Jakks Pacific Inc Q3 FY2023 Earnings Call

Good afternoon, everyone. Welcome to the JAKKS Pacific Third Quarter 2023 Earnings Conference Call with management, who will review financial results for the quarter ended September 30, 2023. JAKKS issued its earnings press release earlier today. The earnings release and presentation slides for today's call are available on the company's recently remodeled website in the Investor section. On the call this afternoon are Stephen Berman, Chairman and Chief Executive Officer; and John Kimble, Chief Financial Officer. Stephen will first provide an overview of the quarter, along with the highlights of recent performance and current business trends. Then John will provide some additional editorial around JAKKS Pacific financial and operational results. Mr. Berman will then return with additional comments and some closing remarks prior to opening up the call for questions. Your line will be placed on mute for the first portion of the call. 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 or sales, margins, and/or adjusted EBITDA in 2023, as well as any other forward-looking statements concerning 2023 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 can 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. 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 through the associated non-GAAP financial measures within the company's earnings press release issued today or previously. As a reminder, this conference is being recorded. With that, I would now like to turn the call over to Stephen Berman.

Good afternoon, and thank you for joining us today. It's been a very busy quarter for JAKKS as Q3 often is with new product segments launching and plans for 2024 firming up. As you know, Q3 is always the highest shipping quarter for JAKKS. I'm proud to say we feel very confident in how we're lined up to finish the year as well as some of the initiatives the teams are working on for 2024 and beyond. We do at the beginning of the year that repeating 2022 revenue levels would be an impossible feat without a total unexpected breakout hit, as we had last year. With that sales outlook, we made gross margin improvement a major focus, as it is extremely important to our blueprint for enhancing overall margin. We have seen in our results that it's imperative in building and maintaining a strong balance sheet. Our teams in Asia work methodically with our manufacturing partners to ensure that we are getting the sharpest possible pricing on legacy items entering their second or third years in the market. Separately, new product development continues to be regularly challenged to ensure we are stretching the team's creativity to generate value for the consumer and for our customers, while also ensuring cost mindful product designs. With Q3's results, we can see the dividends of those efforts paid off. Year-to-date, our gross margin of 32.5% is our strongest performance in this metric since 2011. Our year-to-date gross profit of $186.9 million is $6.9 million or 4% higher than a comparable period in 2022. That improvement has helped us to compensate for increases in SG&A expenses, such that our year-to-date operating margin of 12.7% represents an improvement over the 11.5% operating margin we had in the first nine months of 2022. The net results from an adjusted EBITDA view is $67.1 million in adjusted EBITDA in the quarter, up from $59.4 million in the same quarter last year. Our action play and collectibles business was up 43% in the quarter and 37% year-to-date, accelerating its performance versus last quarter. Our Dolls, Role-Play and Dress Up segment is lapping that exceptional 2022 and was down approximately 27% in the quarter and 30% year-to-date off a larger base. As we pointed out last quarter, we still think it's worth noting that the Dolls segment is up significantly versus 2021, $247 million year-to-date this year versus $207 million year-to-date in 2021. This team is often a victim of its own and many successes. Our outdoor seasonal business showed some trend improvement, down only 2% in the quarter and slowing the year-to-date decline to 23%. We have some quality placement of new items this fall and, as mentioned, we will see some new initiatives in the works, which we think can energize this business next year and beyond. Q3 is, of course, almost the most interesting time of year to discuss our Halloween costume business. The headline is the year has worked out in line with our expectations, which is a great outcome given how big the business has become. Last quarter, we discussed how the seasonality has moved around this year. So we saw it catching up this quarter with a 19% year-over-year growth in Q3. Year-to-date, we shipped $122 million through Q3, which is 9% lower than last year. As we mentioned before, some larger US customers recalibrated their buying levels this year after an aggressive 2022. That drove most of the downside as our international business has been roughly flat year-to-date. We've been aggressively working on our distribution outside of North America and remain focused and committed to building that business to leverage our strength in North America. Again, to provide a 2021 reference plant, that $122 million ship number is significantly higher than the $99 million we shipped in the first three quarters of 2021. So overall, another great year for the team. Moving on to a market view. The past quarter was also noteworthy and continuing our efforts to expand our overall business outside the United States. In Latin America, we are up and shipping 50-plus percent year-to-date. Although we've had an office in Mexico for several years, this year we started offering selective domestic replenishment for key items via a local third-party warehouse. This investment helps to elevate our year-round on-shelf presence, further proving the viability of our product line to local retailers. With this success, they can then place larger orders with us FOB in Asia consistent with our go-to-market approach. Over time, we also see a potential platform for additional shipments into Latin America. And we're quickly seeing a positive reaction to retail with syndicated data suggesting we're up over 50% in Mexico year-over-year. Also in the quarter, we officially opened our dual-purpose office and warehouse facility in Northern Italy. We plan to start shipping from there in the New Year, which will generate a number of new benefits. Specifically, being able to serve a wider range of smaller customers more quickly and with improved economics in shipping smaller orders as individual deliveries from Northern Europe. In addition, we onboarded a new team with deep industry experience in JAKKS France, a market where we know we've been underperforming during COVID. Although our COO, Jack McGrath, is officially not in his new role as President of European operations until the New Year, he has been spending a considerable amount of time and focus on addressing challenges in the region to accelerate our performance in 2024 and beyond. I couldn't be more excited about the opportunity presented but has taken his years of experience with JAKKS and focusing them on taking a fresh look on how we're doing business in the European markets. Switching now to talking about what we're seeing at retail. On the toy side, it's been the case all year and continued this past quarter when we look at our own data and syndicated data. We see that the toy portion of our business continues to perform better than the overall industry in the US. The same has been true in some of our European markets where we also see syndicated data. Certainly, some of the great content from our studio partners is helping to drive people to the register this year, much as it did last year. But broadly, we've been pleased with how the total portfolio is performing this year, as we said last quarter. That being said, in Q3, we did see retail slowing. Retail sales at our top 3 US accounts were down low single digits year-to-date and down high single digits in the quarter. Separately, at the end of the quarter, retail inventory at the same accounts were down over 20% versus the prior year, delivering on their goals to finish the calendar year at lower owned inventory levels. As we work through this transitional year at retail, we manage in stock across all of our key product segments and are set up well to fulfill demand in Q4. I will now pass it over to John for some further comments. After which I will come back to discuss Q4 and a bit about next year.

