess, we had some shift of Q4 sales in to Q3 and Q3 sales into Q4, so it's within that margin of error, but fundamentally we're still on track.

Okay. And on the three big product lines, WWE, Hannah and Pokeman, can you give of giver a magnitude of how much those sales were down year over year?

Pretty significantly. I mean the overall reduction in what I'll call the JAKKS, the non-recently acquired businesses, was on the order of $200 million. It was spread across that and Pokeman as well. So it was pretty significant. We don't break out specifics on the product lines.

Okay. Then direct selling looks like it was down a little bit in dollar terms.

It's back to those product lines, Hannah in particular was losing support at retail and it's -- an analogy just fell off a cliff basically.

So I mean, is this level of direct selling to be expected like in the fourth quarter as well?

Could you repeat that, please?

The direct selling expense, I mean, is this lower level kind of sustainable here or is there a reason it should tick back up in the fourth quarter?

It will typically tick back up because that's when we advertise. We sell in the goods in Q3 and support those with advertising, but we review both commitments and also what makes sense for the products, and we've had other initiatives put in place unrelated to headcount reductions and lease hold abandonments that we'll have benefit, so the lower levels are sustainable and will help us achieve the annual savings that we indicated previously.

Okay. Just to be clear, did you realize any benefit from some of these initiatives during the quarter and how much was it?

We haven't quantity identified it, but we have. We've eliminated outside services and things like that. But the bigger chunks will be the balance of Q3 -- I'm sorry, Q4 and starting in 2010 so, it's pretty much nominal.

So you still think the first quarter in 2010 is a good target for achieving that annualized run rate of $40 million?

The run rate was expected to be achieved by the end of Q1. (Operator Instructions).

Our next questions comes from Jeff Blaeser of Morgan Joseph.

Good evening. Come questions, one of the gross margin was disguise. Could you repeat what that was and do you expect that number to go up or is that just the nature of the business where it's a lower gross margin an than the rest of the toy business?

It's in the low 30s and because they were, they had some financial constraints because of the parent companies international operations, they weren't able to get concessions from their factory. So in addition to helping provide better sourcing and better financial support, we hope that going forward barring any increases or price changes in the commodities that go into the products, we would expect to have a positive impact on them. One of the questions that was asked earlier in terms of the revenue for the acquisitions, we have information now and it was $84 million for disguise, $17 million -- let's see, where was that. The other categories were $24 million. So the total for the acquisitions was $108 million.

Okay. And how much third quarter was 85% I think you mentioned? Is that right?

Yes.

And is the rest in the fourth quarter or sprinkled out with the other three.

There's some reorders but because of the nature Halloween, it just ends very quickly, so there isn't much reaction time. There are some reorders, but most of it's -- it starts in second and ends in third pretty much.

Did you (inaudible) any lines or similar sales to what it was before you acquired it?

Did we what?

Is there any lines of the sales year over year comparables prior to acquisition?

Yes.

Then finally just quick on the $40 million, $45 million, does that include CDI play along earn out potential or or cost cutting? They're all related because when we pick up the acquisitions, there are certain functional areas whether it's marketing or product development that are value added to the company as a whole. But it -- earn outs don't hit the P&L but some of the efficiencies in back office combinations will -- are part of that number. Right, but you were restricted in terms what you could do in terms of cost cutting and that's part --

On historical deals where they had that ability but that was play along and CDI, the most recent ones don't have that same provisions.

Okay, great. Thank you.

You're welcome.

We have no further questions at this time. Mr. Friedman, would you like to make any closing remarks?

Yes, thank you. Thank you, all, for for your attention today and your interest in JAKKS. On behalf of JAKKS and all its employees, I can assure you and all our shareholders we will be be breaking our butts to return to the profitability we had in the past and beyond and, with that, thank you all very much.

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may all disconnect.