JAKKS Pacific, Inc.

Good afternoon, everyone. Welcome to the JAX Pacific Third Quarter 2023 Earnings Conference Call with Management, who will review financial results for the quarter ended September 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 recently remodeled 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, along with highlights of recent performance and current business trends. Then John will provide some additional editorial around Jax Pacific's financial and operational results. Mr. Berman will then return with additional comments and some closing remarks prior to opening up the call for your 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 11 on your telephone keypad. Before we begin, the company would like to point out that any comments made about Jax 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 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 risk uncertainties, which could cause actual results to differ materially from those projected in forward-looking statements. For details concerning these and other such risk uncertainties, you should consult JEC'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 measure within the company's earnings 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.

Good afternoon, and thank you for joining us today. It's been a very busy quarter for Jax, as Q3 often is, with new product segments launching and plans for 2024 firming up. As you know, Q3 is always the highest shipping quarter for Jax. I'm proud to say we feel very confident in how we're lined up to finish the year, as well as some of the initiatives the teams are working on for 2024 and beyond. We knew at the beginning of the year that repeating 2022 revenue levels would be an impossible feat without a total unexpected breakout hit as we had last year. With that sales outlook, we made gross margin improvement a major focus as it is extremely important to our blueprint for enhancing overall margin. We have seen in our results it's imperative in building and maintaining a strong balance sheet. Our teams in Asia work methodically with our manufacturing partners to ensure that we are getting the sharpest possible pricing on legacy items entering their second or third years in the market. Separately, New product development continues to be regularly challenged to ensure we are stretching the team's creativity to generate value for the consumer and for our customers, while also ensuring cost-mindful product designs. With Q3's results, we can see the dividends of those efforts paying off. Year-to-date, our gross margin of 32.5% is our strongest performance in this metric since 2011. Our year-to-date gross profit of $186.9 million is $6.9 million, or 4% higher than at comparable period in 2022. That improvement has helped us to compensate for increases in SG&A expenses such that our year-to-date operating margin of 12.7% represents an improvement of 11.5% operating margin we had in the first nine months of 22. The net results from an adjusted EBITDA view is $67.1 million in adjusted EBITDA in the quarter, up from $59.4 million in the same quarter last year. Our action play and collectible business was up 43% in the quarter and 37% year-to-date, accelerating its performance versus last quarter. Our doll role play and dress up segment is lapping that exceptional 2022 and was down approximately 27% in the quarter and 30% year to date off a larger base, as we pointed out last quarter. We still think it's worth noting that the Dahl segment is up significantly versus 2021, 247 million year-to-date this year versus 207 million year-to-date in 2021. This team is often a victim of its own and many successes. Our outdoor seasonal business showed some trend improvement, down only 2% in the quarter and slowing the year-to-date decline to 23%. We have some quality placement of new items this fall, and as mentioned previously, some new initiatives in the works, which we think can energize this business next year and beyond. Q3 is, of course, almost the most interesting time of year to discuss our Halloween costume business. The headline is the year has worked out in line with