Good morning, and welcome to JAKKS Pacific's First Quarter 2017 Earnings Conference Call with management, who will review financial results for the quarter ending March 31, 2017. JAKKS issued its earnings press release earlier this morning.

Presentation slides containing information covered in both today's earnings press release and call are available on our website in the Investors section. .

On the call this morning are Stephen Berman, Chairman and Chief Executive Officer; and Joel Bennett, Executive Vice President and Chief Financial Officer. Mr. Berman will first provide an overview of the quarter and then Mr. Bennett will provide detailed comments regarding JAKKS Pacific's financial and operational results. Mr.

Berman will then conclude the prepared portion of the call with highlights of product lines and current business trends prior to opening up the call for your questions. [Operator Instructions].

Before we begin, the company would like to point out that any comments made about JAKKS Pacific's future performance, events or circumstances, including the estimates of sales and/or EBITDA growth 2017 as well as any other forward-looking statements concerning 2017 and beyond are subject to safe harbor protection under federal securities laws.

These statements reflect the company's best judgment based on current market trends and conditions today and are subject to certain risks and uncertainties which could cause 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 JAKKS' 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. As a reminder, this conference is being recorded. .

With that, I would now like to turn the call over to Stephen Berman. .

Good morning, everyone, and thank you for joining us today. This morning, we are going to review our performance during the first quarter, review our strategic goals and give an update on the ongoing initiatives to transform JAKKS Pacific from a toy company to a kids consumer products company.

The first quarter of 2017 came in as we had expected and consistent with the seasonality of our business as well as with our view that in 2017, we will be able to grow EBITDA and profits on a decline in sales. .

The net effect of the puts and takes were in line with our expectations and consistent with our view for 2017. Retail sell through for the quarter overall is strong across all core categories.

First quarter is always the lowest revenue volume quarter of the year and relatively small dollar moves in sales and costs can appear bigger in percentage terms, but we are encouraged that the sales performance of core categories and new initiatives validates our portfolio approach to properties and leaves us confident and excited that we are making the right moves and are on track for 2017 and beyond.

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As expected, our sales of Nintendo products got a big boost from the launch of Nintendo's new Switch Platform and the mobile game launch of Super Mario Run. This new system has done very well at retail.

Importantly for us, the games available for Switch are overwhelmingly produced by Nintendo itself and we have the licensing rights for all the Nintendo characters other than Pokémon, which means that consumers now have heightened awareness and are now much more engaged with Nintendo properties and the interest in the toys and collectibles we make have increased.

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We also saw big contributions from several film properties in the quarter.

Disney's Moana reignited in the quarter, while it will not likely reach the levels we saw with Frozen, we are seeing a similar trajectory where the products did well right after the movie debuted in theaters, but took off strongly upon the release of the DVD and we have seen nice increases in retail sales since then.

Disney's Beauty and the Beast was a very nice contributor to first quarter sales and we continue to see the strength in the brand. Those of you old enough and involved in the toy business long enough to remember will know that Beauty and the Beast was a major toy property back in the early 1990s, following the release of Disney's animated version.

We expected the live action version to spur demand for toys and Halloween costumes and we are pleased to see it happen in the quarter. .

Immediately following the release of the film, toy sales picked up. These properties are good examples of our portfolio strategy. They address a variety of consumer groups and some of them have legs well beyond this quarter.

Beauty and the Beauty will see a DVD release later this year and Nintendo Switch and new Nintendo mobile games could result in a multi-year surge and interest in Nintendo characters. .

Let's review our long-term strategic goals. First, build on our solid base of evergreen properties. Second, augment this base with promotional opportunities. Third, build up our own IP, including animated content through Studio JP joint venture with Meisheng. Fourth, develop exclusive private label product lines for our customers.

Fifth, enter in new categories organically and through acquisitions, including non-toy consumer product goods for kids. Sixth, broaden our geographic reach with new offices and licenses. Seventh, grow our business with online retailers as a percentage of total sales. .

We have a strong base of reoccurring revenue that stems from our category leadership in foot-to-floor ride-ons, licensed outdoor furniture, Halloween costumes and Role Play toys just to name a few. Many of these evergreen products see sales influenced by licenses and we have the right licenses.

Honestly Cute is a private label line we developed in conjunction for one of our major customers which also contributed nicely to the quarter. The line consists of baby dolls and accessories focusing on nurturing play patterns.

