JAKKS Pacific, Inc.

Everyone, welcome to the JAX Pacific second quarter 2023 earnings conference call with management, who will review financial results for the quarter ended June 30th, 2023. 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 Steven Berman, Chairman and Chief Executive Officer and John Kimball, Chief Financial Officer. Stephen will first provide an overview of the quarter along with the highlights of product lines and current business trends. Then John will provide some additional editorial around Jax 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 the question, please press star 11 on your telephone keypad. Before we begin, the company would like to point out that any comments made about JAX-specific future performance events and 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 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 Jack's most recent 10-K and 10Q filings with the SEC, as well as the company 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 associate non-GAAP financial measures with 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. Sir, you may begin.

Good afternoon, and thank you for joining us today. As we cross into the second half of the year, we are happy with our performance to date and our outlook for the balance of the year. We feel we're lined up for another very, very good year here at Jaxx. In the second quarter, we marked a number of meaningful positive milestones that are foundational to achieving our 2023 objectives. As we have previously disclosed, in early June, we retired the balance of our long-term debt several years prior to its scheduled maturity. Our tighter working capital management and projections for the balance of the year gave us confidence we could make that decision and access cheaper financing as needed in the short term. We're always looking for ways to improve our bottom line results and given this higher interest rate environment, this is a good opportunity for Jaxx. We consider this a remarkable accomplishment given the high leverage of our recapitalized 2019 balance sheet. Over the last three and a half years, the company has spent over $35 million in cash interest expense. We look forward to any future borrowings being on a more favorable terms and to be done more strategically. Turning to the more operational side of our business, the two major films we're supporting in the first half of the year in both the toy and costume businesses are paying dividends. The Super Mario Bros. movie worldwide box office is now in excess of $1.3 billion and as expected is driving demand for both our classic Evergreen Nintendo product line as well as the new product range inspired by the films. The fire-breathing Bowser has already shipped over 300,000 units and is one of our most prolific must-have toys in recent years. We are extremely proud of the team's success in taking such an iconic character and transforming him into such a memorable wow toy. Separately, the Disney Little Mermaid film has generated over a half billion dollars at the global box office. We've seen great reaction to our Ariel dress, Under the Sea Exploring Aerial Feature Doll with Lights and Music, and our Singing Seashell Necklace that are all inspired by the film. And our Evergreen Disney Princess Business is also benefiting, outperforming last year in terms of sell-through at the top three U.S. accounts. Accordingly, we saw Toy Consumer Products POS at the top U.S. accounts accelerate in the quarter from Q1, reaching high single digits in total. Our action play and collectible business was up 20 plus percent and our doll role play and dress up segment was slightly positive despite a robust Q2 last year. In line with what we're hearing about trends at retail, we finished Q2 with around 10 to 15 percent less inventory on hand in those accounts compared to the end of Q1. Their inventory levels are down even more from this time last year if you set aside carryover from our big holiday 2021 film release. We are continuing to see retail take a cautious attitude towards inventory both now and as they project the holiday season. This approach is important in context in evaluating our Q2 sales results. As a reminder, last year's market had a remarkable number of customers buying product early in the year to avoid out of stocks. and adapt for the longer supply chain they saw in 2021. In 2023, nearly all customers to varying degree are being conservative with their buys now and are looking towards the back half. Retailers are carefully watching their margins and being more comfortable with the prospect of running out of stock than risking being in deep inventory. We are fortunate though to have once again some of the hottest businesses in addition to our proven evergreen lineup in this environment. We continue to work closely with smaller customers who are seeing it as an opportunity to gain market share. This year, we shipped $167 million in the quarter, down 24% from the record-setting Q2 last year. Nonetheless, as expected, we saw a continuation of overall strong first-half performance compared to our historical trends. We attribute these results to a combination of strong first half entertainment properties this year and last, as well as our continued focus on the FOB business model, encouraging customers to buy for the second half at the ports in Asia to leverage their larger and efficient supply chains. For the total company in the first half of the year, we were down 24% in North America and up 10% internationally, led by a near doubling of our business in Latin America. The exceptional growth of our action, play, and collectible division to 52.6 million in the quarter, up 41%, was not enough to overcome the drop in our dolls, role-play, dress-up division, which nonetheless shipped 59 million this quarter, down from an astronomical 102 million this time last year. It's worth noting that this year's doll division performance represents a 21% increase over the same quarter in 2021. Our outdoor seasonal business continues to face some challenges ranging from retailers moving away from large cube items in store, as well as a degree of overhang from COVID stockpiling on many of these items. This business was down 34% year to date, and we are looking on a range of different initiatives to enhance and grow this division, which we are excited about and we'll be able to share more about later this year. In our costumes business, we were down 32% in the quarter. Late in the quarter, we found more customers pushing shift dates into July as their confidence builds around faster supply chains. Overall, we still are anticipating our cost of business to be slightly lower than last year, which was a record high. I will now pass it over to John for some further comments, after which I will come back with some additional material about where we are focusing in the second half. John.

