Jakks Pacific Inc. Q1 2008 Earnings Call Transcript

Apr.23.08 | About: JAKKS Pacific, (JAKK)

Jakks Pacific Inc. (NASDAQ:JAKK)

Q1 2008 Earnings Call

April 23, 2008 9:30 am ET

Genna Rosenberg – Media Relations

Jack Friedman – Co-Founder, Chairman and CEO

Joel Benneth – CFO

Analysts

Anthony Gikas – Piper Jaffray

Steve Epstein - Defiance Asset Management

Todd Schwartzman - Sidoti & Company

Edward Woo – Wedbush Morgan Securities Inc.

Sean McGowan – Needham & Company

Arvind Bhatia – Sterne, Agee & Leach

Gerrick Johnson – BMO Capital Markets

John Taylor – Arcadia Investment Corporation

Operator

Good morning, my name is Dawn and I will be conference operator today. At this time, I would like to welcome everyone to the Jakks Pacific First Quarter Earnings Call.

(Operator Instructions)

Ms. Rosenberg, you may begin your conference.

Genna Rosenberg

Thank you. Good morning everyone. This Genna Rosenberg, Senior Vice President of Communications and Investor Relations for Jakks Pacific. Thank you for joining our teleconference with Jakks’s management to review the results for the first quarter ended March 31, 2008.

On the call today are Jack Friedman, Chairman and Chief Executive Officer of Jakks Pacific, Steven Berman, our President and Chief Operating Officer and Joel Benneht, our Executive Vice President and Chief Financial Officer.

Mr. Friedman will first provide an overview of the quarter and our operational results and then Mr. Benneth will provide detailed comments regarding our financial results. Mr. Friedman will then conclude the prepared portion of the call with highlights of our product lines and current business trends prior to opening up the call for you one on one questions.

Before we begin, I would like to point out that any comments made about our future performance, events or circumstances, including the estimates of sales and earnings per share for 2007, as well as any forward-looking statements, are subject to the Safe Harbor protection under federal securities laws. These statements reflect our 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 our forward-looking statements. For details concerning these and other such risks and uncertainties, you should consult our most recent 10-K and 10-Q filings with the SEC as well as our company's other reports subsequently filed with the SEC from time to time.

With that, I will turn the call over to Mr. Friedman.

Jack Friedman

Thank you. Good morning ladies and gentleman. Thank you for joining us this morning to discuss our results for the first quarter of 2008.

First quarter 2008 net sales for Jakks Pacific increased 5.5% to $130.9 million with traditional toy sales from our diverse product portfolio driving the business. As is typical of first quarter, it is expected to be our lowest sales volume quarter. We are quite optimistic that our 2008 product portfolio will continue to perform within our expectations and believe that we are on track to achieve our 2008 guidance and another record year for Jakks Pacific.

We experienced a continued strong sales in the quarter in several traditional toy categories including action figures, dolls, plush, electronics and pretend play products with the largest contributions coming from those based on the Disney characters between pop-star Hannah Montana and classic princess as well as Puppy in Pocket, WWE, Chronicles of the Narnia, Prince Caspian and Pokemon. Disney recently picked up the third season of its top rated Hannah Montana television show earlier this month and the show star Miley Cyrus continues to dominate the tween markets with Miley having won two Nick Kids Choice Awards during the quarter.

Our Hannah Montana line looks great with major Hannah Montana contributions coming from several Jakks division later this year and retail support for our line is extremely strong. Both Jakks and Disney are excited by the potential for a new Plug and Play Hannah Montana popular guitar video game developed for tween girls which allows Hannah fans to rock out on Hannah Montana guitar while playing the notes to her songs as they come up on the TV.

In addition, new fashion dolls, play sets and role play products are all on track for later this year and we expect the 2008 Hannah Montana line to be even bigger than last year. But Hannah is just one contributor from Jakks portfolio that gives us confidence in our outlook for the rest of the year.

We are also excited about our new EyeClops Night Vision goggles, our new GirlGourmet cupcake maker, our new Plug and Play wireless motion gaming system called the Ulti Motion, additional new Disney initiatives and several of the new Jakks programs hitting shelves later this year.