Acquisitions did not have a material impact on sales in the first quarter, but C'est Moi, the youth makeup and skincare line we acquired last fall, is scheduled for shipments later this year and the consumer launch in early 2018. .

Our additional newly opened international offices did not have much of an impact on the revenue in the quarter, but we continue to make progress. Our German office was opened for the whole quarter this year versus only partial quarter last year and we are in our early stages of opening in France.

These new offices will contribute meaningfully to our international sales growth and our ability to gain new licenses later in the year and going forward.

I will note that the expansion of Germany as well as the addition of our overhead from C'est Moi and additional expenses for Studio JP did increase operating cost in the first quarter without the offsetting of benefit of higher revenue in the quarter as Joel will discuss later in the call. .

Finally, we continue to see our sales to online retailers grow. Total sales to online-only retailers and the online divisions of brick-and-mortar retailers rose in the quarter. Before I turn the call over to Joel, I would like to make one general financial comment.

As you have seen in recent weeks and months, we have been busy working to shore up our balance sheet through a series of transactions designed to help us clean up the outstanding 2018 convertible notes in a manner that is as shareholder friendly as possible. We began by executing small repurchases in the open market in late 2016.

And in early 2017, we executed 2 exchanges of cash and stock for outstanding notes. We also expect to close shortly the sale of $19.3 million in common stock to our Chinese distribution and animation joint venture partner, Meisheng.

The strategic benefits of that transaction include giving us better access to the Chinese market and making Meisheng a more important strategic partner with a vested interest in our success around the world. .

I will now turn the call over to Joel Bennett so he can review our first quarter financial performance and our capital allocation moves.

Joel?.

Thank you, Stephen, and good morning, everyone. Consistent with our general outlook, net sales for the first quarter, which excluded sales to a major U.S.

retailer to whom we stopped shipping in Q4 2016 were $94.5 million, comparable to the $95.8 million in 2016 with a net loss of $18.3 million or $1.01 per diluted share versus a loss of $17.4 million, also $1.01 per diluted share in the year-ago quarter.

And adjusted EBITDA for the first quarter was negative $10.6 million compared to negative $9.2 million in the first quarter of 2016. .

I will now review sales drivers in the quarter by category.

Sales of dolls, role play and dress up, plush and activity products in our girls category amounted to $46.4 million for the quarter compared to $43 million in 2016, driven by dolls and role play toys featuring Disney Princess, Moana, Beauty and the Beast and Frozen, Tsum Tsum and Gift'ems collectible figures and accessories and private label products, though Frozen and Tsum Tsum were down year-over-year as expected.

Sales of action figures, vehicles, role play and electronics as well as pet products in our boys and other category for the first quarter were $15.9 million compared to $17.5 million last year, driven by Smurfs with the movie catalyst and Nintendo with new gaming platform and video game catalysts.

And absent catalysts, Star Wars, Warcraft and Batman Versus Superman declining year-over-year. .

Sales of seasonal products, including licensed ride-ons, ball pits, kids furniture and Maui outdoor activity products were $27.5 million in Q1 2017, down from $30.5 million in 2016. The declines were experienced in the kids furniture and Maui outdoor categories.

Off-season sales in our Halloween category, which is also one of our business segments, totaled $3.7 million in the first quarter of 2017, comparable to the $3.4 million in 2016.

Sales of baby doll accessories, figures and plush in our preschool category were $1 million compared to $1.4 million in Q1 2016, driven by products featuring Daniel Tiger's Neighborhood. .

In the accompanying presentation, we show how gross margin in each of these product categories compare to our overall average gross margin. .

Looking at sales by business segments. North American sales for the first quarter were $70.9 million compared to the $72.2 million in the year-ago period, driven by Disney Princess, Frozen, Moana, Elena of Avalor and Tsum Tsum collectible figures.

International sales for the first quarter were $19.9 million compared to $20.2 million in 2016, driven by the North American drivers plus Sofia the First and Star Wars. And we already mentioned Halloween in the category breakdown. .

Gross margin in the first quarter was 31.8%, down slightly from 32.5% last year due in part to lower prices in our Funnoodle pool toys and higher tooling amortization, offset in part by lower royalties resulting from a shift in product mix.

SG&A expenses in the first quarter of 2017 were $45.7 million or 48.4% of net sales compared to $45 million or 47% of net sales in 2016.