Thank you, Stephen, and hi, everybody. It's always great to report results after a $300 million sales quarter. We knew the first half of the year would have the most difficult comparisons as we were chasing business on a holiday 2021 film. The second half of the year would also be challenging, but hopefully less so. That view is playing out in our results. Although down 20% as a total company in the first half of the year, we were down only 4% in Q3, shipping $310 million in the quarter. As Stephen pointed out, broadly speaking, the year is going about as well as we could have hoped. 2020 unleashed COVID; 2021 had expensive freight; 2022 had warehouses overflowing; and so far, 2023 from the perspective of our business has had more positives than negatives. What that means from a year-over-year perspective is twofold: Bad things that happened in 2022 haven't reappeared and some additional good things have been additive. From a net sales perspective, both the Toy CP segment and costumes are tracking year-to-date at higher levels than anything in the 2019 to 2021 time period. And gross profit dollars for both segments are higher than any time in the past five years as well. There are a number of things happening with gross margin. In the quarter, it was a 600 basis point improvement. So let me try to break that down. As Stephen referenced, the landed product cost improvement amounted to around 350 basis points. I'd say that was a mix of some of the good stuff that Stephen talked about earlier, but also last year on both the toy and costing businesses, we blew out some inventory at margins that weren't anything to brag about for a couple of different reasons that made sense at the time. We also managed to avoid bleeding money by way of above average freight costs. That was a pickup of another 150 points. There are a number of other puts and takes, but I'll throw in for good measures at our REIT of retail last year was more markdown exposure than what we're seeing at this point this year. So that's also net-net favorable. And finally, this quarter, we began capitalizing a small portion of our tooling to our owned inventory valuation, which has been an outstanding topic for some time. But we've got around to figuring out how to get it done without the accounting being too cumbersome. So that was a one-time pickup of $1.8 million in the quarter. We have adjusted that depreciation dollar amount out of our adjusted EPS results. So to answer your question, we think we have line of sight to continue to hang out in this low-30 neighborhood on a full-year basis. But that's, of course, subject to minimizing stuff going wrong, nor does it contemplate any dramatic changes in our product mix which we don't anticipate in the near term. We're losing a bit of scale with SG&A being up, but fortunately, the gross margin lift has been enough to generate operating margin improvement, which is great. That has allowed us to selectively invest in staff and infrastructure where appropriate, with the goal of being in a better place next year organizationally, despite revenue being down this year. We've also made some decisions like skipping the New York Tool this past quarter, which may not have generated massive financial savings but certainly removed the layer of organizational distraction with nothing else. In addition to the P&L, we're feeling good about the balance sheet. Our Q3 ending cash balance of $96.4 million is high for this time of the year. There are a couple of drivers. One is that we're trying to keep a tighter leash on inventory and turning it back into cash in a timely manner. Another is we've accepted the federal government's offer to California-based businesses for payroll and tax payments into October, which helped quite a bit. You'll notice in aggregate that our AP and taxes payable are up over $20 million versus this time last year. We remain debt-free, as of the end of the quarter, and as of today, the majority of the interest expense you see in the P&L is associated with some early payment discounts that we sporadically take advantage of to maximize liquidity. We'll likely be doing less of that in the near term given our current cash situation. Reduction in our cost of capital from our improved financial position increased the preferred share liability valuation to $28.6 million, generating a non-cash loss of $800,000 in the quarter. As is customary, we adjust that amount out of our non-GAAP results. Adjusted EPS for the quarter was $4.75 and $5.66 for the first nine months; those numbers are up from $3.80 and down from $5.68, respectively. From 2022, our trailing 12-month adjusted EBITDA of $74.5 million.