Product development efforts were up in the first quarter as we worked to get these new items developed and produced simultaneously. We have also been working hard on our lines for the 2009 and beyond and we believe the increase product development is an investment into our future that will contribute to a great year for Jakks Pacific.

With first quarter sales growing more than 5% over the same period last year, our performance reinforces our confidence that we will achieve our guidance targets of at least $891.4 million in net sales and $93.6 million in net income and diluted earnings per share of $2.91 for 2008. Our financial position remains extremely strong with working capital of approximately $359.2 million including cash and equivalents of $238.3 million as of March 31 leaving us tremendous ability to execute our acquisition strategy.

We are actively seeking out the next investment into our future. Before I get more into details about our products, performance in the quarter and our outlook for the future, I would like to turn the call over to Joel Benneth for a review of our financial performance for the first quarter of 2008.

Joel Benneth

Thank you, Jack and good morning everyone. First quarter 2008 net sales were $130.9 million compared to $124.1 million in the same period of last year, an increase of 5.5%. Net income for the first quarter was $900,000.00 or $0.03 per diluted share compared to the first quarter of 2007 when we had net income of $3.2 million or $0.12 per diluted share. 2008 was impacted by higher litigation costs, product testing as well as restructuring costs which increased $3.2 million year-over-year to $4 million or $0.10 per diluted share.

And now for our sales by product categories. Worldwide sales of traditional toys which include action figures, vehicles, electronic, plush, role play, dolls, kites, tool toys and outdoor and promotional products were $118.3 million for the first quarter of 2008 compared to $119.5 million in the first quarter of 2007 representing approximately 91.3% of overall sales in the first quarter of 2008 versus approximately 89.2% of overall sales in the first quarter of 2007.

Sales in the quarter were driven by our action figures, dolls, electronic toys and pretend play products based on WWE, Hannah Montana, Pokemon, Disney Princesses and other popular licenses. Our craft activity writing products which consists primarily of our PenTech and Flying Colors product lines have worldwide sales of approximately $6.1 million in the first quarter of 2008 compared to approximately $9.2 million in the comparable period of 2007 representing 4.7% of total sales for the quarter versus 7.4% of total sales for the first quarter of 2007.

Later in 2008, we have several new activities and writing products including our Spa Factory line, Gourmet cupcake maker and more, which we expect will increase sales in this category. Worldwide sales of our pet products were up to $5.3 million in the first quarter of 2008 compared to $4.2 million for the first quarter of 2007 representing approximately 4.1% of overall sales in the first quarter as compared to 3.4% of overall sales in the same period in 2007. Sales in this category were led by AKC and other licensed pet products.

Growth margins for the first quarter of 2008 was 36.2% as compared to 36.7% in the first quarter of last year. The 50-basis point decrease in gross margin for the quarter is due to our product mix which included more lower margin closeout sales offset in part by lower writeoffs as TV game development and license advances.

Adjusted for closeout, sales grew 3.1% to $127.9 million with adjusted gross margin of 37.6%. SG&A expenses in the first quarter of 2008 were $48.3 million or 36.9% of net sales, as compared to $42.2 million or 34% of net sales in the same period last year. This increase is due to higher legal fees related to ongoing litigation which reached $2.6 million in the quarter as activities surrounding the WWE lawsuits increased with the recent dismissal of the Federal claims by the Federal Courts and as the Connecticut action progresses. In addition, higher advertising and marketing cost and increased product development cost in part due to increased product testing.

Depreciation and amortization was approximately $2.8 million in the first quarter of 2008 compared to $4 million for the comparable period in 2007. Stock based compensation for the first quarter of 2008 and 2007 was $2.1 million.

During the quarter, we posted $2.4 million in profits from the video games joint venture with THQ, compared to $1.5 million for the comparable period last year. Strong sales on the joint ventures of WWE Smackdown and RAW 2008 title developed for the Sony Play Station III, Play Station II console, TSP handheld, as well as the Nintendo Wii console and the Nintendo VS handheld and X-box 360 console as well as various mobile carriers worldwide.

Based on these overall variances, we had pre-tax income of $1.3 million for the first quarter of 2008 compared to $4.8 million in 2007. Cash flow from operations in the first quarter of 2008 was approximately $15.4 million compared with $22.4 million in Q1 2007.

