JAKKS Pacific, Inc.

Good afternoon, everyone. Welcome to the JAX Pacific first quarter 2021 earnings conference call with management, who will review financial results for the quarter ended March 31st, 2021. JAX 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 their investor section. On this call this afternoon, are Stephen Berman, Chairman and Chief Executive Officer, and John Kimball, 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. Kimball will provide detailed comments regarding Jax Pacific's financial and operational results. Mr. Berman will then return with additional comments and some closing remarks prior to the opening up for the 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 the question, please press star then 1 on your telephone keypad. Before we begin, the company would like to point out that any comments made by Jax Pacifica Future Performance, events or circumstances including the estimates of sales, and or adjusted EBITDA in 2021, as well as any forward-looking statements concerning 2021 and beyond are subject to safe harbor protection under federal security laws. These statements reflect the company's best judgment based on current market trends and conditions today and are subject to certain risks and uncertainties, which could cause actual results to differ materially from those projected in forward-looking statements. For details concerning these and other such risks and uncertainties, you should consult Jack's most recent 10-K and 10-Q filings with the SEC, as well as the coming other reports subsequently filed with the SEC from time to time. In addition to today's comments by management, we'll refer to non-GAAP financial measures, such as adjusted evidence 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 is being recorded. With that, I would like to turn the call over to Stephen Berman.

Good afternoon, and thank you for joining us as we review our performance in the first quarter of 2021 and our plans for the rest of the year and beyond. We are very pleased with our results for the quarter. It's the fifth consecutive quarter we delivered results that exceeded our internal projections, and it was a strong way to start 2021. Not only were we able to deliver strong sales growth, higher margins, and significant improvement in profitability, we did so without the benefit of a big hit product or blockbuster tentpole entertainment content. Our strong performance in the corner was no fluke. It was the result of many steps we have taken in recent years to broaden our sales base, cut back on low margin products and categories, reduce our manufacturing and operating costs, and manage cash conservatively. As a reminder, the last two years, we've been working diligently to improve our profitability by laying out a three-pronged plan to improve results. First, we have been reducing our product costs and operating expenses to allow us to be profitable on the revenue that comes from our core basic product categories. The results are visible in the sharp increase in gross margin and dramatic reduction in SG&A as a percent of sales that we had in the quarter. This is the highest Q1 gross margin we've reported since 2017 and our operating expenses in the quarter with the lowest level in dollars of any first quarter since 2004. Second, we have been working to cut lower margin products from our portfolio and to take into account the total cost of a product, not just its ex-factory cost. This shows up as lower reserves for allowances, significantly fewer low or no margin closeout sales, and frankly, a leaner, more focused organization. These two steps have lowered our break-even level. Our adjusted EBITDA in the quarter was negative 2.4 million, the best first quarter adjusted EBITDA we have had since the first quarter of 2015, when sales of the product from the original frozen film were still extremely strong. As we have been saying for some time, our goal is to position the company to be profitable without big hits so we can deliver even stronger profits when we do launch an unexpected blockbuster-level product line and category. The third part of our plan has been focused on shoring up the balance sheet by reducing our high-cost debt and stretching out the debt maturities. We ended the quarter with approximately $84 million in cash, and net debt of 77.6 million down from 127.3 million a year ago. We continue to consider ways to realign our debt maturities and look forward to reporting more progress as the year unfolds. Other parts of our balance sheet also show how we are operating much more leanly. Our net PP&E at the end of first quarter was the lowest it's been at March since 2014, and our inventories were at the lowest level in Q1 in more than 10 years. At retail, our products continue to sell extremely well. At our top three retailers, POS of our toy products was up over 20% in both online sales and brick and mortar, and retail inventories of our toy products at our top three customers were down approximately 25% at the end of the quarter compared to last year. As I said earlier, our sales strength was not the result of one giant hit or one movie driving demand for our merchandise. Our sales performance was based on the breadth of our diverse portfolio. Girls, boys, and seasonal were all up strong double digits. In girls, initial sales of Raya and The Last Dragon were solid, and when combined with the positive trajectory of Disney Princess, helped offset the expected decline of Frozen and Frozen 2 products. Our Redux skateboard line