JAKKS PACIFIC, INC. The following discussion and analysis of financial condition and results of operations should be read together with our condensed consolidated financial statements and notes thereto, which appear elsewhere herein.
Explanatory Note
As of the date of filing of this Quarterly Report on Form 10-Q (this "Report"),
there continue to be uncertainties regarding the current Novel Coronavirus
("COVID-19") pandemic, including the scope of health issues, the duration of the
pandemic, and the continuing local and worldwide social, and economic
disruption. To date, the COVID-19 pandemic has had far-reaching impacts on many
aspects of the operations of JAKKS Pacific, Inc. (the "Company," "we," "our" or
"us"), including on consumer behavior, customer store traffic, production
capabilities, timing of product availability, our employees' personal and
business lives, and the market generally. The scope and nature of these impacts
continue to evolve each day. The COVID-19 pandemic has resulted in, and may
continue to result in, regional and local quarantines, labor stoppages and
shortages, changes in consumer purchasing patterns, mandatory or elective
shut-downs of retail locations, disruptions to supply chains, including the
inability of our suppliers and service providers to deliver materials and
services on a timely basis, or at all, severe market volatility, liquidity
disruptions, and overall economic instability, which, in many cases, have had,
and we expect will continue to have, adverse impacts on our business, financial
condition and results of operations. This situation is changing rapidly, and
additional impacts may arise that we are not aware of currently.
In light of the uncertain and rapidly evolving situation relating to the
COVID-19 pandemic, we have taken certain precautionary measures over the past
two years intended to help minimize the risk to our Company, employees and
customers. A recap of the key elements as of today would include the following:
• On March 23,
2020 , we
encouraged our
staff to begin
working from
home. In the
US, we began
to return to
an in-office
working model
in July 2021 ,
but paused
that
transition in
consideration
of the rise in
cases
attributable
to the
Delta-variant
of COVID-19.
As of March
31, 2022 , we
have returned
to an
in-office
operating
model in our
US offices. We
continue to
monitor
federal, state
and local
guidelines;
• Although our
distribution
center in the
City of
Industry,
California
currently
continues to
operate, we
continue to
evaluate its
operations,
and may elect,
or be
required, to
shut down its
operations
temporarily at
any time in
the future;
• We are slowly
increasing
employee
attendance at
industry
events and
in-person
work-related
meetings.
Each of the remedial measures taken by us has had, and we expect will continue
to have, adverse impacts on our current business, financial condition and
results of operations, and may create additional risks for us. While we
anticipate that the foregoing measures are temporary, we cannot predict the
specific duration for which these precautionary measures will stay in effect,
and we may elect or need to take additional measures as the information
available to us continues to develop, including with respect to our employees,
inventory receipts, and relationships with our licensors. We expect to continue
to assess the evolving impact of the COVID-19 pandemic on our customers,
consumers, employees, supply chain, and operations, and intend to make
adjustments to our responses accordingly. However, the extent to which the
COVID-19 pandemic and our precautionary measures in response thereto may impact
our business, financial condition, and results of operations will depend on how
the COVID-19 pandemic and its impact continues to develop in the United States
and elsewhere in the world, which remains highly uncertain and cannot be
predicted at this time.
In light of these uncertainties, for purposes of this report, except where
otherwise indicated, the descriptions of our business, our strategies, our risk
factors, and any other forward-looking statements, including regarding us, our
business and the market generally, do not reflect the potential impact of the
COVID-19 pandemic or our responses thereto. In addition, the disclosures
contained in this report are made only as of the date hereof, and we undertake
no obligation to publicly update or revise any forward-looking statement as a
result of new information, future events or otherwise, except as otherwise
required by law. For further information, see "Disclosure Regarding
Forward-Looking Statements" and "Risk Factors."
