JAKKS Pacific, Inc.

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Good afternoon, everyone. Welcome to JAX Pacific fourth quarter 2022 earnings conference call with management, who will review financial results for the quarter ended December 31st, 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. Stephen will first provide an overview of the quarter and full year, along with highlights of the product lines and current business trends. Then John will provide some comments regarding Jax Pacific's financial and operational results. Stephen 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'd like to be placed in the queue to ask a question, please press star 11 on your telephone keypad. Before we begin, the company would like to point out that any comments made about Jack Pacific's future performance, events, or circumstances, including the estimates of 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's protection under federal securities laws. These statements reflect the company's best judgment based on the 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 and 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 filing 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, most directly comparable GAAP financial metric has been reconciled to associated non-GAAP financial measures within the company's earning 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.

Thank you.

Good afternoon, everyone, and thank you for joining us today as we recap the quarter and year and share our thoughts about what we're seeing in the months and quarters ahead. Our fourth quarter sales ended up slightly exceeding our expectations, despite our exceptionally strong results early in the year. Our fourth quarter net sales totaled 131.9 million, bringing our full year net sales to 796.2 million, the highest annual results since 2014. As we anticipated, sales were down 30% in the quarter compared to the same quarter last year, largely attributable to our prioritizing FOB selling early in 2022 and the related changes in seasonality of our business. Our full-year growth was driven by a combination of key SKUs across our major brands. In our Nintendo business, both our Mario Kart 24-volt ride-on racer and Let's Go Yoshi interactive action figure had great launches. Our Sonic Movie 2 Speed RC had a tremendous year. Our Disney Princess Style Collection Kitchen and Suitcase continued to deliver. In addition, we had two strong entertainment-led product lines for Disney's Encanto and Sega's Sonic the Hedgehog. I'm happy to report that in total, seven of our top largest toy consumer product segments grew in calendar year 2022. We had a very strong holiday season led by key SKUs across our major brands. And our Disney's Encanto Magical Casa Magical we've discussed before, but it's worth bringing up again. It's been such a great item for us. And as we stated on our call, 2022 was our largest selling year with disguise since the acquisition in 2008. We finished the year at 148.9 million in net sales, a 38% increase over 2021. In reviewing the year, customers clearly chased the Halloween holiday in a couple of cases a bit too much, which merits a bit of recalibrating in 2023. That said, this business has never been better with our brand assortment of popular licenses and the steady build and capture of the international opportunity we think exists. Last year at this time, we were deep in the chaos of inbound shipping delays with nearly 30% or approximately 20 plus million dollars worth of our own inventory in transit to one of our warehouses rather than being ready to ship. I'm happy to say that we closed 2022 with only 4.9 million in transit to our warehouses and our overall owned inventory was down to 80.6 million heading into the new year. As we have stated in recent quarters, and really going back to our 2019 recapitalization, it's been a priority to reduce the overall leverage and interest expense. Although our 2021 refinancing was a positive step in that direction, the rise in market interest rates in the past few quarters has increased the overall rate of our term loan above 10% per year. With that in mind, we have been extremely focused on freeing up cash where we can. Our exceptional performance in 2022 in combination with our unusually heavy first half seasonality combined to generate over $86 million in operating cash flow in 2022. As reported in recent quarters, we allocated $27.5 million to the optional term loan pay downs in 2022. In addition, we're reporting today that we made an additional optional payment earlier this quarter of $15 million, $5 million of which incurred a 3% prepayment fee. The ECF sweep provision of our term loan also required us to make an additional mandatory pay down of $23.1 million without any prepayment fees. When we tally up these additional payments, the current payoff level of our term loan as of today is just $30.8 million. We are beyond proud of these improvements to our balance sheet. We are following our roadmap of lowering our borrowing costs and evaluating the broader array of options afforded to us as we increasingly engage the market from a position of financial strength. As you have often heard me say on these calls, when you're in an industry like ours, it's imperative to be resilient and stay attentive to always the changing dynamics of the worlds in which we live in. We were not immune from the issues of other companies in our space experience last year as it relates to how customers track consumer demand and plan for the holiday season. Slowing customer demand in our seasonal business in the second half bogged down our supply chain, generating excessive costs associated with warehousing and importation of product, despite lower container spot rates in the second half of the year. This hurt the productivity of our warehousing operations, and merited taking some aggressive actions as it relates to valuing of our own inventory. Our toy and kids consumer products point of sale remained up double digits in Q4 at our top three accounts. And we think we've performed better in this area than our peer groups. Nonetheless, our provisions for sales allowance in Q4 were unfavorable to our 2021 results like many in the industry. These factors were the primary drivers of our fourth quarter gross margin finishing at 21.7% compared to the 26.6% reported in Q4 2021. John will go through the math in a bit more detail when I hand over the phone to him, but I wanted to highlight this as a clear area for improvement in 2023. With that said, the year ended up pretty much where we thought it would be and planned it to be since our last call. Most of us have been in this business a long time, so forgive me for recapping one more time of the full year highlights. Full year net sales of $796.2 million, a 28% increase over 2021, and a 54% increase over our pandemic low of $515.9 million in 2020. Full year operating income of $61 million and operating margin of 7.7%, a 140 basis point improvement over 2021's 6.3%. Full year adjusted EBITDA of $76.4 million, up 55% compared to last year and our highest level since 2010. At Jaxx, we are thankful and appreciative of all of our success as we know how challenging this business can be. We intend to continue to focus on timeless brands and categories. Our singles and doubles that might not be exciting for everyone, but represents the foundation of which our business was built. We continue to actively pursue the most relevant IP rights for our model, with the knowledge that sometimes passing on an opportunity is more prudent than chasing new business at any cost. In 2023, we will continue to expand our North American distribution footprint beyond the major customers. In addition, as you know, we have been methodically going deeper into the largest international markets with both toy, kid consumer products, and costume businesses, and we intend to continue that in 2023 as well. I'll stop here and let John go a bit deeper into some of the financials, and then we'll come back to talk more about 2023 and beyond. John.

