Stephen Berman - Co-Founder, Chairman, CEO, President and Secretary Joel Bennett - CFO and EVP.

Stephanie Marie Schiller Wissink - Jefferies LLC Tristan Thomas-Martin - BMO Capital Markets Equity Research Linda Ann Bolton-Weiser - D.A. Davidson & Co..

Good morning and welcome to JAKKS Pacific's Second Quarter 2017 Earnings Conference Call with executive management, who will refer - review financial results for the quarter ending June 30, 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 this 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 earnings per share for 2017 as well as any other forward-looking statements concerning 2017 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 could cause actual results to differ materially from those projected in forward-looking statements.

For details concerning these and other 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 like to turn the call over to Stephen Berman..

Good morning, everyone and thank you for joining us today. This morning, we're going to review our performance during the second quarter of 2017. I will talk about how our brand and products performed in the quarter compared to last year and to our expectations.

After my comments, Joel will review the details of our financial performance, provide an update on our debt reduction plan and offer some additional color on how we see the year playing out. Then we will open the calls to questions.

We expressed in February and reiterated in April, with first quarter sales flat to slightly down, we expect our full year 2017 adjusted EBITDA and EPS to be up over last year despite a decline in full year 2017 sales. In line with our internal forecast, total first half sales were down approximately 10%.

In the more important second half, we have some tailwinds on sales we didn't have in the first half and we have significant tailwinds on cost. So we continue to expect full year EBITDA and EPS to be up despite a decrease in sales. We expect the sales decline to be much more modest.

During the quarter, we saw declines in several film-related product lines that were weak last year. But we also saw several lines that performed quite well.

Properties that showed strong year-over-year increases or which renew this year include, Disney's Moana, Beauty and the Beast, Cars, Tangled and Elena of Avalor and DC Superhero Girls from Warner Bros, Nintendo across several categories and Gift 'ems, one of our own proprietary products.

We expect these products, as well as other new products and categories, to be strong performers in the second half as well and to be joined by other new product launches slated for fall which I will talk about later in the call.

Properties that underperformed in the second quarter were Frozen, Star Wars, Ninja Turtles, XPV Skateboarding Mikey, were all tied to entertainment licenses that contributed last year. In addition, last year second quarter, we were still shipping to a major U.S.

retail customer which we then suspended during the third quarter of last year which alone accounted for a meaningful drop in sales for the quarter. Finally, we ran a special promotion program on some outdoor products with a retailer last year that did not repeat this year as we expected.

We knew going into the quarter, that we had these headwinds and we're actually pretty encouraged by the performance of the lines that are working well. That is why we expect the sales declines in the second half to be more modest.

Let me remind you of our long term strategic goals, continue to build on our solid base of evergreen properties, evergreen categories, partner brands and licenses; augment this base with promotional opportunities; build up our own IP; continue the expansion of animated content, both short form, long form and digital through our Studio JP joint venture with Meisheng; develop exclusive private label product lines for our global customer base; enter new categories organically and through acquisitions, including nontoy consumer products for kids; broaden our geographic reach with new offices and licenses; lastly, grow our business with online retailers as a percentage of total sales.

Now let's review how our second quarter results look against these goals. Many of our evergreen properties and categories did well. Excluding the special promotion on outdoor products, our aggregate sales of evergreen products such as Preschool, Kids Only!, Moose Mountain and Disguise were up year-over-year.

Our new launches of specific products are off to a great start in both sell-in and sell-throughs. We also did quite well with some promotional opportunities. We're well positioned to capitalize on the popularity of Moana, Beauty and the Beast, Elena of Avalor, Nintendo and DC Superhero Girls, just to name a few.

Two of our new proprietary brands, Gift 'ems and Cuppatinis were solid in the quarter. Gift 'em started shipping a year ago and Cuppatinis started shipping in the fourth quarter of 2016.