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Disclosure Regarding Forward-Looking Statements
This Report includes "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. For example, statements included in this Report regarding our financial position, business strategy and other plans and objectives for future operations, and assumptions and predictions about future product demand, supply, manufacturing, costs, marketing and pricing factors are all forward-looking statements. When we use words like "intend," "anticipate," "believe," "estimate," "plan" or "expect," or other words of a similar import, we are making forward-looking statements. We believe that the assumptions and expectations reflected in such forward-looking statements are reasonable, based upon information available to us on the date hereof (but excluding the impact of COVID-19, as described above in "Explanatory Note"), but we cannot assure you that these assumptions and expectations will prove to have been correct or that we will take any action that we may presently be planning. We have disclosed certain important factors (e.g., see "Explanatory Note" and "Risk Factors") that could cause our actual results to differ materially from our current expectations elsewhere in this Report. You should understand that forward-looking statements made in this Report are necessarily qualified by these factors. We are not undertaking to publicly update or revise any forward-looking statement if we obtain new information or upon the occurrence of future events or otherwise.
Critical Accounting Policies & Estimates
The accompanying condensed consolidated financial statements and supplementary information were prepared in accordance with accounting principles generally accepted inthe United States of America . Significant accounting policies are discussed in Note 2 to the consolidated financial statements set forth in our Annual Report on Form 10-K for the fiscal year endedDecember 31, 2021 . Inherent in the application of many of these accounting policies is the need for management to make estimates and judgments in the determination of certain revenues, expenses, assets and liabilities. As such, materially different financial results can occur as circumstances change and additional information becomes known. The policies with the greatest potential effect on our results of operations and financial position include: Allowance for Doubtful Accounts. Our allowance for doubtful accounts is based upon management's assessment of the business environment, customers' financial condition, historical collection experience, accounts receivable aging, customer disputes and the collectability of specific customer accounts. If there were a deterioration of a major customer's creditworthiness, or actual defaults were higher than our historical experience, our estimates of the recoverability of amounts due to us could be overstated, which could have an adverse impact on our operating results. Our allowance for doubtful accounts is also affected by the time at which uncollectible accounts receivable balances are actually written off. Major customers' accounts are monitored on an ongoing basis and more in-depth reviews are performed based upon changes in a customer's financial condition and/or the level of credit being extended. When a significant event occurs, such as a bankruptcy filing by a specific customer, and on a quarterly basis, the allowance is reviewed for adequacy and the balance or accrual rate is adjusted to reflect current risk prospects. When certain shocks to the market occur, customers are unilaterally reviewed to assess the potential impact of that shock on their financial stability. Many retailers have been operating under financial duress for several years. Ultimately, we assess the risk of liquidation bankruptcy by a customer and the associated likelihood that we will not be paid for product shipped. To that end, it is not only outstanding accounts receivable balances but the decisions to design and develop account-specific product and ultimately ship product on a go-forward basis that plays into our attempts to maximize profitability while minimizing uncollectable accounts receivable. Revenue Recognition. Our contracts with customers only include one performance obligation (i.e., sale of our products). Revenue is recognized in the gross amount at a point in time when delivery is completed and control of the promised goods is transferred to the customers. Revenue is measured as the amount of consideration we expect to be entitled to in exchange for those goods. Our contracts do not involve financing elements as payment terms with customers are less than one year. Further, because revenue is recognized at the point in time goods are sold to customers, there are no contract assets or contract liability balances. We disaggregate our revenues from contracts with customers by reporting segment: Toys/Consumer Products and Costumes. We further disaggregate revenues by major geographic region. See Note 2 to the condensed consolidated financial statements for further information. 29
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We offer various discounts, pricing concessions, and other allowances to customers, all of which are considered in determining the transaction price. Certain discounts and allowances are fixed and determinable at the time of sale and are recorded at the time of sale as a reduction to revenue. Other discounts and allowances can vary and are determined at management's discretion (variable consideration). Specifically, we occasionally grant discretionary credits to facilitate markdowns and sales of slow moving merchandise, and consequently accrue an allowance based on historic credits and management estimates. We also participate in cooperative advertising arrangements with some customers, whereby we allow a discount from invoiced product amounts in exchange for customer purchased advertising that features our products. Generally, these allowances range from 1% to 20% of gross sales, and are generally based upon product purchases or specific advertising campaigns. Such allowances are accrued when the related revenue is recognized. To the extent these cooperative advertising arrangements provide a distinct benefit at fair value, they are accounted for as direct selling expenses, otherwise they are recorded as a reduction to revenue. Further, while we generally do not allow product returns, we do make occasional exceptions to this policy, and consequently record a sales return allowance based upon historic return amounts and management estimates. These allowances (variable consideration) are estimated using the expected value method and are recorded at the time of sale as a reduction to revenue. We adjust our estimate of variable consideration at least quarterly or when facts and circumstances used in the estimation process may change. The variable consideration is not constrained as we have sufficient history on the related estimates and do not believe there is a risk of significant revenue reversal. Sales commissions are expensed when incurred as the related revenue is recognized at a point in time and therefore the amortization period is less than one year. As a result, these costs are recorded as direct selling expenses, as incurred.
