Stephen Berman - President & CEO Brent Novak - CFO.

Steph Wissink - Jefferies Gerrick Johnson - BMO Drew Crum - Stifel.

Good morning and welcome to the JAKKS Pacific First Quarter 2018 Earnings Conference Call with management, who will review financial results for the quarter ending March 31st, 2018. JAKKS issued its earnings press release earlier this morning.

Presentation slides including information covered in both today's earnings press release and call are available on our website in the Investor section. This presentation includes videos showing some of our key products. On the call this morning are Stephen Berman, Chairman and Chief Executive Officer; and Brent Novak, Chief Financial Officer. Mr.

Berman will first provide an overview of the quarter and provide highlights of product lines and current business trends. Then Mr. Novak will provide detailed comments regarding JAKKS Pacific's financial and operational results, prior to opening up the call for your questions. Your line will be placed on mute for the first portion of the call.

[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 in 2018 as well as any other forward-looking statements concerning 2018 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 such 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 for our first quarter 2018 earnings conference call.

In our call today we'll discuss the factors that drove our first quarter results, including several successful new product launches, some new products that declined from the last year, the impact of the liquidation of Toys 'R' Us North American stores, and our plans for the rest of 2018. I'll make some comments on our business.

Then our new Chief Financial Officer, Brent Novak, will discuss our financial performance. After that, I will talk about some of the things that we are looking forward to over the course of the rest of 2018 and beyond. Not surprisingly our business was significantly affected by two impactful events from Toys 'R' Us.

Going into 2018, Toys 'R' Us bankruptcy filing last year had led us to expect store closures and therefore lower sales to Toys 'R' Us in 2018. The liquidation announced late in first quarter obviously led to lower sales in the quarter and a much lower outlook for the year.

We supported Toys 'R' Us and as a critical vendor continued to ship them during the first quarter, although as conservatively as we could. But the important thing is that underlying demand for our toys has not gone down, it's gone up. Our POS at retailers where we can measure it is up low-to-mid-single-digits in the first quarter.

Our sales to other brick-and-mortar customers were up during the first quarter and our sales to online retailers were up double-digits in the first quarter.

So while we recognize that the loss of a major customer like Toys 'R' Us in North America and in the UK is not a positive, we do expect that over time we can make up most of these sales with increases to other retailers, although 2018 is likely to see disruption.

With this in mind, we are relatively pleased with our sales performance in the first quarter of 2018. Our first quarter sales declined by just under 2% compared to last year. Our sales to customers in the U.S. were actually up approximately 3% offset by declines in sales to customers in other countries.

Our success is always a function of our product offerings and despite the declines at Toys 'R' Us, our products sold relatively well in the first quarter.

The strong sales of new or recently launched product such as Incredibles 2 and Squish-Dee-Lish were offset by declines in several entertainment products, especially Beauty and the Beast, Moana, Smurfs, as well as Tsum Tsum.

Among the products that also performed quite well in the quarter were MorfBoard, our new skateboard and scooter product; Perfectly Cute Baby and Perfectly Cute Home lines, Disguise Costumes, Tangled - The Series, and DC Toddler Dolls.

We will talk about some of these in more detail later, but I would like to highlight them now to show that during the quarter we had successes with a wide range of variety of products. I would say that this is one of the most balanced quarters yet in terms of strong product launches that lined up with our strategic goals.

Proprietary products did especially well, licenses from several major partners continue to perform, our entries into new product categories have worked well, various new private label lines are performing nicely, and online sales rose by double-digit in the quarter. Let me call attention to a couple of these points.

As many of you know, we launched MorfBoard this year, an innovative product and a new category for us. MorfBoard is a revolutionary outdoor action product that combines a fun and physical challenge of skateboards, scooters, bounce and bounce boards.

MorfBoard is targeted to a somewhat older consumer than many of our other products and is finding strong distribution in new channels and new departments of our existing customers. In addition, the product is showing well on our own site Morfboard.com.

