JAKKS Pacific, Inc.

Ladies and gentlemen, today's conference is scheduled to begin shortly. Please continue to stand by and thank you for your patience. Thank you. Good afternoon, everyone. Welcome to the JAX Pacific Third Quarter 2021 Earnings Conference Call with Management. We'll review... Financial results for the quarter ended September 30, 2021. Jack's issue is earnings press release earlier today. The earnings release and presentation slides for today's call are available on the company's website in the investor section. On the 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 the 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 opening the call for questions. Your line will be placed on mute for the first portion of the call. If you would like to be placed in the queue to ask the questions, please press Father in One on your telephone keypad. Before we begin, the company would like to point out that any comments made about JACC's specific future performance, events, and circumstances, including the estimates of sales and all adjusted EBITDA in 2021, as well as any other 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 JAC's most recent 10-K and 10-Q filings with the SEC. as well as the company's other reports subsequently filed with the SEC from time to time. In addition, today's comments by management will refer to non-GAAP financial measures, such as adjusted EBITDA. Unless stated otherwise, the most directly comparable GAAP financial metric has been reconciled to the associate non-GAAP financial measures within the company's earnings press release issued today or previously. As a reminder, This conference is being recorded, and with that, I would like to turn the call over to Stephen Berman. You may begin.

Thank you, and good afternoon, everyone, and thank you for joining us today. Before we start, I'd like to take a moment to express how sad we were to learn of Brian Goldner's passing. Those in the investment world might not realize what a close community the toy industry is. We may work in different cities, at different companies, but there's a continuity over the decades built on passing through the same airports, headed to the same trade shows, leading to conversations that are low, perhaps infrequent, are nonetheless very personal and cherish giving the shared experience and journey. I first met Brian many years ago, and at Jax we have always had a strong relationship with Hasbro since our founding. Although we know Brian has been fighting for his health for some time, His loss still comes as a shock, and I just wanted to make a point that we too mourn his passing and are thinking of his personal and professional family during this difficult time. Thank you. As many of you know, Jack's was started as an FOB business where we sell the product to our customers in larger quantities, usually at the port in Asia, and from there, they bring the product to their home markets, leveraging their own supply chain infrastructure. We continue to do over 50% of our sales that way today. This way of doing business has benefited us all year, inclusive of Q3, leveraging the supply chain strength and scale of the major global retailers to pull our product through to the retail shelf. In addition, we have accelerated our importation of domestic inventory to support sales in the U.S. and internationally for the holiday season as we get ready for 2022. The teams around the world have been working literally around the clock to help customers secure products they've ordered as efficiently as possible and will continue to do so as we get deeper into the holiday season. We appreciate the attention being paid to the challenges at the various large airports around the world and are hopeful that the backlog can start clearing in the weeks and months ahead. We have been working hand-in-hand with all, rerouting product to smaller, less congested ports, and more aggressively picking up product at the plants to minimize bottlenecks while customers work through the lack of ocean transit capacity. In the middle of Q3, while our customers' goods were stuck at our factories awaiting vessel space, our logistics teams began working with our trusted supply chain partners to route our domestic inventory up to Shanghai and store goods at bonded warehouses. This released pressure on our factories of the backlog of goods overwhelming their floor space and in turn allowed them to continue to produce goods. At the same time, moving the goods away from the port of Yantian, we were able to secure vessel capacity for domestic goods through lower volume ports in Shanghai. The extra transportation and short-term storage costs did not materially affect our domestic supply chain costs and more importantly, it reduced the potential of transit time delays due to the challenges in Yantian. Although we ultimately saw sales decline 2% in the quarter versus the year-ago quarter, we remain pleased that on a year-to-date basis, toys and consumer product sales are up 9% plus, and our costume business is up 21% plus, leaving us at 12% plus year-to-date for global company. Getting into more of the details, our year-to-date operating income is over $35 million, its highest level since 2015. Our adjusted year-to-date EBITDA of $44.2 million is up over 80% compared to the first three quarters of last year. Our adjusted EBITDA for the quarter was $41.7 million, or $1.1 million less than the prior year. Our gross margins remain strong, in part supported by the amount of inventory we managed to bring in early in the year. Our retail POS at the top customers is up 9% year-to-date, with cleaners sell through further benefiting gross margins. And not to be overlooked, during the quarter, we retired the remainder of our senior convertible notes, leaving us with an improved balance sheet and reduced interest