And now back to Stephen, for some additional remarks. Thank you, John. Although we reviewed a lot of the key product initiatives last quarter, I wanted to provide a couple of quick updates and then share some new exciting news about 2024 and beyond. Last year, we mentioned it's been two years since we first introduced the Disney ILY brand with Target in the U.S. That business has built steadily with them during that time and is currently putting up some very nice numbers in reaction to our fall 2023 lineup. The inspired by Stitch Dolls, both in the original 18-inch scale as well as our new introduction of Fashion Doll Scale have both been top sellers out of the gate. Overall, the Fashion Doll Scale has been well received when first hitting the shelves, and we are expected for more fans of these characters to find them this holiday season. Last year, we were extremely excited to work with Target to bring their Target Toy Store shopping Card to Life. And once again, on their Target Bullseye's Top Toy List for 2023, reflected its great performance this year. But the new news is the recent launch of the Target Cash Register Accessories items as an extension of our perfect acute line. It debuted during the quarter and has done extremely well, so far as we all thought it might. It's a great value and great fun for the consumer. Be sure to check out the photos in our presentation. Also, be on the lookout for some new introductions in our outdoor season space this holiday season. The team has fought through a gain shelf space at key accounts across ball pits, activity tables, and ride-ons. We have some great new PAW Patrol ride-ons inspired by this summer's movie, which brings a lot of play to classic play patterns. And during Q3, our product lineup in support of the Walt Disney animation studios Thanksgiving film release, which began to hit the shelf. This story focuses on a 17-year-old girl named Asha, a sharp-witted idealist who makes a wish so powerful that it's answered by a cosmic force, a little ball of boundless energy called Star. We're super excited about the film and are playing a role as Disney continues to celebrate the 100th anniversary of its founding this year. Now for a couple of additional comments about 2024. We recently announced a new agreement with SEGA to support the Sonic Hedgehog 3 Paramount Pictures feature film set to release on December 20, 2024. As many of you know, we have worked with SEGA for many years on Sonic and other SEGA properties, inclusive of the first film in 2020. We are looking forward to bringing to market a new innovative range coming to a wide range of products that Sonic fans have come to expect from us, ranging from figures to plush, to play sets to costumes and more. Now moving on to our outdoor seasonal division. I'm extremely excited and happy to be able to talk about a multiyear worldwide relationship we're starting with Authentic Brands Group, ABG. As you may know, ABG is a brand powerhouse with a wide portfolio of IP, which has mass appeal to millennials, Gen Z, and Gen Y. JAKKS and ABG have been collaborating on a wide range of products that will slot into this division as well as expand the scope of our offerings. We have been working on an iconic assortment of their properties, names like Roxy, Quiksilver, Element, Forever 21, Juicy Couture, Sports Illustrated, and Prince, just to name a few. With designs and processes already underway, customers can expect initial fall 2024 rollout skateboards with amazing new designs for Element and Quiksilver at specialty and mass retailers in stores and online. JAKKS will launch branded roller skates, inline skates, volleyballs, outdoor furniture, including chairs, umbrellas, and canopies, beach accessories, inflatable pool floats, sanded flash mats, foldable wagons, and an extensive line of dolls and dolls accessories infused with fashion elements from Forever 21, Juicy Couture, Prince, Sports Illustrated, and Roxy. The strength of the authentic platform and family of IP will grow JAKKS specific product lines and outdoor categories while making way for new collaborations with authentic on existing categories. The addition of more spring and summer-focused business also further leverages JAKKS' infrastructure to counterbalance its traditional Halloween holiday seasonality. So this relationship is really a great match for both of us. Reactions from various customers worldwide and the previews we've shown over the past couple of months of early product directions and initiatives were extremely, very favorable. So although there's still a lot of heavy work and lifting to be done, we are so excited about the potential here. I've personally been working on the development of this business over the past year and can't wait for you to see some of the new products and product executions that we are currently working on today and in the future. But wait, there's more. We are quick to tell everyone that this business is built brick by brick, a series of evergreen brands and categories centered around classic play patterns that we feel persist and stand the test of time even in the increasingly digital world. And we've talked about how our successes in recent years have started new conversations and have created new ideas about business opportunities that marry up our unique role in the marketplace with different brand owners. And you've also heard us mention that when those businesses have an underlying content presence, it only adds to our ability to stay on top of mind with consumers and participate in the energy and excitement around top-tier content, quality and success. So with that foundation, I could be happy to share new news that in fall 2024, JAKKS will be launching an extensive product line dedicated to The Simpsons. As a symptom as well into its record-breaking 35th season this fall, it continues to be one of the most popular series of both Fox and Disney Plus. The upcoming toy line is poised to inject even more excitement and joy into this cherished franchise catering to fans of all ages with a diverse and engaging offering. The toy line will feature a wide range of beloved caricatures from the show available in various forms, such as basic, deluxe, and premium collector figures, playsets, and plush toys along with items like advent calendars and other fun and creative choices inspired by the show's rich history. As you might imagine, our action plan and collectibles team has been having a tremendous time brainstorming the plethora of product opportunities that this show represents, and we are honored as a company to be trusted with such an iconic franchise. As I said at the beginning, it was a very busy quarter, but with the end of the year in sight, it is also extremely gratifying to see us lined up for completing another really successful year here at JAKK, while still seeing great opportunities for sustained growth in the new year to come. Thanks again for your support and interest.