Thank you, Steven. And hi, everybody. As regular listeners know, there's a greater level of granular detail included in our release today, but I'm going to be selective in what I highlight here towards what I think merits the focused attention. We're pretty happy with how the year ended from a shipping perspective, delivering the 20 plus percent top line growth we talked about last quarter. and doing so for the second year in a row. As Steven alluded to, we saw similar trends as others in the industry as it relates to consumer sell-through at retail, inclusive of a bit more of the traditional rush in the last couple of weeks. The shelves could have been a bit more empty on 1231, but we don't think we distinguished ourselves to the negative on that front, which is helpful from a big picture point of view. Gross margin is clearly an area where we were experiencing more challenges. Being proactive as it relates to cleaning up inventory is something you pay for here, especially in a smaller shipping quarter. Royalties continue to run a bit higher, as expected. Our tooling amortization is trending up a bit. We've talked about CapEx being up a bit this year as we duplicated tools on some lines to chase demand. One of the bigger expense areas here is from lack of warehouse productivity. To geek out on it briefly, inbound freight and a portion of warehousing is capitalized to product, and that math is driven in part by how much we've spent on warehousing during the year and also how much product we're importing during the year. When you consider how we've been trying to work down inventory since the beginning of last year, and we experienced higher warehousing expense this year dealing with the supply chain backing up a bit and are needing to secure some incremental space, that math doesn't work in our favor. You have more costs than you'd like and less product to spread the cost over. The result then flows through your P&L. Everything wasn't bad here. We did have some improvements in landed cost margin year over year, and we're lapping the excessive container costs of last year. But when you add it all up, gross margin for the quarter was 21.7%, or 490 basis points worse than Q4 of last year. Full year gross margin ends up at 26.5%, or 300 basis points below 2021. The 2022 gross margin percentage, however, is not adjusted for the portion of co-op advertising, which we moved into sales allowances at the beginning of 2022. Historically, that number is in the 200 to 250 basis point range. So you can adjust that out if you want a more accurate year-over-year comparison here as you ponder what might be feasible in 2023. Direct selling in the quarter was roughly in line with our expectations aside from the aforementioned higher warehousing expenses. The year-over-year number is negative on the P&L as that co-op advertising element is now recorded above net sales. G&A, inclusive of product development and testing and depreciation and amortization, with $31.1 million up from $27.9 million in Q4 2021. On a full year basis, that number was $116.7 million, a 15% increase over 2021. The main driver there has been our adding back positions post-pandemic to support the expansion of the business over the past couple of years. Our non-comp-related G&A, inclusive of stock comp expense, grew high single digits on a full year basis, which feels reasonable as you think about 2022 being more return to office and pre-COVID norms for us, as well as there being a bit of variable spend in that number. We have been working on a bottoms up review of spending as we start a new year to ensure that we're minimizing and optimizing our expenditures. On a full year basis, our operating margin of 7.7% was as high as that number has been since 2008. Closing the books this year required a lot more time and effort as it relates to our tax provision. Shout out to the tax team. We've concluded a 382 analysis on both the federal and state levels to refine the level of net operating losses, or NOLs, we expect to utilize in the years to come in light of a couple of impairments that we