Shipping and handling activities are considered part of our obligation to transfer the products and therefore are recorded as direct selling expenses, as incurred.
Our reserve for sales returns and allowances amounted to
Royalties. We enter into license agreements with strategic partners, inventors,
designers and others for the use of intellectual properties in our products.
These agreements may call for payment in advance or future payment of minimum
guaranteed amounts. Amounts paid in advance are recorded as an asset and charged
to expense when the related revenue is recognized. If all or a portion of the
minimum guaranteed amounts appear not to be recoverable through future use of
the rights obtained under the license, the non-recoverable portion of the
guaranty is charged to expense at that time.
Fair value measurements. Fair value is the price that would be received to sell
an asset or paid to transfer a liability in an orderly transaction between
market participants at the measurement date. In determining fair value, we use
various methods including market, income and cost approaches. Based upon these
approaches, we often utilize certain assumptions that market participants would
use in pricing the asset or liability, including assumptions about risk and/or
the risks inherent in the inputs to the valuation technique. These inputs can be
readily observable, market-corroborated, or unobservable inputs. We utilize
valuation techniques that maximize the use of observable inputs and minimize the
use of unobservable inputs. Based upon observable inputs used in the valuation
techniques, we are required to provide information according to the fair value
hierarchy. The fair value hierarchy ranks the quality and reliability of the
information used to determine fair values into three broad levels as follows:
Level 1: Valuations
for assets
and
liabilities
traded in
active
markets from
readily
available
pricing
sources for
market
transactions
involving
identical
assets or
liabilities.
Level 2: Valuations
for assets
and
liabilities
traded in
less active
dealer or
broker
markets.
Valuations
are obtained
from
third-party
pricing
services for
identical or
similar
assets or
liabilities.
Level 3: Valuations
incorporate
certain
assumptions
and
projections
in
determining
the fair
value
assigned to
such assets
or
liabilities.
In instances where the determination of the fair value measurement is based upon
inputs from different levels of the fair value hierarchy, the level in the fair
value hierarchy within which the entire fair value measurement falls is based
upon the lowest level input that is significant to the fair value measurement in
its entirety. Our assessment of the significance of a particular input to the
fair value measurement in its entirety requires judgment, and considers factors
specific to the asset or liability. See Note 16 to the condensed consolidated
financial statements included within for further information.
Reserve for Inventory Obsolescence. We value our inventory at the lower of cost
or net realizable value. Based upon a consideration of quantities on hand,
actual and projected sales volume, anticipated product selling prices and
product lines planned to be discontinued, slow-moving and obsolete inventory is
written down to its net realizable value.