Our financial position remains very strong. As of March 31, 2008, our working capital is approximately $359.2 million including cash and equivalents of $238.3 million. We continue to evaluate potential acquisition opportunities and expect to continue to grow our business by actively pursuing a creative and complementary acquisitions and executing on internal growth initiatives including creating new products and securing new licenses to provide continued growth for Jakks Pacific.

Our Board of Directors recently authorized the stock buyback program of up to $30 million worth of the company’s common stock and to date no shares have been purchased under the program.

Accounts receivables at the end of the first quarter were $81.9 million compared to $75.1 million at the end of the first quarter of 2007. DSO’s were 56 days, comparable to the 55 days in the same period in 2007. Inventory were $66.9 million at the end of the quarter down from $69 million at the end of the comparable period in 2007. DSIs decreased to 87 days from 96 days at the end of the first quarter of 2007 and capital expenditures for the quarter were $3.5 million and we expect capital expenditure to be approximately $19 million for the full year of 2008.

With that, I will return to call to Jack Friedman.

Jack Friedman

Thank you, Joel. We are in full swing getting into production and on letting you keep on eyes on this for this year and are on track to begin to ship many of these new items late second quarter with the majority of the sales on our key new items shipping in the third quarter as is typical.

As we mentioned, we are feeling extremely confident about our lineup for 2008 with several resonating as favorites amongst the buyers, analysts and media who have seen the lines.

Some new products stem from organic non-licensed product innovation developed here at Jakks while others are innovative initiatives based on our stellar licensing portfolio. The bottom line is, there are new initiatives with great potential coming from every area at Jakks. In the pets, we showcased our 2008 line at the Global Pet Expo in the quarter and we are bombarded by the response to new lines including the US Army, a complete line of Hammer Oral Care products for dogs, an extension of our Right Price oral care dental chews, more new AKC and Cat Fancy and associated products and more.

Expansion in to new drug and mass accounts has been progressing on plan and retailers are responding to the quality offering that is moving consumers in about every channel. In seasonal, we saw a modest improvement. Kite sales for the quarter with successful programs at Club Stores and other accounts as we approach summer and have been working on new seasonal and kite initiatives, we expect to bring to market in 2009.

Our new PenTech, pen spinning product line called Spinz, which capitalizes on the popular sport of spinning pens through the fingers, they are sitting in retail shelves just about now and if it takes off in the US, as it has throughout Asia and Europe, this could be a nice addition for Jakks.

A plush line based on the virtual playground neopets.com launched at Target the first quarter and so far, it has been trending wonderfully for us. We are working closely with Nickelodeon to cross promote the items on the site which is the original and largest virtual community for kids and expect these lines to only grow as we expand to other major retailers later this year.

Another program with Nickelodeon for this year is SLIME. I love SLIME. The Nick Kid’s Choice Awards achieved the highest rating ever and many of today’s top stars got slimed on national TV. Jakks is co-sponsoring a SLIME across America tour hitting cities nationwide this summer and a number of major promotions Nick is executing on to promote SLIME.

Jakks’s has had much success with Nick SLIME back when it was called GOO and we believe the time is right to bring back this gooey compound for kids of today. The line of SLIME products hitting retail later this year should do well for us. Our fun Spongebob plush line also ships to retailers later in 2008.

We have two new exciting initiatives in our activity areas, Spa Factory and GirlGourmet. Cupcakes are usually popular with cupcakes popping up in cities across the US, the feature items in our new GirlGourmet cupcake maker and the response in retail partners has been sensational. Kids can microwave a cupcake in 30 seconds, frost it with gourmet froster and they are delicious. This item will start to ship in second quarter and based on retail commitments and their expected promotional plans for the GirlGourmet cupcake maker, this product has the potential to be a breakout hit for the fall season. We expect it to be a formidable competitor to EZ Bake oven, and other play food items on the market.

Our new Spa Factory gives girls all the tools to pamper themselves for at home parties starting with robe and slippers to making their own aroma therapy potions with essential oils whether alone or with their friends. We think girls will really love Spa Factory and retailers have been extremely supportive with commitments from all the majors to carry the line this fall.