Our first question comes from Andrew Uerkwitz with Jefferies. Your line is now open.

Thank you, John. I have a couple of questions. The first one concerns the action plan and collectibles. They've grown significantly, more than doubling since 2021. Can you elaborate on the factors influencing that growth? Additionally, what sort of impact do you anticipate from The Simpsons collaboration? It seems like a fantastic partnership. Please walk me through the considerations for that segment and how we should view it moving forward.

Thank you, Andrew. This is Stephen. We've had a really strong year in the boys' action and play environment. The success of the Nintendo movie has significantly contributed to our growth, building on the existing classic Nintendo business. It's also now available for streaming on platforms like Netflix and NBC's Peacock. We expect strong momentum as it reaches a wider audience, particularly in spring next year and beyond. The Sonic Netflix series premiering in July and the movie coming next December are also going to be very impactful. They haven't cannibalized each other's sales, which is great. There’s also our content related to other games like Bandai and Crash Bandicoot, which is just starting to gain traction. A key factor for ongoing success in this area is the solid evergreen platform we have, particularly with The Simpsons. This iconic content is celebrating its 35th year, and we’ve reinvigorated it in a way that hasn't been done in over a decade. We're collaborating closely with the Walt Disney Company, and retailers across the board are very enthusiastic about it. This initiative is part of our broader strategy to enhance the action play environment, and we've been patient in securing The Simpsons, which took years of effort. Looking ahead, we anticipate a strong year in that segment.

Got it. That's really helpful. Thank you, Stephen. And then switching to outdoor. You obviously peaked during COVID, I think everybody peaked during COVID. But this latest relationship heading into 2024 and beyond, it sounds like this is pretty substantial. So how should we think about the impact it could have as we start to look out 2024 and beyond? Could we get back to that kind of COVID peak that you guys had?