also continues to sell extremely well with great velocity. Our portfolio of toys based on video game properties continue to perform well, with Nintendo more than doubling off of an already strong base, Sonic the Hedgehog nearly tripling, and Apex Legends, which was launched late last year, building nicely. Video game related toys have become a solid part of our portfolio and we expect to continued growth from this category. To put it into some perspective, our video game related toys were a bigger contributor to our total first quarter sales than any of our larger licensed brands. This is exactly the balance we have been striving to build and achieve. Our goal has been to have a solid profitable business without the big hits which we have achieved. so that when a big hit occurs and we know they will come again, we will be even more profitable. Those of you who have followed us a long time will notice that we're not calling out how our sales performance would have differed if we excluded certain product lines from the figures. We typically do that to help illustrate various trends and to point out the solid sales underneath these more volatile lines. and we are likely to do so in the future if we think it helps understand the broader patterns. Some area of toy sales were down, but there were no declines that were so dramatic that they prevented us from growing, and no increases that were so dramatic that they would create a problem for our portfolio next year. We simply have a well-balanced portfolio of toy products and categories based on brands and play experiences that kids and parents love. Our costume business was flat year over year. The first quarter is not very meaningful. We are excited and confident we will have a good year in costumes. Retail inventories were extremely clean in late 2020. Halloween is on a Sunday this year, and we believe with the vaccinations rising and people increasingly eager to get back to normal, Halloween is going to be a big holiday event this year. In fact, In general, we are seeing things gradually returning to normal among our retail customers and consumers. Retail traffic is improving, although online sales remain at higher levels. Production on new films and television content is ramping up, and films are returning to theaters, even as streaming remains extremely strong. The toy industry held up well last year, much better than most industries. NPD said that the US sales of toys rose 16% in 2020, which is several times the normal growth rate and has been up strongly so far this year, with retail sales rising 41% in the US in the March quarter. The toy industry has done well for a lot of reasons, but the main one is that toys are one of the things that haven't been cut back too much. Parents have spent less on sports, on activities, on vacations, and dinners out, but they haven't come back on their children. In fact, they redirected their spending from other areas into toys. We continue to see some of these trends. As I mentioned, toys tied to video games have been very strong. This makes sense because video games did so well over the last year with kids spending more time at home. That exposure to these digital gaming experiences increased demand for the toys. Our Black & Decker line of play tools more than tripled over the last year, possibly driven by the fact that kids are seeing their parents spend so much time and effort doing home remodeling projects and improvements, which we believe they have a strong desire to emulate that in their play patterns. Within our seasonal business, we saw double-digit increases in shipments driven by continued strong POS. Activity tables have sold particularly well, as have sales of our redo skateboards. These are areas benefiting from a change in consumer behavior and the momentum continues. In 2020, the dolls and collectible categories did not do as well, partly because new entertainment content release dates were continually postponed and moved out to later dates. In some cases, the content would be released on a streaming format only or released simultaneously both theatrical and streaming. What we're seeing now is a return to more normal theatrical releases, less changing of release dates, and the properties are back to being marketed by the content holders and retailers in a stronger, more consistent way. Our perfectly cute baby and perfectly cute home lines did very well at Target, and our shipments are up strongly this year. Sales of our Disney Princess products nearly doubled over the first quarter of last year. With the introduction of Raya and the Last Dragon, Disney Princess and Raya more than offset the decline in Frozen and Frozen 2 products. One of the other big themes for the toy industry in 2020, as well as for all retailing, was a continued shift to online sales, and our top customers Online sales of our toy products were up over 20% in the first quarter of 2021 and represented 17% of our total POS at these customers. This was in line with last year, but outside of a couple of product categories, the overall trend was toward higher online sales as a percent of the total sales. Jax Pacific was built on the foundation of good evergreen basic toys based on leading global IP, targeting proven play patterns. We saw our toys deliver on this promise very clearly in the first quarter, and we expect it to continue throughout this year. I will now pass the call to John to review our financial performance, after which I will come back with comments on how we see 2021 playing out. John.