expense going forward. Our worldwide teams continue to execute extremely well, doing the things we do best and doing both the business at hand today while building new and exciting initiatives and products for the coming years. Our net sales declined in the quarter as our orders outpaced our customers' ability to secure ocean passage or inbound product delays kept us from fulfilling orders before the end of the quarter. In our toy segment, our sales were down approximately 8%. This decline was mostly due to logistic challenges rather than less demand for any particular line of product. As we hoped, We have seen strong POS in our costume business as the days to Halloween tick down. We have shipped 64 million worth of costumes in the quarter, representing a 16% increase to the prior year. Many of our online-only customers increased their annual buys by 30% plus this year, but some of our larger customers who make their commitments back in Q1 were more conservative. Supply chains impacted this business less than toys as the team worked to accelerate shipments as customers would take them earlier to avoid log jams that are now impacting the holiday selling. Given the strong sell-through performance, along with new licenses coming online in 2022, Halloween 2021 is turning out great, which bodes extremely well for next year. On the toy side of the business, strong performers from the first half of the year continue to do well in the quarter. but we're also seeing some new things happening that we're excited to share today. This past quarter, we launched a new doll program in the U.S. at Target, branded Disney Ely Forever. It's a fashion-forward line of 18-inch dolls and related accessories inspired by classic Disney stories and caricatures, including Minnie Mouse, Tinkerbell, Stitch, Ariel, Elsa, Rapunzel, and more. Initial consumer reaction has been tremendous, and we are really proud of how the program has come together in collaboration with Disney and Target. Some other things that we're excited about as we recap Q3, our core businesses around Disney Princess, Nintendo, and Sonic continue to sell in and sell through well. Nintendo inventory at retail remains down despite our broader product line as the demand continues to pull product through. We're particularly pleased with the Super Mario Deluxe Bowser Airship playset this fall and are seeing great early POS results. The Sonic Giant Eggman Robot Battle Set is the largest Sonic's figure Jax has brought to market and early fan reaction also appears really strong. Our Disney Encanto line represents one of the broadest product ranges we have ever brought to market for a Disney Thanksgiving theatrical release. We love the product and can't wait for Disney fans to meet the characters and enjoy the magic of this film. Our private label business continues to grow double digits, and we hope to have more to say about that segment of business in the quarters to come. Our timeless holiday item, the Black & Decker Workbench, is represented well with retail exclusives at all the major U.S. accounts. And this fall, we're launching our indoor trampoline line with Paw Patrol and Disney's Minnie Mouse SKUs. We are pleased with how well some of these new products are being received and the momentum they take into the fourth quarter. We also saw the acceleration of retail POS in the quarter. Top three U.S. accounts' toy POS were up over 10%, while our ending inventory was down nearly 5%. That increases our related year-to-date toy POS number to over 9%, in line with overall shipments for the year. John will now review financials, and I will return with some thoughts around how we're thinking as we head into 2022. John.

Thank you, Stephen, and good afternoon, everyone. Net sales for the 2021 third quarter were $237 million, down 2% compared to $242.3 million last year. Third quarter sales in our toys consumer product segment were down 8% to $173 million globally, compared to $187.3 million in the third quarter of last year. North America was down 8%, while international was down 7%, primarily attributable to the supply chain issues already discussed, as both domestic and FOB sales were impacted. Through the first three quarters of the year, sales were $334.4 million, up over 9% from $306.1 million versus the prior year. Also, on a year-to-date basis, North America toy CP is plus 10%, and international toy CP is plus 8%. In our doll dress-up nurturing play division, net sales were $112 million in Q3, down 13%, compared to $129.3 million in the prior year. Disney Princess and Style Collection performed well in the third quarter, offset by lower sales from Frozen 2 as it approaches the two-year anniversary of the theatrical release. Perfectly Cute also continues to perform very well at retail. In the first three quarters of 2021, the total business is up 2% to $206.5 million versus $202.2 million. In our action play and collectibles division, net sales were $37.6 million, up 12% compared to $33.6 million last year. Sales for our video game-related toys, Nintendo and Sonic, delivered the majority of the growth, while we still see our Black & Decker role-play line strongly contributing. Our holiday advent calendars also generated positive growth versus prior year. Year-to-date, this business with net sales of $73.6 million is up 36% compared to $54 million in the first nine months of 2020. 