Cuppatinis is the first of our products that we have supported with animated content produced by the Studio JP joint venture with Meisheng, a leading animator in China and is making great strides in supporting our new IP with creative content.

We're currently developing content to coincide with the fall launch of Power Rippers, a proprietary line where vehicles meet action figures. We have a few of our own other properties that we're working on and we will address next quarter. In terms of new categories, we made progress during the quarter on our entry into 2 new areas.

We're getting closer to the launch of the C'est Moi youth skincare and cosmetics line, working with a small group of retailers with additional shipments while in conjunction with developing our marketing campaign together. We're also preparing for the launch of Morf, an outdoor product that is part of our activity play initiative.

I will talk more about these later in the call. Our geographic expansion continues with the official opening of our French office during the second quarter.

Not only does this expansion leave us well positioned for higher sales levels and greater profit margin, but it boosts our ability to get broader licenses with local inventory and territories where we're better able to support retailers with just-in-time replenishment to further enhance growth opportunities.

We're especially pleased with our shipments through the online channel. Our second quarter sales to online customers as well, as the E-commerce division of traditional retailers, rose more than 50% compared to last year. We continue to tailor our sales and logistics capabilities to make sure we capitalize on this continued shift to online.

So as we have been planning, we continue to make progress against our long term strategic goals and we continue to expect the second half to show a significantly better profitability, allowing us to meet expectations in 2017 and go into 2018 with good momentum.

Now I will turn the call over to Joel Bennett, who will review our financial performance and update our capital allocation activities.

Joel?.

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

retailer as well as a seasonal promotion that we had in 2016, were $119.6 million compared to $141 million last year, with a net loss of $16.7 million or $0.77 per diluted share which included the onetime noncash bad debt charge of $2.3 million relating to 2014 and 2015 sales.

Excluding this charge, the net loss would have been $14.9 million or $0.69 per diluted share. This compares to a loss of $4.4 million or $0.27 per diluted share in the year-ago quarter. And adjusted EBITDA for the second quarter was negative $5.4 million compared to adjusted EBITDA of $4 million in the second quarter of 2016.

The sales drivers in the quarter by category were as follows, sales of Dolls, Role Play and Dress Up plus an activity products in our Girls category amounted to $51.3 million for the second quarter compared to $61.6 million in 2016, driven by Dolls and Role Play toys featuring Disney Princess, Moana, Elena, Beauty and the Beast and Frozen, Tsum Tsum and Gift 'ems collectible figures and accessories and the launch of DC Superhero Girls, though Frozen and Alice Through the Looking Glass are down year-over-year, as expected.

Sales of Action Figures, Vehicles, Role Play and Electronics products in our boys and other category for the second quarter were $15.2 million compared to $22.4 million last year, driven by Nintendo with new gaming platform and video game catalysts, BIG FIGS and Ooshies and absent catalysts, XPV Turtles RC, Star Wars and Warcraft declined year-over-year.

Sales of seasonal products, including licensed Ride-ons, ball pits, kids furniture and Maui outdoor activity products were $19.9 million in Q2 2017, down from $23.9 million in 2016.

As expected, the decline was experienced in the kids furniture absent the Blitz promotion we had in 2016, but was offset in part by increases in Maui's outdoor categories. Sales in our Halloween category which is also one of our business segments, totaled $31.9 million in the second quarter of 2017 which is comparable to the $31.3 million in 2016.

Sales of baby doll accessories, figures and plush in our preschool category were $1.3 million compared to $1.8 million for Q2 2016, driven by products featuring Daniel Tiger's Neighborhood. Looking at sales by business segment, U.S.

and Canada sales for the second quarter were $70.1 million compared to $89.7 million in the year-ago period, driven by Disney Princess, Frozen, Moana and Elena of Avalor and Tsum Tsum collectible figures. International sales for the second quarter were $17.5 million compared to $20 million in 2016 with the same drivers as North America.

And we already mentioned the Halloween in the category breakdown.