Just a few weeks after our launch, it's hardly the number one selling scooter at target and we are seeing terrific upselling on the various components and accessories that consumers can buy to expand their skills. MorfBoard appeals to female and male customers, twins, teens, and adults and can even be enjoyed indoors and outdoors in certain mode.

It's a great example of our effort to expand beyond toys and into new categories. Incredibles 2 is off to a strong start. The movie opens on June 15. So what we saw in the first quarter was the initial sell-in and we expect additional strong sell-in in the second quarter.

How well it does in the second half will depend on how the kids respond to the movie and the streaming and DVD release which is slated for later in the second half of this year. But we are pleased with our initial sales so far. We have also seen our first sales of C'est Moi, a proprietary line of innovative skincare products for twins and teens.

The early numbers are small, but growing rapidly. While encouraging, this line of products will take some time before becoming a significant piece of our business.

Our sell-throughs online channel rose by 12% year-over-year during the quarter continuing the trend of growing as a percent of our total sales which has been one of our major strategic goals. We expect to see continue especially given how well MorfBoard is selling online.

So in spite of the decline in sales which the majority is attributable to the reduction in sales to Toys 'R' Us, we have seen quite a number of pockets of strength and we believe we are set up well for the balance of the year.

While our sales held up relatively well the liquidation of Toys 'R' Us not surprisingly did have an adverse impact on other aspects of our results.

We were required to recognize additional minimum guarantee shortfall charges because we know our expected sales of certain licensed products will be lower than plan, which significantly hurt our gross margin and we also had to recognize significant bad debt reserves. Brent will discuss these charges later in the call.

We expect our sales to Toys 'R' Us to decline sharply for the rest of the year. In the phase of the lower outlook for Toys 'R' Us sales, we are encouraged by how other major retailers are stepping up to try and grab as much share as they can.

All of our top customers have expressed their desire to work with us to recapture as much of those sales as they can and we expect to have special programs with all of them to maximize our sales. We have a strong and balanced lineup of products planned for the second half of the year and expect to build momentum as the year unfolds.

And when we go into 2019, we believe we are well-positioned for growth which I will discuss later in the call. Before I hand the call over to Brent, let me address the expression of interest that we received back in January from Meisheng, expressing an interest in buying additional shares to bring its holdings to 51% of our shares.

We have no new details to share at this point. As we have announced a committee of independent members of Board of Directors has been formed. The special committee is working with independent legal counsel and investment bank firm to evaluate Meisheng's expression of interest as well as other possible interest.

We will obviously provide an update when we are able to, but for now this is all that can be expressed about the process. With that, I will turn the call over to Brent Novak who started on April 2nd, as our new Chief Financial Officer.

Brent has a terrific background and deep experiences in areas where he will be able to help the company tremendously and we're very happy to have him on the team.

Brent?.

Thank you, Stephen and good morning everyone. Net sales for the 2018 first quarter were $93 million compared to $94.5 million last year. The decline is essentially due to a decrease in sales to Toys 'R' Us.

The reported net loss for the quarter was $36.2 million or $1.57 per diluted share compared to a net loss of $18.3 million or $1.01 per diluted share in the first quarter of last year. Adjusted EBITDA for the 2018 first quarter was negative $14.6 million compared to negative $10.6 million in the first quarter of 2017.

All of these metrics were significantly and negatively affected by the bankruptcy and liquidation of Toys 'R' Us as further discussed in a moment. The sales drivers in the quarter by category were as follows.

Sales of Dolls, roleplay and Dress Up, plush, and activity products in our girls category amounted to $44.5 million for the 2018 first quarter compared to $46.4 million in the comparable quarter last year driven by the 2017 third quarter launch of Squish-Dee-Lish slow-rise foam collectibles, the girls portion of Incredibles, Tangled - The Series, and Perfectly Cute a private label brand we produced for one customer.

These brand helped to offset the expected decline in a number of girls lines including Beauty and The Beast, Moana, Tsum Tsum and Gift Ems. We should note that Perfectly Cute is part of a private label brand that replaced the Honestly Cute line at the same retailer. Sales of Perfectly Cute fully offset the decline in Honestly Cute.

