JAKKS Pacific, Inc.

Good afternoon, everyone, and welcome to the Jax Pacific second quarter of 2022 earnings conference call with management, who will review financial results for the quarter ended June 30th, 2022. 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 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 highlights of product lines and current business trends. Then Mr. Kimball will provide detailed comments regarding Jack's specific 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. If you would like to be placed in the queue to ask a question, please press star 1 1 on your telephone keypad. Before we begin, the company would like to point out that any comments made about Jack Specific's future performance Events or circumstances, including the estimates of sales margins and or adjusted EBITDA in 2022, as well as any other forward looking statements concerning 2022 and beyond are subject to safe harbor protection under federal securities laws. These statements reflect the company's best judgment based on current market trends and conditions today and are subject to certain risks and uncertainties, which could cause the actual results to differ materially from those projected in forward-looking statements. For details concerning these and other such risks and uncertainties, you should consult Jack'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 and adjusted earnings per share. Unless stated otherwise, the most directly comparable GAAP financial metric has been reconciled to the associated non-GAAP financial measures within the company's earnings press release issued today or previously. As a reminder, this conference call is being recorded. With that, I would now like to turn the call over to Stephen Berman. Please go ahead.

Good afternoon, and thank you for joining us as we discuss our most recent quarter and what we see coming for the balance of the year and some thoughts about 2023 as well. It's not often you get to report quarterly year-over-year sales growth of 96%, so you can hopefully forgive our enthusiasm around our latest results. With $220 million in net sales in Q2, we were finishing the first half of the year with $341 million shipped year-to-date. That is the highest year-to-date ship total through June in the history of the company dating back to 1995. I have been strongly passionate all throughout the pandemic about the team working together across offices and collaborating to deliver amazing results. And this past quarter is just another example of what I've been talking about, but taken to a new level. As we have said before, years ago, we implemented a new philosophy and approach to running our company. Within each of our divisions, we seek out a mix of strong and opportunistic licenses to build stable, growth-orientated categories. By focusing on methodically building and refreshing our product lines annually, we create the brick by brick foundation of our evergreen business, delivering the singles and doubles that generate our results year after year. Within those categories, we further develop items for each class of trade in which we see opportunities. En masse for customers like Target, Walmart, Amazon, Tesco, Car-Fu, and more. For specialty channel customers such as Smith's, Kohl's, Game Start, Barnes & Noble. And for value drug and grocery customers like Kroger, Dollar Stores, Walgreens, CVS, Ross, Big Lots, Five Below, as well as many others. In addition, With all these classic trade retailers, we look to be creative at retail with our out of aisle product placement such as check lanes, pallet programs, two by two displays, clip strips and more. By redeveloping items annually, we ensure to the best of our ability margin expansion. And we always look for new opportunities and product innovations and licenses. With that foundation, There will sometimes be unique opportunities to exceed our expectations, which you are seeing this year, with many areas of the company performing extremely well and contributing to tremendous performance against our plan. To name a few, toys developed for the Disney animated film Encanto and the live-action and CGI film Sonic the Hedgehog 2 are having exceptional years. Beyond those two, we are seeing amazing continued expansion of the evergreen Nintendo IP, very strong demand for Disney Princess products, as well as our perfectly cute baby line. And for Halloween, we have a plethora of new licenses and newly developed, really creative product costumes and related accessories. Lastly, with the international initiatives we have embarked on over the years on opening up offices to sell direct to retail in more markets, we are seeing tremendous growth, details of which I will highlight shortly. As we discussed last quarter, we have been seeing exceptional demand for our current product lineup. We've applied tremendous focus to enabling our FOB customers to secure products with enough lead time to avoid the supply chain bottlenecks that negatively impacted everyone in the second half of last year. And at the same time, we've done everything we could to take advantage of off-peak shipping windows to secure the manufacturing and inventories we plan to sell domestically in the second half of this year. Our quarter end inventory level is 124 million, of which 36 million is in