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Failure to accurately predict and respond to consumer demand could result in us under-producing popular items or over-producing less popular items. Furthermore, significant changes in demand for our products would impact management's estimates in establishing our inventory provision. Management's estimates are monitored on a quarterly basis, and a further adjustment to reduce inventory to its net realizable value is recorded as an increase to cost of sales when deemed necessary under the lower of cost or net realizable value standard. When unexpected shocks to market demand occur, we review whether that shock has materially impacted the value of our owned inventory. In some cases where customers have cancelled orders, accommodation can be reached that the product will be reordered when the customer has restarted operations (in the event of store closures) or the customer agrees to minimize/eliminate requests for product line refreshment (in the event ofHalloween order cancellations) which allows the inventory and, in some cases, raw materials to be held through to the following calendar year without incurring any additional obsolescence. Income Allocation for Income Taxes. Our annual income tax provision and related income tax assets and liabilities are based upon actual income as allocated to the various tax jurisdictions based upon our transfer pricing study, US and foreign statutory income tax rates and tax regulations and planning opportunities in the various jurisdictions in which we operate. Significant judgment is required in interpreting tax regulations in theU.S. and foreign jurisdictions, and in evaluating worldwide uncertain tax positions. Actual results could differ materially from those judgments, and changes from such judgments could materially affect our condensed consolidated financial statements. Discrete Items for Income Taxes. The discrete expense recorded for the three and six months endedJune 30, 2022 was$57,000 and$0.1 million , respectively, which relate to foreign return-to-provision adjustments and state income taxes. For the comparable period in 2021, a discrete benefit of$0.3 million was recorded for the three and six months endedJune 30, 2021 , primarily related to the change in uncertain tax positions offset by state income taxes, foreign return-to-provision adjustments, and excess tax deficiencies fully offset by valuation allowance. Income taxes and interest and penalties related to income tax payable. We do not file a consolidated return for our foreign subsidiaries. We file federal and state returns and our foreign subsidiaries each file returns as required. Deferred taxes are provided on an asset and liability method, whereby deferred tax assets are recognized as deductible temporary differences and operating loss and tax credit carry-forwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment. Management employs a threshold and measurement process for recording in the financial statements uncertain tax positions taken or expected to be taken in a tax return. Tax benefits that are subject to challenge by tax authorities are analyzed and accounted for in the income tax provision. We accrue a tax reserve for additional income taxes, which may become payable in future years as a result of audit adjustments by tax authorities. The reserve is based upon management's assessment of all relevant information and is periodically reviewed and adjusted as circumstances warrant. As ofJune 30, 2022 andDecember 31, 2021 , our income tax reserves were approximately$0.2 million . The$0.2 million balance primarily relates to the potential tax settlements inHong Kong . Our income tax reserves are included in income tax payable on the condensed consolidated balance sheets and within provision for (benefit from) income taxes on the condensed consolidated statements of operations. We recognize current period interest expense and penalties and the reversal of previously recognized interest expense and penalties that has been determined to not be assessable due to the expiration of the related audit period or other compelling factors on the income tax liability for unrecognized tax benefits as a component of the income tax provision recognized in the condensed consolidated statements of operations. Income Taxes. In determining the interim provision for income taxes for the three and six months endedJune 30, 2022 , we utilized the discrete effective tax rate method for theU.S. jurisdiction, as allowed by ASC 740-270-30-18, "Income Taxes - Interim Reporting." The discrete method is applied when the application of the estimated annual effective tax rate is impractical because it is not possible to reliably estimate the annual effective tax rate. The discrete method treats the year-to-date period as if it were the annual period and determines the income tax expense or benefit on that basis. We believe that, at this time, the use of the discrete method is more appropriate than the annual effective tax rate method for theU.S. jurisdiction due to the uncertainty in estimating annual pretax earnings in theU.S. and our ongoing assessment that the recoverability of our deferred tax assets is not likely in theU.S. 31
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New Accounting Pronouncements.
See Note 1 to the condensed consolidated financial statements.