our expectations, which is a great outcome given how big the business has become. Last quarter, we discussed how the seasonality impacts has moved around this year. So we saw it catching up this quarter with a 19% year-over-year growth in Q3. Year-to-date, we shipped 122 million through Q3, which is 9% lower than last year. As we mentioned before, some larger US customers recalibrated their buying levels this year after an aggressive 2022. That drove most of the downside, as our international business has been roughly flat year-to-date. We've been aggressively working on our distribution outside of North America and remain focused and committed to building that business to leverage our strength in North America. Again, to provide a 2021 reference point, that $122 million shift number is significantly higher than the $99 million we shipped in the first three quarters of 2021. So overall, another great year for the team at Disguise. Moving on to a market view, the past quarter was also noteworthy and continuing our efforts to expand our overall business outside the United States. In Latin America, we're up and shipping 50 plus percent year to date. Although we've had an office in Mexico for several years, this year we started offering selective domestic replenishment for key items via a local third party warehouse. This investment helps to evaluate our year round on shelf presence, further proving the viability of our product line to local retailers. With this success, They can then confidently place the larger orders with us FOB in Asia, consistent with our go-to-market approach. Over time, we also see as a potential platform for additional shipments into Latin America. And we're quickly seeing a positive reaction at retail, with syndicated data suggesting we're up over 50% in Mexico year-over-year. Also in the quarter, we officially opened our dual-purpose office and warehouse facility in northern Italy. We plan to start shipping from there in the new year, which will generate a number of new benefits. Specifically, being able to serve a wider range of smaller customers more quickly and with improved economics than shipping smaller orders as individual deliveries from Northern Europe. In addition, we onboarded a new team with deep industry experience in Jax, France, a market where we know we've been underperforming during COVID. Although our COO, Jack McGrath, is officially not in his new role as President of European Operations until the new year, he has been spending a considerable amount of time and focus on addressing challenges in the region to accelerate our performance in 2024 and beyond. I couldn't be more excited about the opportunity presented by his taking his years of experience with Jax and focusing them on taking a fresh look on how we're doing business in the European market. Switching now to talking about what we're seeing at retail. On the toy side, it's been the case all year and continued this past quarter when we look at our own data and syndicated data. We've seen that the toy portion of our business continues to perform better than the overall industry in the U.S. The same has been true in some of our European markets where we also see syndicated data. Certainly some of the great content from our studio partners is helping to drive people to the register this year, much as it did last year. But broadly, we've been pleased with how the total portfolio is performing this year, as we said last quarter. That being said, in Q3, we did see retail slowing. Retail sales at our top three U.S. accounts were down low single digits year-to-date and down high single digits in the quarter. Separately, at the end of the quarter, Retail inventory at the same accounts were down over 20% versus prior year, delivering on their goals to finish the calendar year at lower owned inventory levels. As we work through this transitional year at retail, we've managed to stay in stock across all of our key product segments and are set up well to fulfill demand in Q4. I will now pass it over to John for some further comments. after which I'll come back to discuss Q4 and a bit about next year. John.