Sales of action figures, vehicles, roleplay, and electronic products in our boys and other category for the first quarter were $20.5 million compared to $16 million last year, driven by Incredibles, Stanley, Real Workin' Buddies Mr. Dusty, which were partially offset as expected by the declines in Smurfs.

Sales of seasonal products including licensed Ride-ons, ball pits, kids' furniture and Maui outdoor activity products were $21.6 million in the 2018 first quarter, down from $27.5 million in 2017, as solid sales from the launch of MorfBoard were offset by declines in our Maui branded products.

These declines were the result of Toys 'R' Us as well as some programs we ran with club retailers last year that did not repeat this year.

Sales in our Halloween category which is also one of our business segments totaled $5.2 million in the first quarter of 2018, an increase of over 40% compared to $3.7 million in 2017 driven by growth across a number of licensed properties.

Sales of baby doll accessories, figures, and plush in our preschool category were $1.2 million in the first quarter of 2018, up from $1 million in 2017. Looking at sales by business segment, U.S.

and Canada net sales for the first quarter were down slightly to $70.5 million compared to $70.9 million in the prior year quarter driven by the same puts and takes described earlier in the product group descriptions.

International sales for the 2018 first quarter were $17.3 million compared to $19.9 million in 2017, with the decline being driven by reductions in sales of Toys 'R' Us and declines in Smurfs and Tsum Tsum of which bulk are skewed more to the International segment than in North America.

And we already mentioned Halloween sales in the category breakdown. Moving down the P&L, reported gross margin in the 2018 first quarter was 24.7% down from 31.8% in the 2017 first quarter due primarily to increased royalty expense resulting from minimum guarantee shortfalls attributed to the Toys 'R' Us bankruptcy.

If we exclude the effect of this unusual charge, gross margin for that quarter would have been 28.4%. The 340 basis point drop is mainly due to product mix, a combination of higher sales and products with inherently higher COGS as a percent of sales and higher sales of licensed products with higher royalty rates.

SG&A expenses including direct selling expenses and depreciation and amortization in the 2018 first quarter totaled $58.6 million or 63% of net sales compared to $45.7 million or 48.4% of net sales in 2017. The increase in SG&A includes $13.8 million of bad debt expense almost all of which is related to Toys 'R' Us.

Excluding this bad debt charge which we believe is non-recurring; SG&A was $44.8 million or 48.2% of net sales. Income tax benefit for the first quarter of 2018 was $2.3 million compared to a benefit of $300,000 in Q1 of last year.

The variability of the tax provision is based on changes in taxable income levels in various tax jurisdictions in which we operate.

Net cash used in operating activities was $11.4 million for the first quarter of 2018 compared to net cash provided by operating activities of $9.9 million in the first quarter of 2017, with free cash flow of negative $14 million in the 2018 first quarter and positive $5.6 million of free cash flow in the 2017 first quarter.

The decline in cash flow from operating activities is largely due to lower profitability and changes in working capital. As of March 31, 2018, our cash and cash equivalents totaled $46.8 million. This compares to cash and cash equivalents of $68 million at the end of the first quarter 2017 which included restricted cash of $10.6 million.

We continue to focus on improving the company's liquidity position while also balancing the need to invest in the business and securing new licenses. A top near-term priority for us is to repay our $21 million of 2018 convertible notes which are due on August 1st of this year.

Accounts receivable as of March 31, 2018, was $93.9 million, down from $98.5 million at the end of the first quarter of 2017 due to slightly lower shipments during the quarter. DSOs for the 2018 first quarter were 91 days compared to 94 days a year ago.

Inventory as of March 31, 2018, was $54 million versus $67.5 million at the end of the first quarter 2017 and down slightly from the $58.4 million reported at December 31, 2017. DSOs in the 2018 first quarter were 91 days compared to 116 days in the 2017 first quarter.

Capital expenditures during the quarter were $2.6 million compared to $4.4 million in the first quarter of 2017. The diluted loss per share calculation in the 2018 first quarter includes an average of 23.1 million common shares outstanding during the quarter and excludes 21.2 million shares underlying the convertible notes.

With that, I will now turn the call back over to Stephen.