Results of Operations
The following unaudited table sets forth, for the periods indicated, certain statement of income data as a percentage of net sales:
Three Months Ended June 30, Six Months Ended June 30,
(Unaudited) (Unaudited)
2022 2021 2022 2021
Net sales 100.0 % 100.0 % 100.0 % 100.0 %
Cost of sales:
Cost of goods 55.3 54.7 56.8 53.7
Royalty expense 16.2 15.0 15.6 15.0
Amortization of tools and molds 0.9 1.9 1.0 1.7
Cost of sales 72.4 71.6 73.4 70.4
Gross profit 27.6 28.4 26.6 29.6
Direct selling expenses 3.1 5.6 3.4 6.7
General and administrative expenses 13.4 20.7 16.1 22.7
Depreciation and amortization 0.3 0.5 0.3 0.6
Selling, general and administrative
expenses 16.8 26.8 19.8 30.0
Intangibles impairment 0.1 - 0.1 -
Income (loss) from operations 10.7 1.6 6.7 (0.4 )
Other income (expense), net 0.1 0.1 - -
Loss on debt extinguishment - (6.5 ) - (3.8 )
Change in fair value of preferred stock
derivative liability 2.7 (1.4 ) 1.6 (4.5 )
Change in fair value of convertible
senior notes - (3.4 ) - (6.6 )
Interest income - - - -
Interest expense (1.1 ) (3.9 ) (1.3 ) (4.7 )
Income (loss) before provision for
(benefit from) income taxes 12.4 (13.5 ) 7.0 (20.0 )
Provision for (benefit from) income
taxes 0.6 (0.1 ) 0.4 -
Net income (loss) 11.8 (13.4 ) 6.6 (20.0 )
Net income (loss) attributable to
non-controlling interests (0.2 ) - (0.1 ) -
Net income (loss) attributable to JAKKS
Pacific, Inc. 12.0 % (13.4 )% 6.7 % (20.0 )%
The following unaudited table summarizes, for the periods indicated, certain statements of operations data by segment (in thousands):
Three Months Ended June 30, Six Months Ended June 30,
(Unaudited) (Unaudited)
2022 2021 2022 2021
Net Sales
Toys/Consumer Products $ 148,860 $ 81,538 $ 259,983 $ 161,413
Costumes 71,562 30,814 81,320 34,782
220,422 112,352 341,303 196,195
Cost of Sales
Toys/Consumer Products 105,740 55,977 188,706 110,169
Costumes 53,792 24,478 61,790 28,035
159,532 80,455 250,496 138,204
Gross Profit
Toys/Consumer Products 43,120 25,561 71,277 51,244
Costumes 17,770 6,336 19,530 6,747
$ 60,890 $ 31,897 $ 90,807 $ 57,991
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Comparison of the Three Months Ended
Net Sales Toys/Consumer Products. Net sales of our Toys/Consumer Products segment were$148.9 million for the three months endedJune 30, 2022 compared to$81.5 million for the prior year period, representing an increase of$67.4 million , or 82.7%. The Doll/Dress-Up/Nurturing Play and Action Play and Collectibles division sales increased, led by Disney Encanto™ and Sonic the Hedgehog®. Some of the increase in sales was related to convincing customers to place FOB orders earlier in the year in lieu of domestic orders later in the year, in order to get ahead of possible supply chain issues experienced a year ago, and to take advantage of the larger customers' scale in the area of import logistics infrastructures. Costumes. Net sales of our Costumes segment were$71.6 million for the three months endedJune 30, 2022 compared to$30.8 million for the prior year period, representing an increase of$40.8 million , or 132.5%. Similar to the Toys/Consumer Products segment, some of the increase in sales was related to earlier customer shipments to get ahead of possible supply chain issues experienced a year ago. Cost of Sales Toys/Consumer Products. Cost of sales of our Toys/Consumer Products segment was$105.7 million , or 71.0% of related net sales for the three months endedJune 30, 2022 compared to$56.0 million , or 68.7% of related net sales for the prior year period, representing an increase of$49.7 million , or 88.8%. The increase in dollars is related to higher overall sales. The increase as a percentage of net sales, year over year, is due to a higher average royalty rate and higher freight costs, slightly offset by lower product costs. Costumes. Cost of sales of our Costumes segment was$53.8 million , or 75.1% of related net sales for the three months endedJune 30, 2022 , compared to$24.5 million , or 79.5% of related net sales for the prior year period, representing an increase in dollars of$29.3 million , or 119.6%. The increase in dollars is related to higher overall sales. The decrease as a percentage of net sales was driven by lower product costs and a lower average royalty rate.
Selling, General and Administrative Expenses
Selling, general and administrative expenses were$36.9 million for the three months endedJune 30, 2022 compared to$30.1 million for the prior year period constituting 16.8% and 26.8% of net sales, respectively. Selling, general and administrative expenses increased as a result of higher payroll costs. Interest Expense Interest expense was$2.3 million for the three months endedJune 30, 2022 , as compared to$4.4 million in the prior year period. During the three months endedJune 30, 2022 , we incurred interest expense of$2.0 million related to our 2021 BSP Term Loan and$0.3 million related to our revolving credit facility. During the three months endedJune 30, 2021 , we incurred interest expense of$3.0 million related to our 2019 Recap Term Loan,$0.9 million related to our 2021 BSP Term Loan,$0.3 million related to our convertible senior notes due in 2023 and$0.2 million related to our revolving credit facility.