Thank you, Steven. And hi, everybody. It's always great to report results after a $300 million sales quarter. We knew the first half of the year would have the most difficult comparisons as we were chasing business on a holiday 2021 film. And the second half of the year would also be challenging, but hopefully less so. That view is playing out in our results. Although down 20% as a total company in the first half of the year, We were down only 4% in Q3, shipping $310 million in the quarter. As Stephen pointed out, broadly speaking, the year is going about as well as we could have hoped. 2020 unleashed COVID. 2021 had expensive freight. 2022 had warehouses overflowing. And so far, 2023, from the perspective of our business, has had more positives than negatives. What that means from a year-over-year perspective is twofold. Bad things that happened in 2022 haven't reappeared, and some additional good things have been added. From a net sales perspective, both the toy CP segment and costumes are tracking year-to-date at higher levels than anything in the 2019 to 2021 time period. And gross profit dollars for both segments are higher than any time in the past five years as well. There are a number of things happening with gross margin. In the quarter, it was 600 basis points improvement. So let me try to break that down. As Stephen referenced, the landed product cost improvement amounted to around 350 basis points. I'd say that was a mix of some of the good stuff that Stephen talked about earlier, but also last year on both the toy and costume businesses, we blew out some inventory at margins that weren't anything to brag about for a couple of different reasons that made sense at the time. We also managed to avoid bleeding money by way of above average freight costs. That was a pickup of another 150 points. There are a number of other puts and takes, but I'll throw in for good measure that our read of retail last year was more markdown exposure than what we're seeing at this point this year, so that's also net-net favorable. And finally, this quarter we began capitalizing a small portion of our tooling to our owned inventory valuation. This has been an outstanding topic for some time, but we've got around to figuring out how to get it done without the accounting being too cumbersome. So that was a one-time pickup of $1.8 million in the quarter. We have adjusted that depreciation dollar amount out of our adjusted EPS results. So to answer your question, we think we have line of sight to continue to hang out in this low 30 neighborhood on a full year basis. But that's of course subject to minimizing stuff going wrong, nor does it contemplate any dramatic changes in our product mix, which we don't anticipate in the near term. We're losing a bit of scale with SG&A being up, but fortunately the gross margin lift has been enough to generate operating margin improvement, which is great. That has allowed us to selectively invest in staff and infrastructure where appropriate, with the goal of being in a better place next year organizationally, despite revenue being down this year. We've also made some decisions like skipping the New York Toy Fair this past quarter, which may not have generated massive financial savings, but certainly removed a layer of organizational distraction, if nothing else. In addition to the P&L, we're feeling good about the balance sheet. Our Q3 ending cash balance of $96.4 million is high for this time of the year. There are a couple of drivers. One is that we're trying to keep a tighter leash on inventory and turning it back into cash in a timely manner. Another is we've accepted the federal government's offer to California-based businesses to defer payroll and tax payments into October, which helped quite a bit. You'll notice in aggregate that our AP and taxes payable are up over $20 million versus this time last year. We remain debt-free as of the end of the quarter and as of today. The majority of the interest expense you'll see in the P&L is associated with some early payment discounts that we sporadically take advantage of to maximize liquidity. We'll likely be doing less of that in the near term given our current cash situation. The reduction in our cost of capital from our improved financial position increased the preferred share liability valuation to $28.6 million, generating a non-cash loss of $800,000 in the quarter. As is customary, we adjust that amount out of our non-GAAP results. Adjusted EPS for the quarter was $4.75. and $5.66 for the first nine months. Those numbers are up from $3.80 and down from $5.68, respectively, from 2022. Our trailing 12-month adjusted EBITDA is $74.5 million. And now back to Stephen for some additional remarks.