transit to our warehouses. Although this is a high level for Q2, it is reflective of our planning to mitigate potential exposure to our higher second half spot container rates and extended transit times. Given our strong sell-in and sell-throughs to date and reviewing the insights into retail demand for the second half of the year, we are quickly pivoting our attention to ensuring that we exit the year with tight inventories at retail and within our own warehouse infrastructures worldwide. There has been a lot of discussion around the outlook for the economy, retail inventories, and the mindset and spending power of the average consumer. There are several areas of business we've been focusing on, It is well known that the toy industry often shows higher resilience than other consumer areas when spending power is challenged. Current data also suggests that accumulated household savings are at higher levels than they were when entering past slowdowns at the employment levels remain robust. Although it's true that there has been a lot of spending in the toy space over the past couple of years, it is also true that a three-year-old is now a couple of years older too. To our way of thinking, both the younger children entering the toy market as well as the older children entering different phases of development need new and different toys to engage with. And when you layer in basic play and play patterns that are healthy for children and the surge of new content reaching households at theaters and via streaming, we believe it's still a very good time in the toy kids consumer business. At Jaxx, we've been extremely focused over the years to try to ensure a large portion of our product SKU retail price points are lower than $30. We are proud that over half of our revenue comes from items that traditionally retail for $25 or less. And when you move that threshold to under $50, you're closing in on 90% of our sales. That reality of affordable price points in combination with the current popularity of our classic and topical brands leaves us mindful of the current market conditions, yet optimistic that we will finish the year with the right kind of momentum heading into 2023. At retail, broadly speaking, our largest segments of business are performing best, and our sense of the market is our velocity is as good or better than any other company in our space. Of course, we did see some point of sales that slowed down compared with some of the strong numbers we saw earlier in the year, but we are certainly growing faster than the market in total. Our Q2 toy consumer product segment grew 83% with North America up 92% and international up 38%. All of our international regions and nearly all of our top 10 markets were up double digits during the quarter. We are also on track for a tremendous year in our costume business. Q2 represented the biggest Q2 ever for the business since Jack's acquired disguise back in 2008. Last year, some customers were late setting planograms for the Halloween season. This year, we are stretched the industry standard timelines to work with our customers and factories to reduce that likelihood as much as we could. and our international expansion led to most markets shipping a multiple of the level shipped last year. In total, we shipped 72 million in the quarter, more than double what we shipped in the quarter last year. Container costs continue to be a drag on the product margins compared to prior years. We have been relatively pleased so far not seeing a repeat of the costs and delays we were dealing with in the second half of 2021. As mentioned, We were doing everything we could and can to keep these costs in check, inclusive of trying different routings and carriers to import the product. So far, so good, but of course, the next six months will be critical to how our year finishes. Some of our outdoor seasonal items continue to struggle from a margin perspective, given the continued challenges of tariffs and the container cost impact on the larger cube items. This remains one of the toughest parts of our business this year. There's no magical solution, but we know this is a solid segment for us and we continue to explore all angles to get this business on a better trajectory. Shipping in this business was down 25% in the quarter year over year. We are keeping shelf space for these categories of business, but shipping less than normal due to the margin impact. Retailers are also negative about big items in general, given their inventory issues outside of the toy and their general need for space for other goods and categories of goods. As I said in April, with each passing quarter, our balance sheet gets stronger. Given our recent performance and outlook for the next 6 to 12 months, before the second quarter closed, we just decided to make an optional $10 million pay down towards our long-term debt. This will save us meaningful cash interest expense in the second half and gives you some sense of how we're thinking about our performance and liquidity between now and the end of the year. I will now pass the call over to John for some further discussions around our financials, after which I will come back with some more thoughts about the balance of the year and how we are starting to think about 2023. John. Thank you, Stephen, and hi, everybody.