Provision for (Benefit From) Income Taxes
Our income tax expense, which includes federal, state and foreign income taxes and discrete items, was$1.3 million , or an effective tax rate of 4.8%, for the three months endedJune 30, 2022 . During the comparable period in 2021, our income tax benefit was$0.1 million , or an effective tax rate of 0.7%. 33
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Comparison of the Six Months Ended
Net Sales Toys/Consumer Products. Net sales of our Toys/Consumer Products segment were$260.0 million for the six months endedJune 30, 2022 compared to$161.4 million for the prior year period, representing an increase of$98.6 million , or 61.1%. The Doll/Dress-Up/Nurturing Play and Action Play and Collectibles division sales increased, led by Disney Encanto™ and Sonic the Hedgehog®. Some of the increase in sales was related to convincing customers to place FOB orders earlier in the year in lieu of domestic orders later in the year, in order to get ahead of possible supply chain issues experienced a year ago, and to take advantage of the larger customers' scale in the area of import logistics infrastructures. Costumes. Net sales of our Costumes segment were$81.3 million for the six months endedJune 30, 2022 compared to$34.8 million for the prior year period, representing an increase of$46.5 million , or 133.6%. Some of the increase in sales was related to earlier customer shipments to get ahead of possible supply chain issues experienced a year ago. Cost of Sales Toys/Consumer Products. Cost of sales of our Toys/Consumer Products segment was$188.7 million , or 72.6% of related net sales for the six months endedJune 30, 2022 compared to$110.2 million , or 68.3% of related net sales for the prior year period, representing an increase of$78.5 million , or 71.2%. The increase in dollars is related to higher overall sales. The increase as a percentage of net sales, year over year, is due to higher freight costs and a higher average royalty rate. Costumes. Cost of sales of our Costumes segment was$61.8 million , or 76.0% of related net sales for the six months endedJune 30, 2022 , compared to$28.0 million , or 80.5% of related net sales for the prior year period, representing an increase in dollars of$33.8 million , or 120.7%. The increase in dollars is related to higher overall sales. The decrease as a percentage of net sales was driven by lower product costs and a lower average royalty rate.
Selling, General and Administrative Expenses
Selling, general and administrative expenses were$67.6 million for the six months endedJune 30, 2022 compared to$58.9 million for the prior year period constituting 19.8% and 30.0% of net sales, respectively. Selling, general and administrative expenses increased as a result of higher payroll costs. Interest Expense Interest expense was$4.5 million for the six months endedJune 30, 2022 , as compared to$9.2 million in the prior year period. During the six months endedJune 30, 2022 , we incurred interest expense of$4.0 million related to our 2021 BSP Term Loan and$0.5 million related to our revolving credit facility. During the six months endedJune 30, 2021 , we incurred interest expense of$7.3 million related to our 2019 Recap Term Loan,$0.9 million related to our 2021 BSP Term Loan,$0.6 million related to our convertible senior notes due in 2023, and$0.4 million related to our revolving credit facility.
Provision for (Benefit From) Income Taxes
Our income tax expense, which includes federal, state and foreign income taxes and discrete items, was$1.8 million , or an effective tax rate of 7.3%, for the six months endedJune 30, 2022 . During the comparable period in 2021, our income tax benefit was$12,000 , or an effective tax rate of 0.0%. Seasonality and Backlog The retail toy industry is inherently seasonal. Generally, our sales have been highest during the third and fourth quarters, and collections for those sales have been highest during the succeeding fourth and first quarters. Our working capital needs have been highest during the second and third quarters as we make royalty advance payments for some of our licenses and buy and sell inventory subject to customer payment terms. The pandemic has somewhat disrupted historical industry seasonality. Consumer demand for certain product categories has surged during this time. Surges in consumer demand have also strained the supply-chain, lengthening the amount of time it takes to move products from factory to warehouse to customers. Customers have also had increased challenges in managing their inventory levels, resulting in either out-of-stock or over-supply scenarios, depending on the product category and product line. 34
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While we have taken steps to level sales over the entire year, sales are expected to remain heavily influenced by the seasonality of our toy and costume products. The result of these seasonal patterns is that operating results and the demand for working capital may vary significantly by quarter. Orders placed with us are generally cancelable until the date of shipment. The combination of seasonal demand and the potential for order cancellation makes accurate forecasting of future sales difficult and causes us to believe that backlog may not be an accurate indicator of our future sales. Similarly, financial results for a particular quarter may not be indicative of results for the entire year.