Thank you, John. Although we reviewed a lot of the key product initiatives last quarter, I wanted to provide a couple quick updates and then share some new exciting news about 2024 and beyond. Last year, we mentioned it's been two years since we first introduced the Disney Elite brand with Target in the U.S. That business has built steadily with them during that time and is currently putting up some very nice numbers in reaction to our fall 2023 lineup. The Inspired by Stitch dolls, both in the original 18-inch scale as well as our new introduction of Fashion Dolls scale, have both been top sellers out of the gate. Overall, the Fashion Dolls scale has been well-received when first hitting the shelves, and we are expected for more fans of these characters to find them this holiday season. Last year, we were extremely excited to work with Target to bring their Target Toy Store shopping cart to life, and it once again on their bullseye top toy list for 2023 reflected its great performance this year. But the new news is the recent launch of the Target cash register and accessory items as an extension of our perfectly cute line. It debuted during the quarter and is doing extremely well so far as we all thought it might. It's a great value and great fun for the consumer. Be sure to check out the photos in our presentation. Also be on the look for some new introductions in our outdoor seasonal space this holiday season. The team has fought to regain shelf space at key accounts across ball pits, activity tables, and ride-ons. We have some great new Paw Patrol ride-ons inspired by this summer's movie, which brings a lot of play to the classic play patterns. And during Q3, our product lineup in support of the Walt Disney Animation Studios Thanksgiving film release, Wish, began to hit the shelves. This story focuses on a 17-year-old girl named Asha, a sharp-witted idealist who makes a wish so powerful that it's answered by a cosmic force, a little ball of boundless energy called Star. We're super excited about the film and are playing a role as Disney continues to celebrate the 100th anniversary of its founding this year. Now for a couple additional comments about 2024. We recently announced a new agreement with Sega to support the Sonic Hedgehog 3 Paramount Pictures feature film set to release on December 20th, 2024. As many of you know, we have worked with Sega for many years on Sonic and other Sega properties, inclusive of the first film in 2020. We are looking forward to bringing to market a new innovative range covering a wide range of products that Sonic fans have come to expect from us, ranging from figures, to plush, to play sets, to costumes, and more. Now moving on to our outdoor seasonal division. I'm extremely excited and happy to be able to talk about a multi-year worldwide relationship we're starting with authentic brands group, ABG. As you may know, ABG is a brown powerhouse with a wide portfolio of IP which has mass appeal to millennials, Gen Z, and Gen Y. Jax and ABG have been collaborating on a wide range of products that will slot into this division as well as expand the scope of our offerings. We have been working on an iconic assortment of their properties, names like Roxy, Quicksilver, Element, Forever 21, Juicy Couture, Sports Illustrated, Prince, just to name a few. With the designs in process already underway, customers can expect initial fall 2024 rollout of skateboards with amazing new designs for Element and Quicksilver at specialty and mass retailers in-store and online. Jax will launch branded roller skates, inline skates, volleyballs, outdoor furniture including chairs, umbrellas and canopies, beach accessories, inflatable pool floats, sand and splash mats, foldable wagons, and an extensive line of dolls and dolls accessories infused with fashion elements from Forever 21, Juicy Couture, Prince, Sports Illustrated, and Roxy. The strength of the authentic platform and family of IP will grow Jack specific product lines and outdoor categories while making the way for new collaborations with authentic unexisting categories. The addition of more spring and summer-focused visits also further leverages Jack's infrastructure to counterbalance traditional Halloween holiday seasonality, so this relationship is a really great match for both of us. Reactions from various customers worldwide and the previews we've shown over the past couple months of early product directions and initiatives were extremely very favorable. So although there's still a lot of heavy work and lifting to be done, we are so excited about the potential here. I've personally been working on development of this business for over the past year and can't wait for you to see some of the new products and product executions that we are currently working on today and in the future. But wait, there's more. We are quick to tell everyone that this business is built brick by brick, a series of evergreen brands and categories centered around classic play patterns. that we feel persists and stand the test of time even in the increasingly digital world. And we've talked about how our successes in recent years have started new conversations and have created new ideas about business opportunities that marry up our unique role in the marketplace with different brand owners. And you've also heard us mention that when those businesses have an underlining content presence, it only adds to our ability to stay on top of mind with consumers and participate in the energy and excitement around top-tier content, quality, and success. So with that foundation, I couldn't be happier to share new news that in fall 2024, Jackson will be launching an extensive product line dedicated to The Simpsons. As The Simpsons is well into its record-breaking 35th season this fall, It continues to be one of the most popular series of both Fox and Disney+. The upcoming toy line is poised to inject even more excitement and joy into this cherished franchise, catering to fans of all ages with its diverse and engaging offerings. The toy line will feature a wide range of beloved caricatures from the show, available in various forms such as basic, deluxe, and and premium collector figures, play sets, and plush toys, along with items like advent calendars and other fun and creative toys inspired by the show's rich history. As you might imagine, our Action Play and Collectibles team has been having a tremendous time brainstorming the plethora of product opportunities that this show represents, and we are honored as a company to be trusted with such an iconic franchise. As I said at the beginning, it's been a very busy quarter, but with the end of the year in sight, it is also extremely gratifying to see us lined up for completing another really successful year here at JAX, while still seeing great opportunities for sustained growth in the new year to come. Thanks again for your support and interest. 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. We'll compile the Q&A roster. Our first question comes from the line of Andrew Urquitz with Jefferies. Your line is now open.