Thank you, Stephen, and good afternoon, everyone. Net sales for the 2021 first quarter were $83.8 million, up 26% compared to $66.6 million last year. As Steven mentioned, we saw great results across the board in our toy consumer product segment. In our girls and preschool targeted businesses, primarily dolls, dress-up, role-play toys, plush, and other consumer products net sales were $45.2 million in Q1, up 13% compared to $40.1 million in the prior year. The big driver of the growth was the strong sales of Disney Princess and Raya merchandise anchored by the theatrical and streaming release in March, slightly offset by lower sales of Frozen. Our Perfectly Cute ranges also contributed in the positive column. In our Boys Targeted division of action figures, vehicles, role-play toys, and other electronics products, net sales were $16.4 million, up 70% compared to $9.7 million last year. As Stephen mentioned, our video game-related toys delivered the majority of the growth, with our Black & Decker role-play line also strongly contributing. This business is expanding rapidly both in the U.S. and international with more points of distribution in broader product ranges. In our outdoor seasonal division of ball pits, play structures, activity tables, foot-to-floor ride-ons, skateboards, and other spring-summer inspired toys, net sales were $18.3 million in the quarter, up 43% from $12.8 million in the first quarter of 2020, with growth across the whole division. When you add those pieces together, first quarter sales in our toys consumer product segment were up 28% to $79.9 million globally, compared to $62.6 million in the first quarter of last year. The bulk of the growth came from North America, up 33%, while international grew by 5%, despite significant additional retail closures in Europe and beyond. Net sales in our costume segment, disguise, were nearly flat year over year, at around $4 million in the first quarter. As a reminder, Q1 tends to be around 3% to 5% of our full-year costume business. Moving down the P&L, gross margin in the 2021 first quarter was 31.1%, a 650 basis point improvement over the 24.6% in Q1 of last year. About a third of that improvement comes from the royalty line, which was $12.5 million, or 9% higher than a year ago, but 230 basis points better, driven partly by a mixed shift, but also the expiration of some legacy agreements with less than favorable terms. And the balance is attributable to the effort Stephen just mentioned in bringing a stronger product margin line to market and fewer closeout sales. Despite ocean freight costs rising sharply toward the end of 2020, we were really pleased to see these increases in gross margin rate. We will continue to work diligently to mitigate these cost increases throughout 2021. We had significantly lower expense for SG&A in the quarter. Again, as Steven alluded to, there's a mix of cost avoidance and things like the elimination of trade shows in the first half of 2021 and significantly reduced travel, but the quarter also reflects more lasting cost reductions like our efforts to optimize our warehouse footprint and carefully manage receivables. We're also projecting our media spend to be more back-end loaded in 2021 than last year. In aggregate, our first quarter direct selling costs were $6.8 million, or 8.1% of net sales, compared to $8.5 million, or 12.8% of net sales, in the first quarter of 2020. In the G&A section, we had a $1.9 million cost avoidance stemming from the federal government's employee retention credit program under the CARES Act. Although we believe we will benefit from the ERC in future quarters, we consider it a one-time non-sustainable benefit and therefore are reducing our non-GAAP adjusted EBITDA calculation for that amount. With that said, our GAAP 2021 first quarter G&A, including product development and testing, but excluding depreciation and amortization expense, was $21.4 million, or 25.5% of net sales, down from $23 million, or 34.5% of net sales in 2020. We remain very pleased with the company's continued success in working both remotely and within a lower cost structure. These results combine to generate a first quarter operating loss of $2.7 million compared to an operating loss of $16 million in the first quarter of 2020. Our net interest expense in Q1 of this year was $4.9 million compared to $5.5 million last year, reflecting a lower overall level of debt. As a