Gross margin in the second quarter was 28.2%, down from 31.2% last year, due in part to lower prices in our Halloween segment, Funnoodle pool toys in our seasonal category and deleverage on higher tooling amortization and higher royalties resulting from a shift in product mix, with Disguise making up a larger percentage of total sales in 2017 as well as an increase in some royalty rates.

SG&A expenses in the second quarter of 2017 were $47.8 million or 40% of net sales compared to $45.9 million or 32.6% of net sales in 2016. Excluding the bad debt charge, SG&A in dollars was down in 2017 but increased as a percentage of net sales due to the sale decline in 2017.

Operating margin was negative 11.8%, down from negative 0.8% last year due to the deleveraging of fixed costs on lower sales and lower gross margin in 2017. Consistent with the seasonality of our business, operations provided cash of $3.3 million for the second quarter of 2017, compared to using cash of $14.7 million in the same quarter of 2016.

The increase is due in part to lower accounts receivable on lower sales. Free cash flow for the quarter was approximately $100,000 compared to negative $17 million for the same period last year. As of June 30, 2017, our working capital was $191 million, including cash and cash equivalents and restricted cash of approximately $67.6 million.

This compares to working capital of $216.5 million in the same quarter of 2016.

The decrease is due in part to the 2017 exchanges of convertible senior notes using cash in the aggregate amount of $35.6 million, offset in part by the $19.3 million in cash received in connection with the issuance of common stock to our joint venture partner in China during the second quarter.

As for our remaining 2018 convertible notes, their retirement remains a priority for the company as we continue to improve the capital structure in shareholder-friendly manners. Accounts receivable as of June 30, 2017, were $110.5 million, down from $132.9 million at the end of the second quarter of 2016 due to the lower shipments during the quarter.

This resulted in DSOs in 2017 of 84 days, down from 86 days in 2016.

Inventory as of June 30, 2017, was $81.2 million versus $71.5 million at the end of Q2 2016, resulting in DSIs in 2017 of 113 days compared to 87 days in 2016 due to the planned higher-inventory levels to mitigate supply chain constraints as we head into the peak season as well as continue to sell goods brought in for spring due to the timing of customer orders.

Capital expenditures during the quarter were $3.2 million compared to the $2.3 million in the second quarter of 2016 with an estimate for the full year of $14 million to $15 million. Income tax expense for the second quarter of 2017 was $316,000 compared to $704,000 for the second quarter of last year.

The variability of the tax provision is based on changes in income levels in the various tax jurisdictions that we operate. The diluted EPS calculation in the second quarter includes an average of $21.6 million common shares outstanding during the quarter and exclude 17.8 million shares, assuming the conversion of the convertible notes.

Now to our 2017 outlook. For 2017, we continue to expect higher net income, higher earnings per share and higher adjusted EBITDA on lower net sales compared to 2016, excluding the onetime noncash bad debt charge.

This expected improvement to profitability in the second half is driven by tailwinds in our operating cost, including more efficient marketing efforts against prior year comps as well as 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 more about what we'll be doing in 2017 and beyond to further our drive to become a world-class producer of consumer products for kids.

Consistent with our strategic goals of expanding the broad base of stable evergreen categories of products, partner brands and licenses as well as developing our own IP, let's review some of what we have coming up for the second half of 2017 and the early part of 2018.

As you know, we have, for many years, been a very important licensing partner of Disney.

That partnership continues to expand and in the second half of this year, we'll benefit from a growing number of Disney properties, including several that were strong in the first half, namely, Moana, Beauty and the Beast and Elena of Avalor; as well as Cars 3 and Spiderman RC vehicles. With Warner Bros.

DC comics is also broadening out as a licensing partner and we're launching more DC Superhero Girls products as well as several products tied to the Justice League which hits theaters in November. Nintendo continues to be a strong licensing partner.