Hey, thank you. Thank you, gentlemen. Just a couple of questions. The first one is on action play and collectibles. It's grown. I mean, it's more than doubled since 2021. Could you just talk about the puts and takes there and then kind of maybe at the end of your answer, what kind of impact the Simpsons could have on that? I mean, it sounds like a really great collaboration and a great get. So congratulations on that. But just kind of walk me through kind of the puts and takes on that segment and how we should think about it going forward.

Great. Thank you, Andrew. This is Steven. So on the boys action and play environment, we've had a really strong year. One of it was we had a great run with the Nintendo movie that came out on top of the actual classic Nintendo business that has grown with the movie's strength. That being said, it goes on to streaming of Netflix and abroad streaming platforms. December, I think it's the first week of December, it's been on NBC Peacock. But now once it goes into a wide way of distribution for streaming, We think there will be strong tailwinds going into spring next year and beyond to keep that going. You also have the Sonic Netflix TV show that airs in July and a movie that's next December. So those are going to continue to be extremely strong, and we'll look at which areas have growth. They have not eroded each other's sales, which is terrific. They are in the video game platform business with a lot of content on the video game platform, plus media content, which is terrific. At the same time, we have other content called Bendy's, which is from another game, and Crash Bandit. Those are actually just starting to take off, and we'll see how they turn into. But the real catalyst to building this area, we keep saying a very strong evergreen platform is by continuing it, and you can't get stronger in addition to what we already have without having the Simpsons. is across the world. The content is so strong. It's just its 35th year and it hasn't been in the market the way we brought in, I think, for over a decade. So we've been working on this strongly with the Walt Disney Company and the retailers are extremely excited about it. A broad array of retailers from masks to big box to specialty to the value chains. So we just look at this being an added brick by brick philosophical initiative for us to build that whole action play environment. And we look at many different IPs that are out there and we waited a long time until we were able to achieve getting to Simpsons, which took our group many years to do. And with that said, we are looking for a strong year next year in that action play environment.

Got it. That's really helpful. Thank you, Stephen. And then switching to outdoor, you obviously peaked during COVID. I think everybody peaked during COVID. But this latest relationship heading into 2024 and beyond, it sounds like this is pretty substantial. So how should we think about the impact it could have as we start to look out 2024 and beyond? Could we get back to that kind of COVID peak that you guys hit?

Firstly, yes, that's our goal. We jumped into this for a long time. I've been friends with the Salter family, which are the founders of the ABG group, and we've been working for over a year on the right initiatives and platform and IP. They own a breadth and a plethora of different IP, and our relationship together with them is extremely strong, and we've worked out... a various array of different categories that actually will help diversify Colladar revenue stream to put a little bit more into the first half of the year, especially having third quarter and fourth quarter being as strong because of Halloween and the actual holiday seasons. But that being said, the diversification to the buyers that we go to, to the distribution that we go to, from our main distributions that we go to the specialty distribution, we've been looking at this in great detail. And we believe we'll get much stronger and even bigger than we were with our original platform and seasonal in the next couple of years. We have worked on this. We finished the deal over the last few days. We're both excited. We're on the road with retailers already. We're in complete development in Asia. Our team has been there. They're back there again this week. So we just don't know how quick it'll get to the market, but we do think it'll be somewhat material to us in the segments in which we're in. And, you know, Elements is one of the largest brands worldwide for skateboards, and so we have that whole category of skateboards with Quicksilver. We have a beautiful line of rollerblades and roller skates with the Juicy Couture brand. We have a broad array of seasonal outdoor products for beach and parks for, like, football games, soccer games for family and children that aligns with our kids' outdoor furniture that just parlays, bringing it from kids to teens, tweens, and adults. So we're really just more diversifying into a kids' consumer product company and a consumer product company for families. And we're extremely excited about it. ABG is excited about it, and the retailers are excited about it.

That's super helpful. And then kind of just last question. Looking at the international opportunity, I mean, you've made some real inroads, it looks like, this year and on a two-year stack in Latin America. You are down, I think, year over year, year to date in Europe. How should we think about the impact of the efforts there? Is it to help with margins? Will we see growth in international? What's the goal with the European expansion right now? Because it doesn't seem to be showing up in the income statement quite yet.

