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.