SG&A in dollars were up in 2017 due to incremental overhead added in connection with our youth makeup and skincare product line we acquired in the C'est Moi transaction and international expansion, as well as higher product development and testing costs in support of the robust product flow and animation initiative and bad debt recovery in 2016.

The increase as a percentage of net sales is due to the slightly higher expenses on slightly lower sales. .

Operating margin was negative 16.6%, down from negative 14.4% last year due to the lower margins and slightly higher SG&A expenses on slightly lower sales in 2017. Adjusted EBITDA for the first quarter was negative $10.6 million compared to negative $9.2 million in the year-ago quarter.

The $1.4 million decrease is due primarily to the variances in operating margin just mentioned. Consistent with the seasonality of our business, operations provided cash of $9.9 million for the first quarter of 2017 compared to $33.4 million in the same quarter of 2016.

The decrease is due in part to increased license advances in 2017 that will be earned out in the remaining quarters of 2017 and the planned higher inventory level in 2017. .

Free cash flow for the quarter was $5.6 million compared to $29.6 million for the same period last year. As of March 31, 2017, our working capital was $196.5 million, including cash and cash equivalents and restricted cash of approximately $68 million. This compares to working capital of $226.9 million in the same quarter of 2016.

The decrease is due in part to the 2017 exchanges of convertible notes using cash in the aggregate amount of $24.1 million. .

Accounts receivable as of March 31, 2017, were $98.5 million, up from $85.3 million at the end of the first quarter of 2016, due in part to the timing of shipments during the quarter, resulting in DSOs in 2017 of 94 days, up from 81 days in 2016.

Inventory as of March 31, 2017, was $67.5 million versus $53.5 million at the end of Q1 2016, resulting in DSIs in 2017 of 116 days compared to 93 days in 2016, due to the planned higher level of inventory in preparation for the earlier Chinese New Year, factory closures and Easter holiday sell-in and down as expected from year-end. .

Capital expenditures during the quarter were $4.4 million compared to $3.8 million in the first quarter of 2016 with an estimate for the full year of $14 million to $15 million. Income tax for the first quarter was a benefit of $300,000 compared to expense of $400,000 in Q1 last year.

The benefit in dollars now reflected an effective tax rate in 2017 were due in part to the utilization of deferred tax assets. The diluted EPS calculation in the first quarter includes an average of 18.1 million common shares outstanding during the quarter and excludes 19.4 million shares, assuming the conversion of the convertible notes. .

During January and February 2017, we exchanged a total of $39.1 million principal amount of our 2018 notes for 2.9 million shares of common stock and $24.1 million in cash. The remaining principal amount of these notes of $54.7 million will continue to be addressed ahead of their upcoming maturity in August of 2018.

Within the next several days, we expect to close on the sale of approximately 3.7 million shares of common stock to Meisheng, our China distribution and animation joint venture partner, for $19.3 million. This sale will bolster our alliance, which we expect will further enhance our opportunities in the region. .

Now to our 2017 outlook. For 2017, the company continues to expect higher net income, higher earnings per share and higher adjusted EBITDA on lower net sales compared to 2016.

This expected improvement to profitability as a result of our continued focus on building our base of evergreen brands and categories as well as entering new categories creating a strong portfolio of new and existing licenses and developing owned content in concert with our ongoing margin expansion and cost-containment efforts. .

And with that, I will return the call back to Stephen. .

Thank you, Joel. Before opening the call for questions, I wanted to talk briefly about some things we can look forward to later this year to further our drive to become a world-class producer of consumer products for kids. As always, our core businesses will benefit from existing evergreen brands and licenses, plus new licenses.

New licenses we expect to be strong in 2017 are Marvel's Guardians of the Galaxy 2, Beauty and the Beast, Disney/Pixar's Cars 3, Nintendo, DC Superhero Girls, Power Rangers, The Lego Ninjago Movie and Microsoft's Minecraft just to name a few.

We expect these licenses to be important contributors to our sales on our seasonal division, our girls doll division and our Halloween costume division. .

In terms of our own brands, Gift'ems will anniversary its launch later this year. We soft launched Cuppatinis in the first quarter and we're looking forward to build that brand this year with promotional efforts in the second half.

Later this year, we will be introducing the JAKKS branded Chocolate Egg Surprise Maker, a fun activity toy that gives kids the ability to make their own chocolate egg surprise gifts. Real Workin' Buddies Dusty is another owned IP we are extremely optimistic about for the second half. .