have identified as taking place in 2019 and 2021. A longer recap on this topic will be included in our 10-K filing. As part of that exercise, and in conjunction with our financial projections, as part of this quarter's close, we're releasing a valuation allowance against a portion of those historical NOLs. This release generates a one-time non-cash gain of $52.6 million as part of this quarter's P&L, which we have adjusted out of our adjusted EBITDA, adjusted net income, and adjusted EPS calculations. Looking forward, we'd anticipate being around 21% as an effective tax rate in 2023. Although Stephen walked you through it, I want to revisit the current state of our debt. Part of our annual closed process, we generated full-year operating cash flow of $86.1 million. When adjusting for CapEx and optional paydowns we made during the year, our term loan has a mandatory paydown provision which calls for a payment of half of that amount. And as a result, we have moved that dollar amount, $23.1 million, to short-term debt as part of our 1231 balance sheet. We have, in fact, gone ahead and made that payment as our numbers finalized. In addition, we made an optional paydown in January of $15 million the last $5 million of which included a 3% prepayment fee of $150,000. When you add those two amounts together for total payments of $38.1 million to date in 2023, that reduces our current term loan payoff amount to $30.8 million. The carrying amount is slightly lower given unamortized loan fees, but that will be addressed as part of our Q1 close process. As of March 3rd, our unrestricted cash balance was $37.9 million, net of those loan pay downs, and we currently have no draw on our ABL. This is the time of the year where our liquidity tends to get tight as we are building product for second half consumer demand, but we're comfortable based upon our projections that we can navigate towards the second half of the year leaning on our ABL line if needed. Relevant interest rate on our loan is around 11.2% in Q1. With a drastically reduced balance, the associated interest expense is less of a drag on our results. acknowledging the drawing on our ABL is also more expensive these days given the higher Fed funds rate. In any case, currently job number one remains executing against this year's operating plan. We clearly had an atypically robust revenue line last year driven by a couple of hits. We have a lot of great initiatives this year, as Stephen will soon highlight, but how those two ultimately balance out is inevitably hard to project if one is being honest. We have clear opportunities to improve gross margins, and then the challenge becomes what sort of scale can we get out of our fixed cost base. With a lower interest expense projection for the balance of the year, we plan to be opportunistic in evaluating whether refinancing our remaining debt is the right course of action or whether we should let the quarters ahead play themselves out, particularly given the range of opinions about where interest rates and market liquidity might be 12 months from now. Elsewhere on the balance sheet, in reviewing our preferred stock derivative liability, primarily due to higher market discount rates, this quarter we recorded a lower valuation of the liability, generating a non-cash gain of $1.4 million. We back that market adjustment out of our non-GAAP calculations of adjusted EBITDA, adjusted net income, and adjusted EPS. Our adjusted diluted EPS for the quarter is a loss of $1.44 down from a gain of 14 cents from Q4 2021. Full year adjusted diluted EPS was $4.28 compared to $2.59 for full year 2021. Quarterly EPS is calculated based on a basic share count of 9.7 million, year-to-date EPS is calculated based on a diluted share count of $10.2 million. And in aggregate, our adjusted EBITDA for the quarter was a loss of $12.1 million versus a gain of $5 million last year. Our full-year adjusted EBITDA was $76.4 million, or 9.6% of net sales, compared to $49.2 million and 7.9% of net sales in 2021. And now, back to Stephen for some additional remarks. Thank you, John.