Liquidity and Capital Resources
As ofJune 30, 2022 , we had working capital (inclusive of cash, cash equivalents and restricted cash) of$116.7 million , compared to$114.5 million as ofDecember 31, 2021 , representing an increase in working capital of$2.2 million during the six-month period endedJune 30, 2022 . Operating activities provided net cash of$36.5 million during the six months endedJune 30, 2022 , as compared to net cash used of$18.5 million in the prior year period. The increase in net cash provided by operating activities year-over-year is primarily due to a higher net income, an increase in accounts payable due to higher inventory purchases, an increase in accrued expenses primarily due to higher royalty accruals, partially offset by a higher inventory balance, a higher accounts receivable balance due to higher sales, and lower non-cash charges related to valuation adjustments for our convertible senior notes and preferred stock derivative liability. Other than open purchase orders issued in the normal course of business related to shipped product, we have no obligations to purchase inventory from our manufacturers. However, we may incur costs or other losses as a result of not placing orders consistent with our forecasts for product manufactured by our suppliers or manufacturers for a variety of reasons including customer order cancellations or a decline in demand. As part of our strategy to develop and market new products, we have entered into various character and product licenses with royalties/obligations generally ranging from 1% to 22% payable on net sales of such products. As ofJune 30, 2022 , these agreements required future aggregate minimum royalty guarantees of$86.4 million exclusive of$3.2 million in advances already paid. Of this$86.4 million future minimum royalty guarantee,$29.9 million is due over the next twelve months. Investing activities used net cash of$5.3 million and$3.7 million for the six months endedJune 30, 2022 and 2021, respectively, and consisted primarily of cash paid for the purchase of molds and tooling used in the manufacture of our products. Financing activities used net cash of$11.5 million and$32.5 million for the six months endedJune 30, 2022 and 2021, respectively. The cash used in financing activities during the six months endedJune 30, 2022 , primarily consists of the repayment of our 2021 BSP Term Loan of$10.9 million , and the repurchase of common stock for employee tax withholding of$0.6 million . The cash used in financing activities during the six months endedJune 30, 2021 of$32.5 million consists of the repayment of our 2019 Recap Term Loan of$125.8 million , as well as, debt issuance costs of$2.8 million incurred in connection with the refinancing of our debt (see Note 5 - Debt), partially offset by the net proceeds from the issuance of our 2021 BSP Term Loan of$96.3 million . As ofJune 30, 2022 , we have$87.6 million of outstanding indebtedness under our first-lien secured term loan (the "2021 BSP Term Loan Agreement") and we have no outstanding indebtedness under our senior secured revolving credit facility (the "JPMorgan ABL Facility"), aside from utilizing$17.2 million in letters of credit. The First Lien Term Loan Facility Credit Agreement (the "2021 BSP Term Loan Agreement") and the Credit Agreement withJPMorgan Chase Bank, N.A ., as agent and lender (the "JPMorgan ABL Credit Agreement") each contain negative covenants that, subject to certain exceptions, limit our ability and our subsidiaries ability to, among other things, incur additional indebtedness, make restricted payments, pledge our assets as security, make investments, loans, advances, guarantees and acquisitions, undergo fundamental changes and enter into transactions with affiliates. The terms of the 2021 BSP Term Loan Agreement also require us to maintain a Net Leverage Ratio of 4:00x, with step-downs occurring each fiscal year starting with the quarter endingMarch 31, 2022 through the quarter endingSeptember 30, 2024 in which we are required to maintain a Net Leverage Ratio of 3:00x. OnApril 26, 2022 , we entered into a First Amendment to the 2021 BSP Term Loan Agreement, to provide, among other things, that we must maintain Qualified Cash of at least: (a) at all times after the Closing Date and prior to the First Amendment Effective Date,$20.0 million ; (b) at all times during the period commencing on the First Amendment Effective Date through and includingJune 30, 2022 ,$15.0 