Stephen?.

Thank you, Brent. Before we get into the Q&A, I will share some thoughts on how we see the rest of this year playing out, starting with a few properties that will be important. As I said earlier, Incredibles 2 hits theaters on June 15 and we are very well-positioned with a full line of figures, accessories, diecast, role play, and costumes.

It's one of our broadest lines ever of licensed product. MorfBoard is off to a fantastic start and the momentum is really building. The fact that most of it is an outdoor toy should make it sell well during the summer, but we also expect it to do well during the holidays because of its price point and because it's a great gift.

Another seasonal product we're expecting good results from is Fly Wheels, a proprietary line of kid-sized tricycles with special features and the best licenses. This is a proven ride on category and our line provides great value for consumers and good margins for JAKKS.

We continue to add licenses to our Squish-Dee-Lish line which is one of the leaders in the slow-rise foam category and sell-through continues to be strong. Squish-Dee-Lish is driving at the time when some of the industry's collectible lines are getting a bit tired.

Fancy Nancy is the new license from Disney and we have a solid line of dolls and accessories tied to this loved book series with a TV series that begins airing on Disney Junior TV in July.

In our Disguise Halloween costume division, we are already up in sales and we expect sales to benefit from strong licenses such as Blizzard's Overwatch video game, Incredibles 2, Transformers, and others. C'est Moi is building nicely at retail. We see this line as a long-term opportunity in high growth, high margin non-seasonal category.

We believe that C'est Moi like other lifestyle brands aimed at Millennial's and their kids is a line that will sell disproportionately well online and that's why we have focused our efforts on e-commerce.

Internationally, we expect to benefit from our geographic expansion, new warehouses, new licenses, and the fact that Disguise is now in almost all markets. We are expecting strong output from Studio JP.

Wee Whimsy [ph] is a property where the product and an app are closely linked and interactive and we are launching this app this fall to be followed by product in Spring 2019. The teams in the U.S.

and in China are currently working on new franchises with innovative and exciting toy lines across all categories including one of Meisheng studios top sellers in China, Constellation High. Finally, it is too early to formally announce some of the new licenses we have been awarded for 2019.

We can say we believe you will be impressed with some of the new product licenses we picked up for next year.

In conclusion, we see this year presenting some disruptions but also some opportunities to be positioned well for the future, while some of the retail challenges are continuing and the whole industry is wrestling with a loss of Toys 'R' Us sales, we are seeing stronger sales to other customers.

We believe this year will be a year where you see our strategic goals being validated. Expansion of licensing partnerships, strong performance from our owned IP, online sales growing as a percent of total sales, expansion of our Studio JP effort, enter into new categories, and international expansion.

In terms of our outlook, we're assuming very sharp reductions in our sales of Toys 'R' Us for the rest of the year, figuring out the net impact requires estimating not only how much business will be picked up by other retailers, but what the impact on consumer demand will be from the massive liquidation sales that happened in the first half.

We're taking a pretty conservative look on how much of these sales we can make up over the balance of this year, but we do expect to see improved financial performance in 2018 compared to 2017.

With that, we'll now take questions, operator?.

Thank you. We will now begin the question-and-answer session. [Operator Instructions]. And our first question comes from Steph Wissink from Jefferies. Please go ahead..

Thanks, good morning everybody..

Good morning, Steph. Just a few questions, Stephen.

I’m very encouraged to see some of the scale stability given the backdrop, so I’m curious if you can just give us an update on if you're fully reserved now for Toys 'R' Us, should we expect any future write-offs related to that account and then how are you managing into some of the markets that may not be part of the liquidation and still delivering good to Toys 'R' Us or you pulling back in those markets as well?.

Hi Steph, this is Brent. So just on the whether we’re fully reserved, yes for Toys 'R' Us, we are fully reserved..

And then on the other part with regards to Toys 'R' Us in other territories, we're just taking a very cautious outlook of what's occurring right now in Canada and then parts of the EMEA and in Asia.

So at this time we haven't shipped any of the Toys 'R' Us around the world until we have a better understanding of where the footprint is of who's investing and the financial backing..