Sticking with the idea from last quarter, I will skip reading through the various financial details included in our release today, even if they are pretty good. But I'll try to touch upon what are hopefully some more insightful thoughts and observations as we mark the halfway point in the fiscal calendar. Even if there's not a lot to add, I'm not going to pass on the opportunity to say something about sales. Singles and doubles generally isn't supposed to mean nearly doubling last year's sales number in a quarter, but we'll take it. What I think you see in these results are execution against what we've been talking about the last couple of quarters. A longer and more expensive supply chain for us translates to our wanting to do even more FOB business and to reaffirm our focus on our biggest and most popular brands and segments. It also increases the urgency to be thoughtful about inventory purchasing and to similarly prioritize our best-selling items. We've also been talking about great consumer demand for our product lines and customer enthusiasm for our current lineup as everyone gets ready for the all-important second half. Add all those factors together and layer in the great momentum of our costume business. That leads you to the types of sales numbers we've seen in the first half of the year when supported by the team's relentless execution. As we've also said before, we really do manage the business with a full year view given our seasonality. So although we love being able to deliver quarterly results like these, we really are focused on finishing strong on 12-31 and then starting all over again. I will point out as a reminder that we had about $30 million worth of Q3 sales ship out of the quarter into Q4 last year due to customer pickup delays in Asia, contributing to a much higher Q4 than we would have expected. Those dynamics are always in play given current events. But beyond that, there's not a lot more to be said about seasonality than what we've already covered. The sales performance to date has been exceptional, along with the timing of when it's happened, given that increased freight costs have eroded some of the progress we were making in gross margins in 2020 and early 2021. That said, we're pleased to only be down less than 80 basis points in gross margin percentage compared to last year. Our product margins are holding up well thanks to a combination of designing for improved margins and pricing. Royalty expense is tracking a bit higher, as some older agreements charge a higher rate for FOB sales versus domestic sales, and there's a product mix element in play as well. As Steven pointed out, the narrative on ocean freight in Q2 is along the lines of, so far, so good. Still unfavorable versus prior year, but it certainly could have been worse. Where this topic ends up six months from now will have a meaningful impact on our full year results, as well as our ability to drive bottom line margin percentage improvements in 2023. Great sales volume clearly is especially good when it leverages the fixed elements of our cost base. Operating margin for the quarter was positive, and our trailing 12-month operating margin increased to 8.2%. As Stephen also mentioned, we took the opportunity to make a fee-free paydown of our long-term debt at the end of Q2. With LIBOR increasing, this represents at least $400,000 in cash interest avoidance between now and the end of the calendar year based upon projected rates. Interest expense in the quarter was $2.3 million, down from $4.4 million in the same quarter last year. And the marketing to market of our preferred stock liability resulted in a non-cash gain of $6 million, primarily due to rising interest rates. We back that gain out of our non-GAAP calculations of adjusted EBITDA and adjusted EPS. In aggregate, our adjusted EBITDA for the quarter is $27.1 million versus $5 million last year. Our trailing 12-month adjusted EBITDA is now $75.7 million, or 9.9% of net sales, which was $49.1 million and 8.7% of net sales at this time in 2021. Moving on to the balance sheet. You'll note with the surge in sales and our pulling forward of inventory, our mid-year non-cash working capital is very high compared to historical loans. We've generally been able to self-fund that and would expect that number to work itself down a bit by the end of the year or early next, in part driven by timing and levels of 2023 shipments. Our cash balance at the end of the quarter was $62.3 million. Our total debt was $84.9 million, and we had no draw on our credit line. We like where that puts us, but we still have the bigger half of the year ahead of us, which isn't lost on anyone here, so plenty of work left to do. Finally, some of you noted that we filed an S3, more commonly referred to as a shelf registration, with the SEC earlier in the month. Broadly speaking, we've intended for quite some time to get a shelf in place, in case a situation arises in the next couple of years where management and the board feel offering some more shares would be the right thing to do. We consider having this flexibility to act quickly to seize upon opportunistic scenarios another positive for the company. So we were happy to get around to getting it filed. And with that, I will now hand the call back over to Stephen for some additional remarks.