Jakks is in the doll business. For 2008, we have at least eight doll lines shipping to retailers, something we are quite proud of. This is exciting. Camp Rock is slated to be Disney’s new big hit along the caliber of High School Musical, starring the hottest boy band around The Jonas Brothers. Jakks is launching Camp Rock dolls at the end of the second quarter as target and as well and the potential for Camp Rock is phenomenal and long term with more Jakks products slated for next year to other retailers as well.

Of course our Hannah Montana line performed very well last year and in 3008, we have dynamic new Hannah Montana dolls that sing and dance, our Hannah Montana beach house play sets, new wigs and hairstyles featured on the TV show, Dance Master that teach kids to dance like the children pop star, new musical instruments, new electronic products and more. Every key retailer looks at Hannah as a hot growth category and we are confident that this will keep up this demand while managing the property of retail to maximize the product properly with longevity.

We announced the new line of Taylor Swift dolls that will be hitting Wal-Mart and other retailers in August. The endearing country music doll won CMT Female Video of the year and Video of the year during the quarter and response from country music fans to her upcoming signature doll line has been promising.

Fancy Mancy based on the children’s book series that has been on the New York Times best seller list for over 100 weeks. We created an adorable lodge doll line with dress up outfits for the doll and matching dress up outfits for little girls which hit target shevels early in the second quarter.

Jim Couturier is a new fashion line inspired by trendsetters in Harajuku, Japan based on the twin fashion, craze of layering and mismatching clothing, shipping to retail this summer.

Our beloved Cabbage Patch Kids are celebrating a milestone 25th Anniversary since the original craze in 2983 when Calico first introduced it to kids. Young parents and grandparents of today identify with this classic brand and there are a number of special initiatives and high profile celebrity tie-ins slated to commemorate the brand and drive sales for Jakks at retail later this year.

And shortly, we will roll out our exciting new line of NASCAR toy vehicles and play sets designed for fans of all ages and in particular, kids three to eight, and our NASCAR toys should have excellent placement in retailers for this fall. With 75 million fans, it is the number one spectator sport with a ten month season and we believe that our NASCAR line will be a great contributor in 2008. Vehicles and play sets based on our MXS motorcross brand seem to be in the upswing with good placement in retail for 2008.

Puppy in my Pocket has been doing terrific and the new character extension such as ponies and jungle animals are also performing to our expectations with expanded shelf space at some accounts, many accounts actually.

We have a new line of beautiful pretend products based on Disney fairies in anticipation of the new Platinum DVD Tinker bell coming out this fall and also a new line of Sleeping Beauty pretend products including an enchanting styling vanity, a line of dress and role play toys.

Our Black & Decker role play products are still doing terrific for boys and we are continuing the line as well as large cars, the movie, work based on the movie, a plethora of novelty choice and many private label brands in the role play choice category that consistently perform and are strong contributors to our overall business.

The Plug it and Play TV games line has been a catalyst for growth into several terrific line extensions. We continue to ship our core TV game based on classic video game licenses, game shows and kid driven titles and we will ship new tween titles based on Disney’s High School Musical and Hannah Montana in the second and third quarter.

As I mentioned, the Plug and Play Hannah Montana Pop Hero Guitar video game is expected to be a top item in this category. Our EyeClops Bionic Eye further extends the Plug and Play category for Jakks and with many members of the media last year touting EyeClops as one of their top picks with the recent nod by the scholastic instructor magazine identifying EyeClops as the teacher’s pick in the current April-May issue.

Our new EyeClops Bionic cam which features a multi zoom lens, a color LCD screen for portability and built in camera and flash drives so kids can now use their EyeClops to see things on the go will begin to ship at the end of the second quarter, as well as our exciting EyeClops Night Vision Goggle which is looking even better than we had hoped.

At Toy Fair, we showed the product to retailers and media who were awed by the 20 foot range. Well, now it is coming in at a 50 range in total darkness. These are real working night vision goggles at a price point of $79.00 or less. We expect this line to perform excellently for us.

Our new Ulti Motion wireless motion video game line which combines Plug and Play gaming with the role play in one of the most popular trends in video gaming today, motion games and are very well placed at our top accounts. We have a non-license title on popular sports and several titles co-developed with Disney slated for later this year.