Thank you, Stephen. And hello, everyone. We've been busy over the past few weeks reviewing the quarter and first half results, trying to figure out what's gone according to plan, what's been better than we would have hoped, and what areas have been a bit lacking. And overall, as Steven pointed out, we're pretty happy with where we are, as it's roughly where we hoped we would be. We knew we had an extremely difficult revenue comparison due to the massive top line growth we've achieved in recent years. But we also had a degree of confidence that gross margin percentages could improve and that we could hold the line on SG&A spending reasonably well to mitigate the revenue downside. And broadly speaking, that's where we've ended up. So now we're onto the back half, and we'll try to stay on that path. So some first half headlines. Revenue was down 20% for the first half, and we continue to see a more front-weighted year compared to recent years, as Stephen noted. As an additional reference point there, Although down year over year, our first half sales results are 40% higher than the comparable period in 2021. We're happy to see second quarter product margins expand to 48.4%, up 370 basis points from 44.7% in prior year. For the first half, we're at 47.4% product margin, which is 420 basis point improvement from 2022. This improvement mitigated our gross profit dollar decline of 16% in the quarter and 9% for the first half. The first half gross margin of $82.6 million is the second highest number since 2009, 14 years ago. It's also the first time our quarterly gross margin percentage exceeded 30% since Q3 2021. Moving on to SG&A, similar to last quarter, we see some expense areas running higher than prior year and are exploring operationally to recalibrate where appropriate. Overall, we've managed to keep the net dollar growth to $4 million year-to-date across direct selling and G&A, excluding depreciation and amortization. Operating margin in the quarter dropped to 9.9% from 10.7% in the year-ago period. As the year progresses, we're continuing to evaluate spending decisions, prioritizing improvements to our infrastructure and processes, as well as demand creation for key product lines. It is normal course of business for us to be in a constant state of looking to reduce or eliminate more legacy costs that have historically been a bit more fixed within our cost structure to self-fund those initiatives as much as we can. It was that logic, in part, which motivated our early-term loan payoff, as eliminating unnecessary interest expense frees up cash and spending for more productive uses. The payoff triggers another one-time prepayment fee, this time of $300,000, as well as triggering a write-off of deferred financing costs of around $700,000, which we reflect as a loss on debt extinguishment. But netting out the prepayment fee as well as some estimate of potential short-term borrowing costs for the balance of the year, we're still confident this transaction allows us to avoid around $2 million in cash interest payments we otherwise would have been obligated to pay in 2023. For clarity's sake, it's not necessarily our intention to run the company debt-free. We continue to monitor the debt markets and talk to people about scenarios and ideas to increase our liquidity, particularly with a lower cost of capital than what we've enjoyed in recent years. But as of now, the combination of our short- to medium-term plans and the current rate environment leads us to what you see today. We plan to maximize the day-to-day and rebuild our cash balances. Similarly, we're continuing our efforts to improve our working capital management. You'll notice our owned inventory is at $65.1 million, which is the lowest Q2 level since Q2 of 2021. That number somewhat masks that we're increasingly holding more inventory in Europe as we build out our direct sales capabilities in those markets, although to be clear, we remain an FOB-first company rather than one that is going to build backup inventory on the prospect of a possible sale down the road. Another noteworthy element of this quarter's financials is the increase in the marketing-to-market valuation of our preferred stock derivative liability. The reduction in our cost of capital with the elimination of our term loan increased the liabilities valuation to $27.8 million, generating a non-cash loss of $6 million in the quarter. As is customary, we adjust that amount out of our non-GAAP results. You also might note a write-off as an adjustment to this quarter as we continue to wind down some older joint ventures to refocus our energies on the core business. Our adjusted EBITDA for the quarter was $20.7 million compared to $27.1 million in the same period last year. Our trailing 12-month adjusted EBITDA is $66.9 million. Adjusted EPS for the quarter was $1.26 and 90 cents for the first half of the year. Those numbers are down from $2.10 and $1.85 respectively from 2022. Finally, we wanted to acknowledge our recent inclusion in the Russell Index for the first time in several years. We're happy to be back in the club, as we've seen increased trading volume since being added, which is great. And now, I'll pass the call back to Stephen for some additional comments.