This year, you've seen in our industry, I think we were flat. This year, the toy companies have had down years overall. That being said, we wouldn't be moving Jack McGrath and a team of people from the US to the international territories, allowing the team to make immediate decisions and not having to come to the corporate office. Jack has worked with me for over 25 years. He's got my complete and the company support and the board support. We just opened up, I just got back a week ago from Piacenza, Italy, where our new distribution center and offices are at, our new offices in France. We will see growth, I would say, hands down just by having him there, but not just that. We also have a broad array of products that are new and that are consistent. We have a whole line of the Princess Style Collection that's a mature line and growing product. in North America, but it's only been in Europe for about two years, and it took us five years to get that growth. We have the Simpsons. We have Authentic Brands. We have the new movie Wish. We have a plethora of different areas of business from the boys' action. So we will see growth. I'm very confident and adamant about it. And we should see enhanced margins because the operational side of things, Jack is very involved with. So we will see growth and I think operational enhancement globally starting probably the first half of next year to the second half. Got it.

That's very helpful. And I do have one more question kind of on Q4. Yeah, yeah. Listening to some of your competitors that have reported so far, both kind of mentioned that they view kind of Q4 holiday spending, you know, returning back to quote unquote normal. And I think that what they really mean is that the spending will mostly happen in the end of November, December period. Just curious what your thoughts are on where the consumer is at from a spending pattern perspective this particular holiday.

I'll talk for Jackson. I'll talk just kind of overall consumer. I think we're parlaying a little bit different of an approach to our larger competitors of we're – call it – leaps and bounds of really on-the-ground enhancement of distribution and margin criteria. If you've seen our enhancement of our gross margins, and we're up 600 basis points, I think, for the quarter. That's something that we're leaning to ensure for next year. We do see our level of inventory currently on hand. We've been managing it down, as you've seen in our financials for the first nine months, and we'll expect to even end the year lower than what we were previous years. That's from us managing the retail inventory levels to ensure that they have just-in-time inventory from our FOB basis to our domestic basis. We are seeing customers coming in. We are seeing sell-through strong, and we can only speak for ourselves that we think we'll have a very nice, strong, clean year. For everyone else, we're not looking for being able to have something that's a home-runner grand slam, which we had again last year with Encanto, and something may occur with Wish or Authentic Brands. or Nintendo streaming. We don't bake those into our numbers, but they may happen. We run a very conservative brick-by-brick philosophy of business with ongoing excitement. And I think you can hear in my voice, I'm extremely excited for the things that we are working on. And our business, just with our general methodology, is strong and we believe will grow next year, grow in profitability and grow in revenue. That being said, we don't know where that will take it, but the consumer for us and our level of business is strong. Overall, the consumers at the medium to low income basis, you're seeing some weakness in their purchasing just general at retail. When you speak to the retailers that have groceries, that's their catalyst of getting the consumer in. From that point, the spontaneous purchases or ancillary purchases are becoming less and less. But a lot of our business, I think it's over 70% is under $40. at retail, and a good portion of it is under 20. So we're in the right category of business, and we're right for the holidays. We have some high-end products. So overall, the mix of what we have is a cross-array of different, I would call it an income stream. So we're really happy with how Halloween turned out for us and how retail is turning out for us.

Got it. That's super helpful. Thank you, Stephen, and very solid, Corey. I appreciate it.

Thank you. Thanks, Andrew.

Thank you. I would now like to hand the call back over to Stephen Berman for closing remarks.

Everybody, thank you very much for attending the call today. Again, we are excited for this year, finishing up, and we're extremely excited for 2024 and beyond with the new Simpsons lines, with our ABG line, with the Wish going into streaming in spring and Nintendo. There's a lot of things at JAXA that we're excited on, and we look forward to having our call on fourth quarter and year-end next year. All the best.

This concludes today's conference call thank you for participating you may now disconnect.