Our action figures also continue to be a strong category for Jakks, driven by our WWE and Pokemon figures, which position Jakks with two of the top five action figure lines in retail.

Internationally, WWE also remains one of, if not the strongest, boy’s property in both the UK and Australia and we have many new assortments from both lines growing out in 2008.

With Pokemon Diamond and Pearl Figure play sets and accessories, we will feature our battle link system allowing kids to connect all the pieces to the large scale play set making it massive in size, and we continue to roll out new Pokemon characters that kids seem to be clamoring for.

In 2008, with WWE forged figures in the largest scale ring, they will rejoin the line up with new classic superstars and superstars currently in programming.

Action figure play sets and role play toys based on the excellent films from Disney’s franchise, The Chronicles of Narnia, Prince Caspian accounted to be one of the biggest family films of this summer, opening in mid May began to ship in the quarter.

We will also be producing toys for the third installment of the franchise Voyage of Dawn Treader which hits theaters in 2010 on a worldwide basis.

We have been working with our Discovery Kids line and expect to ship the line of interactive toys and make learning fun for retail and fall 2008. We have Smart Animals and other products based on nature as well as learning toys and other genres.

Based on the response and despite some uncertainties related to price increases and production issues that are affecting both our industry and others in manufacturing in China, we believe 2008 is shaping up to be a great year for Jakks Pacific. The portfolio of products that we have developed and nurtured along with our relationships with retailers, licensures and consumers has positioned us well for this year. We are working hard to execute on our strategy and on behalf of our shareholders and are excited by the opportunities that lie ahead. With that, I will open the call up to questions.

Question-and-Answer Session

Operator

(Operator Instructions)

Our first question comes from the line of Tony Gikas from Pipper Jaffray.

Jack Friedman

Good morning, Tony.

Anthony Gikas – Piper Jaffray

Hey good morning, guys. A few questions, maybe just a little bit more color on the legal fees, how they are expected to progress through the year, also on the ad spending, it looks like that was higher as well as product development, how should we plan those line items through the balance of the year, and then maybe just a little bit of comment or color on the gross margin, how are input costs affecting you. Do you expect the gross margin to be flat on a year-over-year basis, and then I will have a follow up.

Jack Friedman

Okay, regarding the legal, within our original forecast that we reaffirmed today, we believe that we have the appropriate amount of legal fees reflected in there. The only thing that we do not control is the timing and then a low volume quarter, obviously, it is more prominent as it is this quarter.

Anthony Gikas – Piper Jaffray

Was the timing for legal fees higher in this quarter or was it--?

Jack Friedman?

Yes. Again, we believe we have enough in the forecast, as I said, in the lowest volume quarter, it stands out a bit more.

Anthony Gikas – Piper Jaffray

Ad expense and product development then?

Jack Friedman

Product development increased, as we have indicated in prior calls, we increased activities in testing at the factories related to recalls within the industry. We have not had any problems, but we also have a lot of new products, so a portion of it was just increased normal testing, but we have also got a number of new initiatives, new licenses, non licensed products rather that we are introducing this year several of which incorporate adapting technology in to our products, including the Night Vision; we have also got a handful of other big key items, GirlGourmets, Spa Factory, the next generation, EyeClops, Ulti Motion et cetera. So all of this spending is in anticipation of the launches of some key items for this year.

Margins, Q1, as mentioned in my portion; ordinarily we did close out at or above cost. We did have some that were below cost and adjusted for the close outs which were about $3 million this quarter. The gross margins would have been 37.6%. We do expect expansions for the year. Again, our forecast has not changed. It is more just the timing of the way things played out.

Anthony Gikas – Piper Jaffray

And with the softening retail environment, do you anticipate taking ad spending up, is there anything there that we should be aware of, and then two, just housekeeping questions, amortization for tools and molds was up in the quarter, how do we plan that line item and depreciation was well below trends, maybe just a little help there.

Jack Friedman

Regarding depreciation and amortization, basically as more time passes from the last acquisition which was CDI, the limited life assets are quickly being fully depreciated, so we are expecting about a $4 million decrease year-over-year and then next year, it goes down another $3 million or $4 million, these are related to play along and the CDI. So we will see that continue to trend down as those assets get fully amortized. What was the other part, Tony?