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 $23.4 million in the quarter, down 4% from $24.4 million in the third quarter of 2020. In the first nine months, outdoor seasonal net sales were $54.3 million versus $50 million, up 9% year-to-date. Net sales in our costume segment, disguise, were up 16% at $64 million in the third quarter. Some of the big performers for us this year in this segment were Harry Potter, Pokemon, Minecraft, Toy Story, and The Nightmare Before Christmas. Stephen pointed out we remain excited about a bigger and better Halloween season this year with Disguise. On a year-to-date basis, our costume segment is up 21% to $98.8 million, compared to $81.5 million in the first nine months of 2020. Moving down the P&L, gross margin in the 2021 third quarter was $74.9 million at 31.6% of net sales and 82 basis point improvement over the 30.8% of Q3 last year. Product COGS for the third quarter were 53.2% of net sales, an increase of 262 basis points from 50.6% in the third quarter of 2020. This increase was due to increased ocean freight costs and some unfavorable product mix. The overall improvement in gross margin for the third quarter was the result of a 338 basis point improvement in the royalty line, which was $32.3 million versus $41.2 million in the third quarter of 2020. The lower royalty rate for the quarter was driven partly by a reduction in expected royalty guarantee shortfalls due to higher shipping levels from the relevant licenses. Despite higher ocean freight costs, we were pleased to see further improvement in gross margin rate. As a technical matter, it is worth noting that higher freight costs incurred to import our domestic product are capitalized in the inventory and only expense when the product is sold to customers. As a result, we anticipate seeing some lag effect in terms of higher freight costs working their way through the P&L, even as we work past peak shipping season and ideally see a reduction in these charges in the quarters to follow. Anticipated increases in our media and marketing spend were offset by a reduction in co-op advertising and timing of other selling-related expenses in the quarter. Overall direct selling costs were $10.7 million, or 4.5% of net sales, compared to $13.5 million, or 5.6% of net sales, in the third quarter of 2020. Our 2021 third quarter G&A, including product development and testing but excluding depreciation and amortization expense, was $26.8 million, or 11.3% of net sales, up from $23 million, or 9.5% of net sales in the third quarter of 2020, when austerity-related spending reductions were in place. These results combined to generate a third quarter operating profit of $36.7 million, slightly lower than the operating profit of $37.5 million achieved in the third quarter of 2020. As anticipated during the quarter, the balance of our senior convertible notes converted into common stock. In addition, during the quarter, the company received confirmation from the SBA that our application for PPP debt forgiveness had been approved. Also during the quarter, the company made its first scheduled payments against the term loan secured in June. With all these activities taken into account, as of September 30th, 2021, the company's debt at face value was $98.8 million, all owed under the term loan due June 2027. As of quarter close, we had no draw on our credit line. we did have $9.7 million in letters of credit. As of September 30, our availability under the line was $43.1 million. Our year-to-date interest expense is $11.9 million compared to $16.7 million in the first nine months of 2020. With greater certainty around our refinanced balance sheet, we can share that we're currently projecting full-year 2022 interest expense of $9.1 million, a meaningful improvement over 2020 and 2021, when full-year interest expense was $21.6 million and a projected $14.1 million in 21. As a reminder, the derivative liability attributed to our preferred stock is marked to market quarterly with non-cash gains or losses dependent on the valuation exercise. In the third quarter of 2021, that valuation resulted in a loss of less than $100,000. Capital expenditures during the third quarter of 2021 were $2.7 million compared to $1.8 million in the third quarter of 2020. Depreciation and amortization for the third quarter of 2021 was $4.3 million, compared to $4.5 million in the third quarter of 2020. In summary, Q3 net income attributable to common stockholders in the quarter was $36 million, or $3.97 per diluted share, compared to a net income attributable to common stockholders of $32.1 million, or $3.19 per diluted share, in Q3 of 2020. Excluding the impact of the non-cash valuation adjustments, stock compensation expense, and the one-time gain associated with our PPP loan forgiveness, our adjusted net income attributable to common stockholders in the third quarter of 2021 was $34.2 million, or $3.76 per diluted share, compared to our adjusted net income attributable to common stockholders of $32.6 million, or $3.56 per diluted share, reported in the third quarter of 2020. Accounts receivable as of September 30, 2021, were $209.2 million, up from $166.8 million as of September 30, 2020. DSOs for the 2021 third quarter increased to 81 days from 63 days reported in the 2020 third quarter, primarily due to a change in approach in working capital management. Inventory as of September 30, 2021, was $89.8 million, versus $54.6 million at September 30, 2020. The significant increase is a result of over $40 million worth of product that has left the plants in Asia but are taking a very long time on the journey to our warehouses in Southern California and Western Europe. DSIs in the 2021 third quarter were 51 days compared to 30 days in the 2020 third quarter. Our adjusted EBITDA for the quarter was $41.7 million, compared to adjusted EBITDA of $42.7 million in 2020. That brings our trailing 12-month adjusted EBITDA to $48.1 million, representing 8.6% of our trailing 12-month net sales. The diluted income per share calculation for the third quarter of 2021 was based on a weighted average of 9.07 million common shares outstanding, down from 9.31 million in the third quarter of 2020. This 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 pass the microphone back to Stephen.