Firstly, yes, that's our goal. We jumped into this for a long time. I've been friends with the Sultzer family, which are the founders of the ABG Group, and we've been working for over a year on the right initiatives and platform and IP. They own a breadth and a plethora of different IP, and our relationship together with them is extremely strong. And we've worked out a various array of different categories that actually will help diversify, call it, our revenue stream to put a little bit more into the first half of the year, especially having third quarter and fourth quarter being as strong because of Halloween and the actual holiday season. With that being said, the diversification to the buyers that we go to, to the distribution that we go to from our main distribution that we go to the specialty distribution, we've been looking at this in great detail. And we believe we'll get much stronger and even bigger than we were with our original platform in Seasonal in the next couple of years. We have worked on this. We finished the deal over the last few days. We're both excited. We're on the road with retailers already. We're in complete development in Asia. Our team has been there. They're back there again this week. So we just don't know how quick it will get to the market, but we do think it will be somewhat material to us in the segment of which we're in. And ELEMIS was one of the largest brands worldwide for skateboards. And so we have that whole category skateboards with Quiksilver. We have a beautiful line of roller blades and roller skates with the ABG brand. We have a broad array of seasonal outdoor products for beach and parks for like football games, soccer games for family and children that aligns with our kids outdoor furniture that just parlays bringing it from kids to teens, tweens, and adults. So, we're really just more diversified into a kids consumer product company and a consumer product company for families. And we're extremely excited about it. ABG is excited about it and the retailers are excited about it.

That's very helpful. I have one last question. Regarding the international opportunity, it seems you made significant progress this year, particularly in Latin America, although you appear to be down year-over-year and year-to-date in Europe. How should we assess the impact of your initiatives in that region? Are they aimed at improving margins, or do you anticipate growth in the international market? What is the current objective of your expansion in Europe, considering it hasn't yet reflected positively in the income statement?

This year, in our industry, we were flat overall, while toy companies have faced down years. However, we are moving Jack McGrath and his team from the US to international territories, enabling them to make quick decisions without needing to consult the corporate office. Jack has been with me for over 25 years, and he has my full support as well as the Board’s. I recently returned from Northern Italy, where we have opened a new distribution center and offices, along with new offices in France. I am confident that we will see growth simply by having him on the ground. Additionally, we have a wide range of new and consistent products. Our princess style collection, which has been established and is growing in North America, has only been in Europe for about two years; it took us five years to achieve that growth. We have The Simpsons, aesthetic brands, and a new movie, along with various boys' action products. I am very confident about our growth potential, and I believe we will see improved margins due to Jack's involvement in operations. Growth and operational enhancements should be evident globally starting in the first half of next year and continuing into the second half.

Got it. That's very helpful. I think I do have one more question kind of on Q4. Listening to some of your competitors have reported so far, both kind of mentioned that they view kind of Q4 holiday spending returning back to normal, and I think that what they really mean is that the spending will mostly happen in end of November, December. Just curious what your thoughts are on where the consumer is at from a spending pattern perspective this particular holiday.

I'll speak on behalf of Jack and provide some insights on the overall consumer landscape. Our approach differentiates us from larger competitors as we are focusing on practical enhancements to our distribution and margin criteria. We’ve seen a significant improvement in our gross margins, increasing by 600 basis points for the quarter, which we’re committed to sustaining in the coming year. Currently, our inventory levels are being managed down, as reflected in our financials over the past nine months, and we anticipate ending the year with even lower inventory levels compared to previous years. This is due to our efforts in managing retail inventory to ensure just-in-time supply from both FOB and domestic sources. We’re experiencing strong customer engagement and sell-through, and we feel confident that we will have a solid year ahead. While we’re not relying on any blockbuster hits like last year’s Conto, or potential wins with WISH, authentic brands, or Nintendo streaming, those could still come into play. We operate with a cautious, step-by-step business philosophy while maintaining excitement about our initiatives. I’m genuinely enthusiastic about our progress and believe in our business model's strength as we aim for growth in profitability and revenue next year, although the exact trajectory remains uncertain. Overall, the consumer environment is robust, though we are noticing some weakness in purchasing among medium to low-income consumers in retail. Retailers who focus on groceries find that this drives consumer engagement, though spontaneous and ancillary purchases are decreasing. Nonetheless, over 70% of our products are priced under $40, with a significant portion below $20, positioning us well for the holiday season. We offer a range of products, including high-end options, which gives us a diverse mix across various income levels. We are pleased with our Halloween results and how retail trends are shaping up for us.

Got it. That's super helpful. Thank you, Stephen and a very solid quarter appreciate it.

Thanks, Andrew.

Thank you. I would now like to hand the call back over to Stephen Berman for closing remarks.

Everybody, thank you very much for attending the call today. Again, we are excited for this year finishing up, and we're extremely excited for 2024 and beyond with the new Simpsons lines, with our ABG line, with the WISH going into streaming in spring and Nintendo. There's a lot of things that JAKKS that we're excited about, and we look forward to having our call on the fourth quarter and year-end next year. All the best.

This concludes today's conference call. Thank you for participating. You may now disconnect.