Thank you, John. During the past quarter, our resolve strengthened that we were set up to have an extremely good year, and we took additional actions to make the most of it. At the same time, we're not going to ignore what we're seeing happening out in the market. As we talked about last quarter and are reiterating now, we remain extremely mindful of our customers' inventory levels as well as our own, and we will work to finish the year as clean as we can. Among our most significant financial goals here is to constantly generate yearly cash flow from operations in an aggressive but importantly not reckless manner. It's with that mindset that we look forward to the second half and work on developing our 2024 and 2025 plans. We have a wide assortment of new key drivers launching in the second half of the year, designed for the holiday gift-giving season, and I want to take the opportunity to highlight a few of them. Exciting with Jack's Disney portfolio, the Disney 100 celebration is ongoing. The Disney Princess brand is is the focus for the month of August, and we have created retail exclusive items to align with major customers' promotional efforts. The Disney Princess brand remains a top priority for our company, and we are excited to see our largest customers viewing the brand the same way as we head into the fall planogram set. Our lead amazing item in the Disney Princess is our Style Collection Fresh Prep Gourmet Kitchen. This amazing kitchen has tons of interactive features for kids to enjoy, including an all new steam feature for realistic stovetop cooking experience. It comes complete with five interactive appliances. Its stovetop burner lights up and recognizes pot and frying pan with boiling and sizzling special effects and a virtual steam feature. With over 35 pretend play accessories, there's a ton of play value and exciting role play opportunities for kids age three and up. This fall is also the 10th anniversary of the theatrical release of Disney's Frozen. Our Disney Frozen product line is another exceptional, important business for us, and we are excited to be launching the Ice and Snow Elsa Feature Playdate Doll to commemorate the occasion. The doll sings Let It Go while also showcasing her ice powers in a fun, magical way. We will continue to support our Little Mermaid product lines into the fall with the additional of Ursula Mystical Cauldron. Inspired by the Sea Witch from Disney's Little Mermaid movie, pretend to cast spells like Ursula again and again with two feature play modes for both water and non-water play, plus a spell book with recipes for homemade potions. This cauldron is also motion-activated. Wave your hands over the cauldron to activate lights, music, and real water bubbling feature. It also plays Ursula's song, Poor Unfortunate Souls. And it comes with color-changing aerial figure, potion bottles, bath fizzies, and more potion-making accessories. Also this quarter marks the second year anniversary of our first launching of Illy Forever. a completely new line of 18-inch dolls, fashion and accessories leveraging the latest fashion trends and girls' favorite Disney characters and stories. We launched it exclusively at Target in the U.S., and it's been a consistent on-shelf presence ever since. Beginning this quarter, we're expanding the line to include fashion doll scale and play, both at Target but also adding Walmart and Amazon distributions. We are planning a full 360 paid media campaign supporting new items, including digital, social, PR, and trade support. The campaign focus will be on awareness, building up new 18-inch dolls, as well as a fashion doll launch, in addition to the new thematic accessories and play patterns. Changing aisles. While we chased a man from the Super Mario Brothers film, Wave 2 of the movie-specific product is also coming to retail, including 5-inch figures, micro-figures, the Bowser Castle playset, and a Donkey Kong Arena playset. Our Super Mario Evergreen product line is highlighted by the launch of the Bowser's Battle playset. Keep a lookout for the TV commercials highlighting these items in the weeks to come. Part of our team was at the San Diego Comic-Con this past week, where we introduced some of those items for the first time. We are also very excited about the Sonic Prime products, which will start hitting retail shelves in August, anchored by the Sonic Prime ship in the 2.5-inch figure scale. Our all-new 5-inch figure scale adds all the details and articulation of the Sonic Prime Shadowverse characters and being very well received by fans of all ages. And our Death Egg playset, remains a cornerstone of our ever-popular Sonic Classic line. Disguise, our Halloween division, will continue to lead with licensed costumes this year, adding new gaming rights such as Poppy Playtime, Piggy, and Sonic Prime, while continuing with costumes based on strong 2023 film releases like Paw Patrol Movie 2, Rise of the Beasts, Dungeons & Dragons, Minions & Trolls, to name a few. Our international expansion will continue with new Disney brands launching in Europe to support a strong holiday this fall. Overall retail conservatism on the year has already been built into our annual plan, especially coming off such a significant level of growth last year. We're feeling very positive about the business this year, and we have initiatives to expand the portfolio and footprint in the coming years. And just a few more items, which are not massive launches, but we think are fun, so we'd like to draw some attention to them during this call. We're expanding our distribution for Ami Amis in the second half of the year and looking ahead to spring 2024. Look for them in the U.S. at Macy's and Joanne's and in the U.K. exclusively at Sandsbury's and more accounts to be announced soon. We're happy to be adding peanuts to our successful lineup of Advent calendars this year, and Shelf Talkers expanding our Talking Flesh holiday characters, which started with Buddy the Elf and Clark Griswold, into a second year-round collector opportunity. The line features characters from cult classic movies and TV shows, as well as fan-favorite comedies, voiced in their most memorable and quotable lines. looking for characters from Beavis and Butthead, The Big Wabowski, National Lampoon's Animal House, Superbad, and Cobra Kai, amongst others. We have many more initiatives at various stages of development, and we'll have a lot more exciting things to discuss during the second half of the year. We'll stop there and open up for Q&A. Thank you again for your support and interest. Operator?