Anthony Gikas – Piper Jaffray

And the other part was ad spending, how do you feel about that?

Jack Friedman

Easter came actually early. It was in March this year and ordinarily the spend usually occurs in April, so while we do have some key items that we expect to advertise that will hit more third and especially fourth quarter, so year-over-year, it was more of a shift as opposed to a need to push the sales at retail.

Anthony Gikas – Piper Jaffray

Okay, and then the last one was the amortization of tools and molds?

Jack Friedman

$19 million in capex, most of the tools and molds will be brought on line at the end of the second quarter, beginning in the third quarter when we start shipping the big new items. So it should be about what it is, for Q2 and then probably up a few hundred thousand a quarter in the third and fourth quarter.

Anthony Gikas – Piper Jaffray

Okay, thanks guys, good luck.

Jack Friedman

Thank you.

Operator

Your next question comes from the line of Steve Epstein with Defiance Asset Management.

Steve Epstein - Defiance Asset Management

Hi everybody. A couple of questions and some follow ups. On inventory levels, could you comment on inventory levels at retail for Jakks at the beginning of the first quarter and the end of the first quarter and just what their trends and behavior have been; it is well publicized that retailers have gotten much more conservative on the inventories occurring in this economic situation.

Jack Friedman

We are comfortable with our inventories with retail, it is something that we look at on a daily basis. I would say that some of the Hannah Montana products came in very, very late or into January, some of the retailers were expecting it to hit a week or two earlier in December that they would have sold it through, but the sell through from that inventory that has hit shelf are doing very, very well, so I would say that we basically had some closeouts that we needed to take care of that Joel mentioned and we are in great shape at retail.

Retail as over the past years have been desirous for less weeks on hand and that varies by retailer by retailer. We think that we and our major retailers are quite sophisticated at handling those inventory situations and we do, and our retailers like to buy a lot of our products on a letter of credit basis. It is beneficial to them and to us as well.

Steve Epstein - Defiance Asset Management

So Jack, exiting Q1, your retailer weeks on hand inventory is appropriate for the current situation now?

Jack Friedman

Absolutely.

Steve Epstein - Defiance Asset Management

Okay, so coupling that, the retailer trends are being conservative on weeks on hand, you mentioned that the majority of new products will ship in Q3, I assume revenue growth should be higher in the second half than in the first half, is that fair?

Jack Friedman

Definitely.

Steve Epstein - Defiance Asset Management

Okay, and then could you quantify the operating efficiencies of integrating play along that you cited will begin in the second quarter?

Jack Friedman

Yes. And one thing more, our new items are beginning to ship out of the Far East late second quarter which we are very thrilled that we are shipping as early as we can, as early as we are including Night Vision, GirlGourmet, Spa Factory, our new iPops and our Ulti Motion and Spinz and some of our private label program. We are actually feeling very good about the shipping dates this year and we are, I would like to emphasize, given the opportunity now that we are very excited about Camp Rock. It was something we were not able to talk about until very recently and Jonas Brothers are hot as could be. They seem to be the equivalent of Hannah Montana.

Steve Epstein - Defiance Asset Management

Jack, are those shipments a little earlier then? I know it is a matter of weeks, I am sure, but a little earlier than last year?

Jack Friedman

Not so much in dollars but we are getting our new products and we have many more new products this year than last year out earlier, I guess, if you are asking, they tend to put Q2 is looking up, we do not want to comment on Q2, but we are very satisfied with our business.

You know we are sorry some of the things, we are sorry for the shareholders and our sales and everybody that some of the things dropped into Q1 the way they did, sometimes that looked bad and I see that our stocks are down this morning, but everything is really on target for us.

Steve Epstein - Defiance Asset Management

Right, well, it is more of a timing issue with the way the analysts have spread out, the sell side has --

Jack Friedman

As Joel mentioned, we always do some advertising for Easter to get some things kicked off, and unfortunately Easter was in Q1 and we have spent it as it happened, so that was a swing of a couple of million dollars, from 07 to 08 because of when Easter was. Now unfortunately, that’s life and it is hard to do anything different about it. We are actually very well satisfied with our first quarter internally.