Some of the new Disney girl properties such as Beauty and the Beast, Moana, Elena of Avalor are performing extremely well as is Disney's Princess. We expect Frozen to get some benefit later this year from an animated 22-minute short film, Olaf's Frozen Adventure, a holiday TV special in the fourth quarter.

As I mentioned earlier, the strong launch of Nintendo Switch continues to grow interest in Nintendo characters. In addition to collectibles, our Nintendo business in 2017 should benefit from Splatoon, our blaster toy that perfectly ties into the gameplay of the popular Nintendo game of the same name. .

Regarding international expansion. In 2017, we will have direct sales offices in the U.K., France, Germany and Mexico, plus a joint venture in China which expanded our footprint and is supporting our efforts in this market. This international expansion is expected to grow our sales, our profit margins and our access to attractive new licenses.

We recently extended and expanded our Disney property licenses for the Chinese market. We will continue to strengthen our efforts to increase our sales to online retailers and the online divisions of brick-and-mortar retailers.

Over the past couple of years, we have put a significant effort into building our distribution centers and distribution platform. This effort includes designing the facility to be efficient and nimble enough to move goods at an expeditious pace. With an amazing internal staff in the U.S.

and abroad, which also includes our own in-house customs clearing. .

We have developed innovative technology that allows us to expedite many areas of warehousing and distribution, so that we are able to make deliveries direct to consumers within 24 hours from the time they make the purchase from our various retailing partners.

Our staff are experts on the distribution needs of all customers, including brick-and-mortar retailers, along with their own internal online initiatives as well as dedicated online retailers. .

A few words about Meisheng. Last month, we announced and expect to soon complete the sale of $19.3 million in stock to China-based Meisheng Cultural & Creative, which is also our distribution and animation partner in China.

The benefits of strengthening the relationship between our 2 companies, Meisheng is already an important manufacturing and distribution partner for the Chinese market.

Our other joint venture with Meisheng, Studio JP, gives us access to Meisheng's state-of-the-art animation capabilities, which we are currently using to create proprietary animation content such as Creepy Crawlers and Cuppatinis just to name a few. We are adding Mr.

Zhao to our Board of Directors, which will help us navigate the Chinese market and we will have a partner in China with an increased incentive to see us do well across the whole company. .

To wrap up, our strategy remains growing our core evergreen products with licenses and innovative IP, to augment this with promotional products that have the potential to become hits, whether they are licensed or on original IP basis.

On top of that, we will continue to enter new kids consumer product categories with our own IP, while still focusing on the toy categories and appropriate licenses that are correct for today's kids play patterns.

We will continue diversifying into attractive growth areas around the world as we have done entering the youth skincare and beauty market with C'est Moi and kids health, wellness with fun products that we will show later this year.

And we will continue to expand our geographic footprint by opening new international offices and, as just previously mentioned, have a special focus on efforts to maximize worldwide online channels. This ends the prepared portion of the call and we will now open it up to questions and answers.

Operator?.

[Operator Instructions] And from Stifel, we have Drew Crum on line. .

So could you -- on a point of sales or consumer takeaway, could you address or quantify what you experienced during the quarter and maybe through Easter? I think you termed it as strong in all of your core categories. .

Yes. At the end of fourth quarter, I think you've heard and we announced and other people had a slowdown during the last 3 weeks of December.

But the sell-throughs during the first quarter and building up to Easter in our categories, I'm speaking on behalf of JAKKS, we had extremely strong sell-throughs in our categories of business with ones that have the correct portfolio of licenses. So we actually had a robust sell-through in the majority of the categories that we lead in.

And it was exciting for the first quarter to look at the sell-throughs and also, continue through Easter, which was a couple of weeks past last year's Easter holiday, which ended up in March -- April, excuse me. .

Got it. Okay.

And then with respect to your efforts overseas, what are you assuming or embedding in guidance as far as incremental contributions from some of the new offices you're opening or have opened? And as it relates to China, as you continue to grow that business, what are your expectations around profitability? Some of your competitors have noted very strong top line growth in China, but those subsidiaries are not profitable for them as of yet.

So just wondering what your expectations are in terms of bottom-line for your China efforts. .