Thank you. Ladies and gentlemen, as a reminder to ask the question, please press star 11 on your telephone and wait to be announced. To withdraw your question, please press star 11 again. Please stand by while we compile the Q&A. Our first question comes from the line of Andrew Urquist with Jeffrey. Your line is open.

Hey, thanks, John and Stephen. Just a couple questions. I guess the first one, you kind of touched on it in your prepared remarks, Stephen, but just kind of double-click on the idea of how costumes, how retailers are feeling about costumes this fall in light of consumers, and then kind of just touch on consumer buying habits for costumes relative to toy segments.

Good afternoon, Andrew. So on Halloween, we're actually having a very strong year with the sell-in right now, and currently during second and third quarter are the primarily manufacturing and sell-in periods. We had this time last year, we had a bunch of retailers that were worried about not getting the goods due to the shipment delays. And primarily, the majority of that business is 90% FOB. So this year, due to the shipping delays that kind of have gone to the wayside and shipping is somewhat back to normal, people are taking the normal goods on hand at the appropriate time and not rushing to get it early. So that was really the shifted quarter. It wasn't that it was changing our year forecast. And then an additional last year, we had one retailer that bought in very big in the Halloween business that cut back this year. Outside of that, we are having a very strong, solid Halloween business, very diverse distribution. Our second big year internationally, that is actually we're seeing really nice growth. And we have going into this year and going into next year more so, we have a lot of new IP and properties that we'll be announcing shortly. So overall, the Halloween business is really solid it was just more shifted in the quarter and we had our biggest halloween last year which we would not expect to have this year but we had we're having a very strong halloween as it stands today and then when it comes to the consumer buying patterns um i'd say you know very proud of our company and proud of what we've developed internally on our divisional segments because our segments are really what's strong and then while we have these segments we have the right ip within those segments so for instance our voice segmentation. We have really strong IP with the Nintendo classic, the Super Mario Brother movie. We have Sonic classic, Sonic movie, Sonic Prime. We have Apex Legends. We have a plethora of content and some new that we'll be announcing shortly. So that's really strong and where category strength is really performing well worldwide in those categories. Disney segmentations, we're in a, call it preschool, pre-cool is really what we call our Disney business. So while we're hearing really nice things about the Barbie movie, our Disney business does not get affected primarily because we're not in that same category of an 11 1⁄2-inch doll. So we're much in a younger period before really a child would buy a Barbie. They're buying our products at a younger age. So we're really in a great area of business. So overall, we're seeing a slowness In retail, but for Jax, our sell-throughs have been strong. Our inventory levels are lower both at retail and in our distribution centers. So we've been managing this process for over a year and looking at how things are lining up. And we're just managing the business, I think, extremely well and strong and looking at not trying to be a hero in this environment, but be strong in profitability, as you can see that as we paid off down our debt. and looking at healthy revenue sales and profitable sales versus just sales to get sales.