I want to turn now to talk about some of the key areas we're focusing on this year. In our action figure and collectible business, we are extremely excited about the new Super Mario Brothers movie from Illumination and Nintendo launching in theaters April 5th. The team has created an entirely new five-inch scale with greater articulation in conjunction with the movie, along with micro figures and play sets and a seven-inch fire-breathing Bowser. All that product and more is hitting shelves now. We are extremely excited for fans to see the movie and the product. And if our experience with Sonic the Hedgehog is any indication, the entertainment will bring new fans into the franchise to discover both our movie product as well as our deep catalog of Super Mario toys we've been building for several recent years. We are expecting some great things with Nintendo this year. That's not to say we have forgotten about Sonic in the slightest. The new Sonic Prime episodic programming started on Netflix in December and has been a great success. We have related products launching this fall, coordinated with an additional drop of content. We were really pleased with the Sonic's performance in Q4 and how the product line will continue to expand this year, supported by new content development. And this team in particular is always aggressively looking out for new opportunities, which at this point would be 2024 and beyond. But watch this space for more news here. Our Dolls Roleplay and Dress Up segment is coming off a massive year, led by growth in Disney's Encanto, Disney Princess Dress Up, and the Disney Princess Style Collection. For those of you that know the business, we have some difficult comps year over year in this area, but there are many new initiatives bringing new news and energy to these aisles at retail. In Q1, we partnered with Walmart to exclusively launch our latest new IP, Ami Amis, a new collectible plush line that inspired by the trend of yarn and crocheting. This is a broad collection of soft and cozy characters that personify all of collector's favorite things. Every collectible has a sweet little personality that is described on their hang tag and found in their product details. The awe factor of this product is really off the charts and we've been hiding it from the world until our release last month. Its distribution will begin to go wider in the second half of this year and we are eager to see the reaction to what the team has put together over the past year. Our Disney business is working on to support Disney 100 celebrating 100 years of the Walt Disney Company. This 18-month celebration commenced December 26 and runs through June 2024. Each month, Disney will celebrate a key franchise every month. Disney's Encanto was a focus in February. We have created exclusive Disney 100 products for top U.S. customers as part of their respective programs to celebrate this milestone. We'll be sharing more about the Disney 100 celebration throughout the year and are obviously extremely proud to be part of such a large cultural event. As we mentioned last quarter, we have new product lines launching in support of two Disney theatrical releases this year. Coming in May is Disney's The Little Mermaid live action retelling the beloved animated story. Leveraging the new art styles, icons, and designs from the movie, we have dress-up, role-play, toys, and large dolls inspired by the film. We are extremely excited in Thanksgiving's release window as Disney's Animations Wish, exploring how the iconic Wishing Star came to be. As Disney's 100 immerses fans around the world in the magic of Disney all year, this is a great foundational cornerstone release launching during the holiday season. Our Disney Italy large doll remains on the end cap at Target in the US and continues to get great reaction in the 18-inch doll space. International expansion of this line continues in 2023, and later this year, we're bringing the brand to fashion doll scale, so stay tuned for more details about that launch. The effect of the supply chain disruptions and freight costs increases of late 2021 and 2022 impacted the seasonal business, particularly more in 2022. The input costs of bulk-sized products and resulting freight costs of activity tables, ball pits, and ride-ons led to price increases to consumers which slowed down POS and contributed to the overall shipments being down year over year. With freight costs closer to pre-pandemic levels, we are looking to stabilize the seasonal business in these core segments, as well as grow the reduced skateboard business and expand action sports with inline roller skates. Moving on to our disguised costume business, Q1 marks the first full year of holding the Disney license in Europe, and we are really pleased with how the business is developing. Adding those rights has provided us with more scale, enabling greater investment in local resources to tailor our product offerings to the local tastes and requirements, and also provide the right level of service and attention to costume buyers. Back in North America, some of our customers got a bit ahead of themselves in 2022, setting a high hurdle for this year. But overall, the trajectory of this global business looks great. From a seasonality perspective, certainly there's a lot of talk about the economy, retail inventories, and the mindset of the consumer. We are extremely comfortable with where we are with respect to our peers and are looking forward to the highlights I just mentioned and pushing forward some other initiatives that we have in the works. We do agree that 2023 will return the toy industry to its more normal traditional heavy second half focus than what we've experienced the past few years. We had tremendous POS in the first half of last year as we chased demand on a couple of our larger businesses, performing at a higher level than one would reasonably plan for. As we remain very much an FOB-first company, we still expect the first half of the year to be material for us. Although it's a new year, we continue to focus on the basics of our business, working closely with our factories to ensure we are securing the best prices and on-time deliveries. working with our customers and licensing partners to develop the right promotional programs to generate robust sell-throughs for this year's products while we simultaneously develop next year's. And lastly, we are always talking to everyone all the time about brand new product line extensions and opportunities to continue to layer on the newness and excitement that our business requires. We look forward to updating you during the year about our progress and appreciate your continued support and interest. One final point before we move on to questions. Our company is focused on expanding its global distribution network. We have been methodically building out our international structure and teams for long-term growth in both mature and underdeveloped markets. This has been rewarded with steady increases in our international sales over the past several years. In order to further that growth, I'm extremely pleased to announce that effective January 1, 2024, our Chief Operating Officer, Jack McGrath, will move full-time to our UK office and assume the role of President of European Operations. We anticipate that this will augment the coordination of our U.S. and international initiatives and help us achieve our fullest market potential. We are confident that Jack will use his many years of experience with our U.S. operations to take advantage of the opportunities for appropriate expansion of our international footprint. This restructuring has been in the works for some time, as we have plans to reassign his current responsibilities to the appropriate leaders of other departments. There is no intention to backfill the corporate COO position at this time. With that, we will now take questions.

Operator?

Thank you. As a reminder, to ask a question, please press star 11 on your telephone and wait for your name to be announced. To withdraw your question, please press star 11 again. Please stand by while we compile the Q&A roster. I would now like to turn the conference back to CEO Steven Berman for closing remarks.

Thank you, ladies and gentlemen. We have a lineup of calls after this one, so we appreciate everyone that were on the call today and who we'll be speaking to after this call. And we look forward to talking to you after our first quarter is completed and during our first quarter earnings. Thank you again.

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

The conference will begin shortly. To raise and lower your hand during Q&A, you can dial star 1 1. The conference will begin shortly. To raise and lower your hand during Q&A, you can dial star 111.