million ; and (c) at all times on and afterJuly 1, 2022 , throughSeptember 30, 2022 ,$17.5 million ; provided, however, that if the Total Net Leverage Ratio exceeded 1.75:1.00 as of the last day of the most recently ended month for which financial statements were required to have been delivered, then the amount set forth in this clause shall be increased to$20.0 million . Notwithstanding the foregoing, the Applicable Minimum Cash Amount shall be reduced by$1.0 million for every$5.0 million principal prepayment or repayment of the Term Loans following the First Amendment Effective Date; provided however, that, the Applicable Minimum Cash Amount shall in no event be reduced below$15.0 million . 35
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The 2021 BSP Term Loan Agreement and the JPMorgan ABL Agreement contain events of default that are customary for a facility of this nature, including (subject in certain cases to grace periods and thresholds) nonpayment of principal, nonpayment of interest, fees or other amounts, material inaccuracy of representations and warranties, violation of covenants, cross-default to certain other existing indebtedness, bankruptcy or insolvency events, certain judgment defaults and a change of control as specified in each Agreement. If an event of default occurs under either Agreement, the maturity of the amounts owed under the 2021 BSP Term Loan Agreement and the JPMorgan ABL Agreement may be accelerated.
We were in compliance with the financial covenants under the 2021 BSP Term Loan
Agreement and the JPMorgan ABL Agreement as of
See Note 5 - Debt and Note 6 - Credit Facilities for additional information pertaining to our Debt and Credit Facilities.
As ofJune 30, 2022 andDecember 31, 2021 , we held cash and cash equivalents, including restricted cash, of$62.3 million and$45.3 million , respectively. Cash, and cash equivalents, including restricted cash held outside ofthe United States in various foreign subsidiaries totaled$53.5 million and$30.7 million as ofJune 30, 2022 andDecember 31, 2021 , respectively. The cash and cash equivalents, including restricted cash balances in our foreign subsidiaries have either been fully taxed in theU.S. or tax has been accounted for in connection with the Tax Cuts and Jobs Act, or may be eligible for a full foreign dividends received deduction under such Act, and thus would not be subject to additionalU.S. tax should such amounts be repatriated in the form of dividends or deemed distributions. Any such repatriation may result in foreign withholding taxes, which we expect would not be significant as ofJune 30, 2022 . OnJuly 1, 2022 , we filed a Form S-3 shelf registration statement (File No. 333-266009) with theSEC to register for future issuances, from time to time, up to 2,000,000 shares of common stock, in one or more offerings in amounts, at prices and on the terms that we will determine at the time of the offering. OnAugust 1, 2022 , theSEC declared the Form S-3 shelf registration filed by us to be effective.
Our primary sources of working capital are cash flows from operations and borrowings under our JPMorgan ABL Facility (see Note 6 - Credit Facilities).
Typically, cash flows from operations are impacted by the effect on sales of (1) the appeal of our products, (2) the success of our licensed brands in motivating consumer purchase of related merchandise, (3) the highly competitive conditions existing in the toy industry and in securing commercially-attractive licenses, (4) dependency on a limited set of large customers, and (5) general economic conditions. A downturn in any single factor or a combination of factors could have a material adverse impact upon our ability to generate sufficient cash flows to operate the business. In addition, our business and liquidity are dependent to a significant degree on our vendors and their financial health, as well as the ability to accurately forecast the demand for products. The loss of a key vendor, or material changes in support by them, or a significant variance in actual demand compared to the forecast, can have a material adverse impact on our cash flows and business. Given the conditions in the toy industry environment in general, vendors, including licensors, may seek further assurances or take actions to protect against non-payment of amounts due to them. Changes in this area could have a material adverse impact on our liquidity.
As of
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