Got it. No, that's super helpful. And then just kind of digging in on a couple other segments, action play in collectibles seem to be going really strong. Obviously, a lot of that's probably driven by Super Mario Bros. movie in your toy line there, but has there been any halo effect where Sonic is maybe outperforming because it's kind of in that game segment as well? It's interesting.

So Super Mario movie product is doing extremely well and Nintendo Classic is doing well. And what we've seen, what we were expecting of a possibility is seeing a slight slowdown of possibly Sonic. But at the same time, it's not happening. Our Sonic sales are extremely strong. So we're not getting, we're not trading dollars for one property to another. It is happening at retail that it's affecting other boys' properties. But what we're seeing, we're doing extremely well. Our penetration is getting deeper and deeper at various other retailers from, you know, value chains to specialty stores to masks. So we're really in a good spot. We have registered checkout lane products that are selling exceptionally well. And Sonic is still doing really strong with Nintendo and other checkmate products. So overall... For us, we're not trading dollars. It is affecting other licensed boys IP, but not in our segmentation.

Got it. That's helpful. Thank you. And then just kind of like an industry question, because I know you've done this for a little while. When you say retail wants to run lean inventory, does that mean fewer SKUs where they maybe have normal inventory levels for the best performing toys? Or is that just kind of lean across segments? all toy segments, all toy lines, regardless of how successful they are. It's a good question, Andrew.

So let's call across retail themselves. They're looking for overall inventory levels to be lower, not just in our toy segmentation. Outside of grocery, we call it all the hard goods, electronics, we call it the home entertainment areas. They're trying to keep a lower inventory. But As it is, during the first half of the year, as you know, toy sales are really non-holiday. They're more gift-giving, whether it's an Easter or a birthday or that type of process. Going into the second half, retailers are garnishing, getting more inventory, making sure they have the right product. I think what's changing now is they don't need to buy everything from everyone. They're focusing on the right companies that have the right product for their needs and doing more with less companies. Thankfully, we're one of those companies that we span across so many various buyers at retail that a retailer can do a lot more with Jack's and many of their segments versus other toy-related companies. They are looking cautious for their inventory, but it's across the board. But remember, Andrew, they still need, call it market drivers, areas that they can promote and bring in customers so they continue the traffic during the holidays. So they do want the hot things for the holidays.

Got it. And then last question I had, you know, you've paid down your debt. I mean, you've always been on offense here, but it looks like you probably put your foot on the pedal. How are you thinking about international and growing that over the next several years? So

Right now, everyone knows the U.S. or North American market is a mature market. So the only way we can grow international is call it more ancillary distribution, more shelf space, and then continuing of more IP or more products within our categories. That's North America. internationally, as we mentioned, I think, in first quarter, that I'm delighted, at the same time sad, because he's very close to me in the company and very strong in our company. But our COO, Jack McGrath, is moving internationally because he can handle the growth that we expect. He understands the DNA of Jack, so he can make decisions immediately. He understands, you know, he's been with us 25 years. So we wouldn't be moving him all the way overseas unless we believe, you know, materially in the growth. And We've already made rapid changes immediately. We have a new warehouse that opens up next month in August. We have a new staff or additional staff in Italy. We grew Latin America this year. So Jack, working with myself and the team, will be able to expand that growth. Let's say it would take five years, six years to do it. We can get that growth in two years and yearly growth. So We're really excited about international. In fact, I'm going again with him. August, we're going again in October. There's a lot of growth opportunity and we're getting a lot more licenses and categories because people are having issues worldwide. So we're benefiting from, you know, on an offensive internationally, not defenses. We're, you know, people are coming to us to actually distribute their product internationally because they don't want to build the overhead in which we've already built. So we're excited really, really internationally as well as just in total of the company.

Got it. Thank you, guys. I really appreciate the time.

Thank you, Edu. Thank you. Ladies and gentlemen, those are it for the Q&A. We have calls that are ongoing throughout today and this evening. We appreciate everyone on the call. Thank you for joining. We're going to have a lot more to hopefully talk about during our Q3 conference call and beyond. Thank you very much.

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.