Okay, that's very helpful.

Then on SG&A or maybe the G&A side, it over indexes in the first half of the year just given the sales scale but how should we think about SG&A as a rate of sales for the full-year, how much variability and flexibility do you have to kind of manage into some of the headwinds in sales with some flex in the fixed cost structure?.

SG&A in terms of as a percentage of sales, I would think would be relatively consistent, in terms of variability it doesn't vary tremendously with the change in sales. I think the variability comes in -- more in the gross margin line from a royalty expense and obviously direct material cost expense standpoint..

Okay, Brent, as a guide for 2018 in total should we look at the rate of dollars by quarter being pretty consistent, how should we think about SG&A dollars by quarter throughout the year?.

I would look at just kind of historical trends as at least a benchmark.

You see it's kind of trended up if you're going back to 2014, 2015, 2016, a lot of that especially when you look at 2016 -- or I mean, I'm sorry 2017 was impacted by the initial charges that we had to take for Toys 'R' Us, and clearly in 2018 the first quarter was impacted by the bad debt charge we had to take for Toys 'R' Us.

But we're not expecting those to obviously continue in the future we're fully reserved. So I would think that that percentage as a percent of sales will go back to more historical norms..

Okay, very helpful. And then last question Stephen on C'est Moi. I can sense your enthusiasm around that can you just remind us where the distribution is currently, online which retail partners and how we should think about the expansion of that brand over the next two years. Thank you..

So first we are excited about C'est Moi in addition to our MorfBoard brand. But specifically on C'est Moi is that target.com and is launched at the target retail. For the first half of the year as well as cestmoi.com and the expansion into other retailers will happen in the second half of this year and going through the first half of 2019.

Those retailers will be announced shortly because they have different programs and plans that will be launched during the fall..

And the question comes from Gerrick Johnson from BMO. Please go ahead..

Hey, good morning.

I wanted to ask C'est Moi until Steph brought it up, but how are you sizing that business, what's the target for that business, how should we think about, how big you're planning that to be?.

I think for the early-on stages it's a growth initiative and it's right now it's not material to the company in sales. But if you take a look for the next two to three year strategy plan for it we will have a much bigger impact as it grows it’s a significant area of growth for the company but it's a much longer process to get to that level..

Okay, thank you for that. Hey, nice to see an increase in POS retail sales but as you know there are a lot of moving parts there.

So I was wondering if you could sort of adjust for Toys 'R' Us as well as the Easter shift and give us sort of the underlying retail POS that you saw and on a flip side as well you probably brought some advertising expense into the first quarter from the second quarter so that shift as well those two shifts for Easter. Thank you..

Yes, correct. So when Easter comes earlier in the -- for us -- for everybody in the quarter obviously the advertising impact is much more first quarter than second quarter.

The sales in first quarter as Easter was in the early part of April really happens for us as an Applebee business in December and January because Chinese New Year's comes up in the late part of January early February then it becomes the domestic part of shipments.

So we've already planned for that as it happens periodically that Easter is in March or April. So the shift wasn't too dramatic for us it was pretty much well known early on where we'd be.

What was really positive was the sell-throughs that occurred during the first quarter which happened across the board with major retailers and also alternative channel distribution. So our online sales were up due to sell-throughs and our alternative distribution picked up during the quarter which helped our sell-throughs through as well.

On the impact of Toys 'R' Us I don't have that information currently of what the sell-throughs were or were not without Toys 'R' Us but the liquidation didn't occur I think until the 22nd of March so as normal sales sell-through period up until that period of time.

So I don't have that number off the top my hand and we could do a call afterward if need be..

Okay, I don’t know if we got to the retail impact because Easter was what April 1 and it was April 16 the year before. So clearly a lot of that retail occurred in March, so that's just what I was getting at with the retail shift would've been if you sort of have an Easter-over-Easter comparison..

Gerry, I’ve to get back to the make sure I've the correct information I don’t have that readily available..

Okay, can I ask one more question?.

Sure..

All right.

You had a big inventory drop, were there any write-downs there for Toys 'R' Us perhaps and I thought it would been a little bit higher to have more incredible coming?.