reminder, Certain elements of our capital structure, specifically our convertible senior notes and preferred stock derivative liability, are marked to market quarterly with non-cash gains or losses depending on a number of factors, inclusive of market debt rates and our current share price. In the first quarter of 2021, the combined impact of those valuations was a loss of $16.4 million. As a result, despite the combination of our improved operating performance and lower interest expense, we nonetheless reported a GAAP net loss in the quarter of $24.1 million or $4.54 per share compared to a loss of $12 million or $3.97 per share in Q1 of 2020. Excluding the impact of the non-cash valuation adjustments, employee retention credit, as well as stock compensation expense, our adjusted net loss attributable to common stockholders in the first quarter of 2021 was $9.5 million, or $1.77 per basic and diluted share, compared to a loss of $21.9 million, or $7.23 per basic and diluted share reported in the first quarter of 2020. Our adjusted EBITDA for the quarter was a loss of $2.4 million, an improvement of $11.4 million over 2020. This brings our trailing 12-month adjusted EBITDA to $39.5 million, its highest dollar level since Q1 2017, and at 7.4% of net sales, our highest adjusted EBITDA margin level since Q3 of 2015. We remain very pleased with the team's performance in improving our results as it relates to this metric during the past year. Net cash used by operating activities was $7 million for the first quarter of 2021 compared to net cash used of $18.9 million in the first quarter of 2020. Free cash flow was a negative $8.4 million in the 2021 first quarter compared to a negative $20.5 million in the 2020 first quarter. As of March 31st, 2021, our cash and cash equivalents, including restricted cash, totaled $84.1 million compared to $44 million at the end of 2020's first quarter. Counts receivable as of March 31st, 2021 were $79.7 million, up from $64.8 million as of March 31, 2020, DSOs for the 2021 first quarter decreased to 86 days from 89 days reported in the 2020 first quarter. Inventory as of March 31st, 2021 was $36.7 million versus $48.2 million at March 31st, 2020. DSIs in the 2021 first quarter were 75 days compared to 116 days in the 2020 first quarter. The company intends to apply for forgiveness of its PPP debt of $6.2 million but has yet to do so. In the absence of knowing whether any funds will be forgiven, the company presumes a two-year loan period with interest beginning to accrue in June of 2020 with payments beginning in September of 2021. As a result, we now reflect $1.7 million in short-term debt and $4.5 million in long-term debt on our balance sheet related to this loan. In addition, we anticipate a $5 million pay down of our term loan in 2021 based on the amendment filed last year related to our debt covenants and our projections for cash and liquidity in 2021. Taken together, these two attributes comprise the $6.7 million in short-term debt on our balance sheet. From the beginning of the quarter, $3 million of the July 23 convertible senior notes were converted to common shares at $5.65 per share. As of March 31, 2021, the face value of the July 2023 convertible notes is $20.9 million, including accumulated PIC interest. As a result, as of March 31, 2021, the company's debt at face value was $152.4 million, including the aforementioned $6.2 million PPP loan due June 2022, $20.9 million of recapitalized convertible senior notes due July 2023, and $125.3 million owed under our term loan due February 2023, both inclusive of PIC interest. We currently have no outstanding balance under our credit facility aside from $10.8 million in letters of credit as of March 31st. Capital expenditures during the first quarter of 2021 were $1.5 million compared to $1.6 million in the first quarter of 2020. Depreciation and amortization for the first quarter of 2021 was $1.8 million compared to $1.9 million in the first quarter of 2020. The basic and diluted Income per share calculation for the first quarter of 2021 was based on a weighted average of 5.379 million common diluted shares outstanding, up from 3.021 million in the first quarter of 2020. This number reflects the impact of our reverse stock split in July 2020, as well as the aforementioned convertible senior note conversions. And with that, I will now hand the call back over to Stephen for some additional comments.