Our Nintendo sales were up strongly in the first half and should do well with our Nintendo's Splatoon shooter, a physical product that emulates the videogame. Other important licensing partners that will help our second half includes Black & Decker toys and Role Play, WWE big figures and dress up and Ooshies licensed collectibles.

And, of course, our Disguise division always does well with licenses such as Disney Princess, Lego, Nintendo and Pixar characters, with new licenses this year and Disguise, including Minecraft, PJ Masks, Shopkins and others.

As importantly, we continue to launch new proprietary brands which we expect to sell well and to generate above-average profit margins. Upcoming proprietary launches included the Chocolate Egg Surprise Maker and Unicone, 2 new entries in the activity toys category.

Power Rippers, an innovated and proprietary new line of action figures and superfast vehicles fused together. Cuppatinis, as previously mentioned, is the first of our products that we have supported with animated content, produced by the Studio JP, joint venture with Beijing. Real Workin' Buddies Mr.

Dusty, a 3-in-1 vehicle with over 50 sounds and phrases. A new kid suspense game called, Pull My Finger. The name says it all. I think you can guess the gameplay. And Squish-dee-lish, a line of slow-rise, squishy toys that are fun to squeeze and collect. Squish-dee-lish is yet another example of our ability to move fast when a new trend hits the market.

Inspired by the slow rise trend started in Asia-PAC countries, we began the ideation for this product line the last year. And only within 9 months, we were able to take this from concept, secure a top license and ship in time for fall planograms.

In addition, we're especially excited about 2 new products we're launching in the second half that are in new categories. C'est Moi is our first entry in the youth skin care and cosmetics. We have a couple of retail partners lined up for a limited shipment this fall and continue to work out the details for broadening the distribution early next year.

This is a high-growth, high-margin category and we believe we have a differential product that will resonate with tweens. We have discussed this with many retailers who feel the same. The other new category we're entering is the sporting goods category as part of our whole active play initiative. But our new product Morf is aimed at an older consumer.

This patented product combines the best features of skateboards, scooters and balance boards to create an ecosystem that makes it easy to balance, bounce, skate and scoot by switching out the wheels and handles on a solid deck. Active play is one of the areas we have identified for its high growth potential and have quite a few new launches in 2018.

These category launches won't have a very big impact on this year's sales because they are late launches this year but we're eager to get into these categories. Let's turn to the improvements we're making that go beyond the products we have coming up later this year. As I said earlier, our geographic expansion is helping us get broader licenses.

But it's not just the new foreign offices. The combination of bigger global footprint, our strong relationships with IP holders, a proven track record of innovation and the ability to execute well has given our licensing partners the confidence toward us with more and more master toy licenses.

For 2018, there are 9 properties for which we have the global master toy license compared to 6 in 2015. And there are 13 properties for which we have master toy licenses that are broad but not fully global compared to 9 back in 2015.

Some of these evergreen master toy licenses are for properties with modest upside potential, but others are major properties and we look forward to announcing some of these deals when the time is appropriate. As you can clearly see, our balance sheet is significantly improved.

At this time last year, our long term debt net of cash was $121 million and this year, it is $85 million. And the vast majority of that is not due until 2020 so it is extremely manageable. As we announced earlier this year, Meisheng is now a major partner of ours.

They are our largest single shareholder and a partner in manufacturing, distribution and content creation through joint ventures, but we believe have only begun to see the benefits of the collaboration with Meisheng and it's CEO, who sits in our Board of Directors.

So in conclusion, we see our momentum building in the second half with better sales performance and better cost management.

We're making progress on strategic goals, we continue to improve our balance sheet, our partnerships continue to expand with leading entertainment companies around the world and we're well positioned to take advantage of a growing number of growth opportunities later this fall and throughout 2018 and beyond.

This ends the prepared portion of the call. We'll now open up the call to questions and answers.

Operator?.

[Operator Instructions]. And our first question comes from Steph Wissink from Jefferies..