In general, international -- our international expansion is a fixed template. Our offices typically have 3 to 4 people. In China, we're utilizing the resources of Meisheng. Also in some of these areas where we otherwise use sales reps, we're picking up their -- or actually distributors rather, we're picking up their part of the margin.

So net-net, ours are actually going to improve. And again, by maintaining an efficient infrastructure, we expect that to continue. .

And also to add to the Chinese market, we just expanded our rights with Disney for the current rights that we had and on top of that, many other properties. And what we do is we have -- as you know, China has 5 different tiers.

So there's different distribution platforms that we work with from the brick-and-mortar to Tmall to a B2B platform to get -- hit the wholesalers, well over 3,000 wholesalers, to get to the outer rims. So we've been working on the China platform for many years.

So China, from almost the first year, has been profitable for us just because of the way that we took the platform and the way that we work with Meisheng in our distribution abilities. .

Got it. Okay. And then just one last question for me. Just talk about the next milestone or milestones as you continue to address the converts that come due next year. .

The capital allocation committee, as we said, I think, in our February conference call is always looking at the opportunity and will work on the 2018 converts where they see appropriate and where the convert holders work with us. But we have not publicly announced when we do it. It's done on a entrepreneurial basis, working with these convert holders.

So we plan to have the converts completed hopefully by this year. .

[Operator Instructions] And from BMO Capital Markets, we have Gerrick Johnson. .

It sounded like Nintendo is ahead of your expectations.

Is that -- would that be accurate?.

Nintendo, yes. Worldwide is internally above our expectations. .

Okay.

And that's a worldwide license?.

Excluding Japan. .

Okay.

So my next question, if that was ahead and your guidance is unchanged, what's underperforming that prevented you from lifting your guidance?.

First, we didn't give guidance on sales. And right now, as we're looking into the year, we've taken all considerations in the retail environment. As you've seen, retailers have different strengths and weaknesses that we've seen.

So even though that Nintendo is doing well and Beauty and the Beast, Moana and other properties and categories, we're just taking a cautious approach this year. And we'll look on a quarterly basis and review where we're at with our sales, our profitability, and make changes where we see fit.

But right now, as last year, we went through some pain with regards to sell-throughs and the retail environment, we're just taking a cautious approach this year. .

Plus the first quarter is the lowest sales volume and it's not a great indicator of how the next 9 months will be, but it certainly gives us additional confidence that we're on the right track. .

Okay. Sounds appropriate. And next and last question.

To what extent did the Easter shift have an impact on the quarter? Was it beneficial shifting advertising spending out? Was it hurtful perhaps shifting the shipments out?.

This is Stephen. It was beneficial.

One thing is we brought in enough inventory in at the end of last year that we had a good inventory amount and for good reasons because I believe our categories and the strong portfolio of licenses, we had strong sell-through and that continued through April, which having Easter later in April, I believe it was the 16th, allowed us a few more weeks of really solid sell-throughs.

And not just sell-throughs, but also purchases from our retailers. .

I was kind of talking Jack -- sorry, Stephen, about the first quarter, did you -- were you able to shift some advertising out that would benefit the first quarter on year-over-year basis and... .

Yes, of course. Advertising shifted a little bit more into second quarter as Easter was 2 weeks into the quarter. So some of that advertising that you'd see if Easter was in March, you'd see much -- a little bit more -- not much more, more advertising in the first quarter than you would if it shifted into the second quarter. .

Okay. And are there any changes to your advertising strategy, given that a lot of manufacturers did not see the kind of lift they usually do with TV over the holiday period necessitating sort of a change in strategy and how we advertise our products.

So any shifts in strategy for 2017 in how you advertise?.

Yes, it truly depends on the category in which we're advertising. So a good example would be the C'est Moi line that we're doing where we'll be using much more of YouTube influencers and promotional activity at the retail level.

And then you take certain areas of businesses, call it, our baby dolls that we will do our traditional TV, but at the right time zones -- or the actual time appropriately for the preschool market and the network. So it really depends. And Facebook and other platforms have become much stronger for us in advertising.

So it really depends on the categories. Halloween, we are doing much more social media advertising with Minecraft and Halo, it's hitting the different marketplace, PJ Masks and so on. And majority of the Halloween sales or a large portion are online sales versus brick-and-mortar. .

[Operator Instructions] And we have no further questions at this time. Ladies and gentlemen, this concludes today's conference. Thank you for joining. You may now disconnect..