Yes, no write-downs for Toys 'R' Us..

And your next question comes from Drew Crum from Stifel. Please go ahead..

Okay, thanks. Good morning everyone.

So just on clarify that the guidance for 2018 I think the last update you suggested modest sales growth was achievable now you're saying improved financials, are you abandoning the sales guide or the sales growth for 2018 given the Toys 'R' Us situation?.

Drew, yes. Due to Toys 'R' Us liquidation and not sure the amount of business will pick up through other retailers as well as Toys 'R' Us reacted well in Canada and Asia and they turn into being a healthy retailer. We just don't know where the sales would pick up. So we have abandoned that..

Okay, okay fair enough. Got it, okay.

And then with online growing and Toys 'R' Us liquidating, can you talk about the economics between the two and whether or not that margin dilutive to your business going forward?.

So as online sales are growing rapidly, the margin impact will be very similar to just the brick-and-mortar sale. What occurs when we’re selling online, there's just different loads that are taken by each individual online retailer.

So either a specific direct online retailer has a different loads than brick-and-mortar has on their online division, so we coming for that and no surprises to them..

Okay.

And then any not looking for numbers but just expectations on the Incredibles 2, how it compares to some of the other large licenses you have had in the past and the kind of tie into that, what are your expectations for royalty expense as a percentage of revenue, if you exclude the Toys 'R' Us impact?.

I will answer the first question. I'll answer the first question I will turn the royalty expense over to Brent. We are excited and as well as retailers are excited with Incredibles 2, it’s really a family kid orientated movie and I don’t know if you've seen the trailers but it's a fun movie.

So our expectations internally are modest but we believe it's going to be extremely strong but we always take a conservative approach.

The sell-in that we are seeing around the world is extremely strong and what we've seen based off of Frozen, what we have seen even with Cars and Moana the movie when it does well, it's nice when we launch the product but really the success is when the streaming and DVD gets launched, is where we have the legs to the actual content.

So we're excited for the movie to be launched in June and then for the second half of the year when the streaming and DVD gets launched, that will get a larger kick it's a really terrific fun filled family movie. So we're really excited and it really in a sense it’s a terrific movie as well a lot of merchandise that's really applicable to the movie..

Yes from a royalty anytime, we secure license such as the Incredibles 2, you're going to have a slightly higher royalty rate compared to let’s say a blended average that you’re seeing on the P&L right now..

And our next question comes from Gerrick Johnson from BMO. Please go ahead..

Hey, come back..

Hi, Gerrick..

So you definitely have to plan a little bit on what you think you're going to shift to other retailers in the back half and you do have, can you share with us an idea of what percent of those Toys 'R' Us U.S.

sales that are going away that you will make up elsewhere?.

We don't break out sales by individual retailers but we will tell you that we've had retailers out here Spring 2018 International Toy Fair. We've been prior to the Toys 'R' Us confirming the liquidation we've been out at all retailers major and alternative channels.

So I don't have a clear fix of how much will be picked up but it's actually it's an ongoing process that our sales teams around the world are doing and we also did plan for the Canadian side of Toys 'R' Us to be back and help mode as well as international.

So we will also have additional sales that we didn't plan to Toys 'R' Us where they are healthy..

So at what point we have to know definitively so that you can plan for your manufacturing, I guess your manufacture partners will lead a firm plan at some point?.

It will go based off customer and based off of category and areas of business. So for example in our girls area of business, there is different as we see Squish-Dee-Lish, there is different processes needing for manufacturing. So we’re working with our factories weekly of what's needed.

So for instance, we had a lot of exclusive items that were done for Toys 'R' Us that many of our retailers are looking to get those immediately. So we are on a ongoing process of working with our retailers and our factories to make sure that we could facilitate what's needed both for the retailers and the factories and for JAKKS..

Thank you. Well ladies and gentlemen thank you for the call today and there is no further questions and we look forward to speaking with you in the second quarter call. Thank you..

Thank you. Ladies and gentlemen this concludes today's conference. Thank you for participating. You may now disconnect..