I think I saw all the detail in the prepared remarks. I just have a few questions. The first is just with respect to the sale decrease year-over-year, if you could just help us forth-rank the large customer that you suspended last year which hasn't quite anniversaried yet.

I think you mentioned some entertainment properties that were down year-over-year and then the promotional program that you didn't anniversary. Just help us appreciate relativity among those three impacts in the quarter..

Okay. The customer was in the mid-to high-single, 7-digit range as with the promotion. And also, for that matter, Frozen. Offsetting that, in part, were some of the initiatives that Stephen explained in his portion of this call..

Okay.

So the large customer and the promotional program, the larger of the 2 or should we think that all 3 of those are similar in size?.

I would take the large customer, the promotional program and the properties that - which we mentioned, I think it also was Ninja Trutle XPV were pretty much the total decrease for that - for the quarter..

Okay. And then on the inventory, I think you mentioned some planned inventory purchased and what you have on your balance sheet today for some of your back-half initiatives.

But could you just provide us some contexts and how that relates to some of your geographic growth strategies as well?.

Sure. With our expansion in the international markets, we also have local inventories that help - that better help support the local retailers and we expect we'll have overall revenue enhancement capabilities. In the international markets, the increase is about $7 million.

In addition, on the domestic side, we have some new initiatives on the Halloween side with our dot-com customers which accounted for an increase year-over-year of about $6 million. And a little bit is, we're still working through some of the inventory that we've brought in for spring..

Okay. Just a couple more, guys. One quick one on Disgues, just remind us what the growth margin profile is of that business relative to your corporate average.

And is there any strategy in terms of kind of how to think about the evolution of that model from a margin perspective over time?.

Well, Halloween is kind of a mature business and there's much elasticity in the pricing. Even though we have great costumes and great licenses, we don't command premiums, it's just the nature of the beast. The average margin is below the corporate average.

So when this particular quarter also dovetailed into a margin answer for the question you didn't ask, is that, with Disguise up a little bit in the quarter, it amount to - it made up a higher proportion of this quarter's sales. So that was a little bit of the drag on the margin.

But it's a great business, we do have a wonderful mix of licensed and nonlicensed properties that we expected to make great contributions for the foreseeable future. So....

Okay. Just a final one for us guys, it's related to the EBITDA bridge for the full year guidance, I think you're suggesting EBITDA up slightly versus last year.

If you could just remind us what the base is that you're using for your guidance? The 2016 base? And then secondly to that, how should we think about the kind of 60 million-plus acceleration into the back half relative to what you've reported year-to-date.

And help us just size that what the drivers of that EBITDA should be in the back half?.

Sure. Last year's EBITDA is $41.7 million and 2 big components of the back half, at least in terms of the comps. Within Q3, we had $4.2 million of legal and audit settlements from prior years. And also, we expect, having forecasted at this level of sales, our marketing spend will be much more efficient.

So that translates into about $10 million of tailwinds. In addition, as we go into the back half, it's roughly 2/3 of the year's sales. So we expect to regain the leverage lost in the front half. So based off of the sales, those tailwinds in our costing in general, actually our SG&A was down year-over-year in Q2.

So all of the components that we put in place are well on track for us to achieve those general outlook numbers..

Our next question comes from Tristan Thomas from BMO Capital Markets..

Just 1 quick question.

Have you observed any change in customer shipping to either more FOB, away from domestic?.

Actually, we're much more focused as an FOB company than a traditional, kids consumer product company or toys companies in general. But I'd - on a - we haven't seen more of a shift, we've continued that path as a company. We have seen more of a shift more on the U.S. side of larger retailers wanting just-in-time inventory.

So you're - we're managing more of the just-in-time inventory on an FOB basis. But at the same time, that also needs a requirement of bringing some more domestic inventory to fulfill those needs..

Our next question comes from Linda Bolton-Weiser from D.A. Davidson..