Steve Epstein - Defiance Asset Management

Is there a typical amount on new product launches, a typical percentage of orders that are in for a full year by this time, any idea of what you actually get to see?

Jack Friedman

It does not really work that way. What you get is your space allocation and some ad and other commitments for end caps and things of that nature. That becomes our guide. At this time of year, you are basically getting a forecast and our sales people work on a daily basis with our retailers working out when we can ship, how much to ship, how much they need, how much to launch. It is not as simplistic as you ask the question. It is very complex and interesting and I think, we and our retailer partners do a good job managing it.

Steve Epstein - Defiance Asset Management

And we are just looking for kind of evidence behind your sources of optimism if it is met with much related products?

Jack Friedman

They are from retailers and we do get forecasts, variable forecasts for many of our products and they are excellent.

Steve Epstein - Defiance Asset Management

Okay, one last question, the play along integration. Could you quantify those operating efficiencies?

Jack Friedman

I mean, basically what we did is we started or we finalized combining our operations in Hong Kong and also in Florida, so we have smaller space and fewer headcount, but we are expecting an upwards of a million dollars over the second and third and fourth quarter.

Steve Epstein - Defiance Asset Management

Okay, thanks guys.

Jack Friedman

Thank you.

Operator

Your next question comes from the line of Todd Schwartzman with Sidoti & Company.

Todd Schwartzman - Sidoti & Company

Hi good morning. What are you seeing in terms of cost related to China compensation, insurance, occupancy and such utilities.

Joel Benneth

Our presence there, we do have testing office, a testing facility. We do not have a lot of space, so our employees are not subject to those same pressures. On the manufacturing side, we have been doing some opposites in production, you know working closely with the factories to manage or to help them manage their capacity, so they tend to absorb more of the increases in the inputs.

In these development process we locate the margins that we need to make and again, work with the factories and re-design items to hit the margins. So while certain input costs are going down, a lot of our items are new each year, so we do not have any precedence in terms of pricing. With all new items, we have all new pricing. We have got more than 80 different factories that we deal with, so to some degree, there is some competitive aspects to where we place the orders.

So while certain inputs are going up, we are taking advantage of different opportunities to keep a handle on things. One of which in the last year or so, we started combining all of the requirements of all of our divisions on some of the raw materials, namely the plastics, so instead of having three individual smaller companies purchasing raw materials, we make a commitment now across the company so we are able to extract cost that way and we bang out an upwards of 200 million units of products a year, so a penny here and a penny there really goes a long way.

Jack Friedman

On an apples to apples basis, we certainly have increased selling prices this year. When there is something to compare apples to apples, as well as virtually all of our competitors and some of those price increases at retail, we have not seen a decline in year unit sales so far.

Todd Schwartzman - Sidoti & Company

So aside from commodity cost, there is no specific category of expense related to China that you are growing particularly concerned about, is that a fair assessment?

Jack Friedman

The Yuan has increased against the dollar, and raw materials, labor and transportation have all increased.

Todd Schwartzman - Sidoti & Company

Jack, just some clarification on a statement you made before regarding revenue, you had mentioned that. You expect sales growth to be greater in the back half of the year versus first, that is even in light of the fact that your comps are going to be more difficult than the second half?

Jack Friedman

I do not know if they are more difficult. I do not have to say it that way. I mean, we have lots of good selling products and lots of new products coming out that we have great shelf space and various pangrams for and I do not know how to say it differently, sitting here today, and we do not think it will change. We are really feeling good about it.

Joel Benneth

The back half is really the median of the year for us, so although the comps especially in Q4 having been up so much. We do have a lot of new products coming out, so we really have the flow that will enable us to achieve the growth especially in light of the placements that we have on it.

Todd Schwartzman - Sidoti & Company

Got you, and where are you with the PHQ arbitration?

Jack Friedman

This is Jack answering that one. We are still waiting for the California Judge to tell us which arbitrator we are going to use and as soon as it comes. We do not know when the Judge is going to do anything, but we do expect it very shortly and then probably about 60 days after that, we would probably go to arbitration. I am just guessing that is 60 days, but that would seem likely for both sides to be able to prepare the information or the arbitrator.