Hasbro, on its call yesterday, talked about expecting fourth quarter sales to be bigger than third quarter which is a little unusual. I would assume that's because retailers are wanting to take products later and later.

So is that something that you're kind of expecting too? And I'm just asking because you actually have an easier comparison in the prior year in third quarter and a harder comparison in fourth quarter.

So how are you kind of expecting things to kind of look in terms of year-over-year growth rate for each of the quarters? Because the comparisons would suggest you'd have a better third quarter, but that kind of goes against Hasbro and what they said about the shifting of sales later.

So can you give a little color on that?.

Yea, I believe that - I think Brian from Hasbro mentioned it that fourth quarter will have a little bit of a shift of more sales. And were seeing that as well, based off planograms and based off of the plans that are done, I would say globally, not just in North America.

So we're actually seeing a shift with promotional programs, with set dates for a little bit more in fourth quarter than in third quarter from the past prior years. So what Hasbro said, we're seeing the same thing..

Right. But for you, your third quarter is just usually so much bigger.

It still will be a bigger sales quarter, right, for you? The third quarter?.

Yes. The third quarter will be a much larger quarter than fourth. But we still - as I think I just answered what Hasbro said, to be in sync, there is a pickup in fourth quarter as well, but our third quarter will definitely be bigger than our fourth..

Got you. And then I think that you had mentioned some of the pricing pressure or something in pool toys a couple of times now.

Is that kind of a long term phenomenon? And how big of a business is that for you?.

It was actually that the pressure we felt was in our seasonal area, the Funnoodle business. And it actually just fluctuates with oil prices and also demand and manufacturing capabilities, as there's less manufacturers. We saw this year, a little bit more pricing pressure that way, more on the manufacturing side.

But it fluctuates throughout the last 14 years, it fluctuates year by year. So I think we've seen the bottom of the lower margin aversion in that area..

Okay.

And then can you talk a little bit about the situation with the converts? Because I think there's still a balance outstanding and would that become a current liability on the balance sheet in August? And what does that mean? I mean, does that affect your ability to borrow under your revolver? Or can you just kind of talk about what that means for that to become a current liability?.

Yes, Linda, with all the exchanges that we've done in Q1 and Q2, the current principal amount on the 2018 is $42.7 million. It does become current August 1. So to the extent that no others are exchanged and retired that would become current. We have no real concern about that. There's no covenants in our credit facility.

We're very much aware of the maturity coming up. And as we mentioned in the call and previous calls that we're dealing with those and we expect to do it in ways that are positive for the shareholder..

Okay. And then just on your operating cash flow. I think for the first half, it looks like it's kind of down year-over-year, but I believe you're probably expecting positive free cash flow for 2017.

In case something happens with Christmas, because it is a difficult retail environment, if something happens with Christmas and your cash flow is more neutral like it was last year, what would be the plan then with regard to dealing with the rest of your converts outstanding?.

Well, I think the order of magnitude regardless of Christmas wouldn't be that great. We started the year with a lot of cash. We're expecting - we planned for many different contingencies and we still expect to be able to take them out, like I said, in shareholder friendly manners. This year, a lot of what is going to drive the back half is continuing.

The working capital will be a source of cash as we work down our inventory levels. Also, in Q4 being one of the low quarters from an overall volume perspective. We generally throw up most of our cash in the fourth quarter.

And we don't expect that to change and given the conservatives within the forecast, that's all basically factored into the plan that we've articulated..

And Linda, just also add to that. Primarily, I think it was an question, a lot of - majority of our businesses is done on an FOB basis. So that those orders are all in line and we have a great backlog. So that really, I think we don't have as much pressure as normal due to the retail environment.

But by the way, the retail environment and at least call it kids consumer goods and toys, the sell-throughs have been terrific to date. So that's a good comforting feeling..

Thank you, everybody, for the call. Those were the last Q&A questions. We appreciate the time and we're looking forward to our third quarter conference call coming up in October. Thank you again..

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating and you may now disconnect..