Todd Schwartzman - Sidoti & Company

Also, can you talk a little bit more about distributions for Neopets. You mentioned, later this year, you are going to be, I do not know if it is penetrating some new categories of retailer, can you talk about which customer categories you would be further penetrating.

Jack Friedman

Initially, the deal that we had struck required us to ship target first and very shortly, we will be shipping all of our major retailers and specialty accounts, on a worldwide basis, not just in the US.

Todd Schwartzman - Sidoti & Company

And when is that ramping up significantly domestically as well as abroad? Which quarter?

Jack Friedman

Probably the very end of second quarter getting into third quarter.

Todd Schwartzman - Sidoti & Company

And what about the Camp Rock products? When did those launch?

Let us just say in the next 30 to 50 days, we are very excited about that product line.

Todd Schwartzman - Sidoti & Company

And then the movie is out in June, correct?

Jack Friedman

I am not sure if it is June or July.

Todd Schwartzman - Sidoti & Company

Okay, final question, no buybacks during the quarter? What is holding you back?

Joel Benneth

That thing is really holding us back. We have sort of an informal threshold. The stock has been trading up and holding it pretty nicely. So it is sort of in that range, but just was not on us, although, today might be as good as any day. Not today, but once a window opens, it might be as good as any this week to commence that.

Todd Schwartzman - Sidoti & Company

And when does that window open?

Joel Benneth

In like two or three days after the announcement of the earnings.

Todd Schwartzman - Sidoti & Company

Great, thanks guys.

Jack Friedman

Welcome.

Operator

Your next question comes from the line of Edward Woo with Wedbush.

Jack Friedman

Good morning, Edward.

Edward Woo – Wedbush Morgan Securities Inc.

Good morning. I had a question, you mentioned that you guys were implementing price increases. Have you guys already done that with your products and what is in the range of the increases?

Jack Friedman

We have implemented that. That is a hard question to answer and we would rather not get to far until we have our strategy and in some cases, we have changed certain things and certain products. I could answer that the other way, I think you will see price increases in the toy industry, anywhere from 5% to 15% this year, depending on the products and that would probably not be any different than our competitors in that.

Edward Woo – Wedbush Morgan Securities Inc.

Great, the other question I have is, has there been any change in the outlook for a possible acquisitions emanating in this industry?

Jack Friedman

Yes, there has been. Since our last significant acquisition which was CDI, we got into a period from our point of view that people were asking a lot of money for their companies. I guess there was a lot of M&A and private equity stocks going on, and bobbing going back to about last November, forcing to our side to change dramatically. Some of that is recalls, scared particularly the smaller guys that could put them out of business. It scared some of the retailers that the supplier might not be able to back up a recall and both of those have been coming down and we have much more activity going on right now than we have had probably in the last three years combined.

So we cannot promise anything until the deal is done, but we are very active in the category and of course, we have the balance sheet to support.

Edward Woo – Wedbush Morgan Securities Inc.

Great, and one last question, is there any update to the WWE litigation?

Jack Friedman

Only in the sense that it is processing and we did spend money in the first quarter in the Connecticut court. Our attorneys are moving to have the case dismissed in Connecticut and we will see what happens. We hope for what we are hoping for and not hope against hope, but we are hoping for early dismissal and finally put the whole thing to an end.

Edward Woo – Wedbush Morgan Securities Inc.

Great and good luck.

Jack Friedman

Thank you.

Joel Benneth

Thanks, Edward.

Operator

Your next question comes from the line of Sean McGowan from Needham & Company.

Joel Benneth

Good morning, Sean.

Sean McGowan – Needham & Company

Thanks guys. Thank you. These areas are follow ups, but one with more detail. Regarding the legal expense increase in the first quarter, why would those expenses not have been accrued in the fourth quarter when the activity around the dismissal was most heavy? Why would there be an increase in the first quarter, a weight over 2007. Maybe, you did not get the bill, but would the accrual not have matched better in the fourth quarter?

Joel Benneth

We do record the expenses in the period where the services have been rendered. Initially, the Judge’s one page dismissal came at the end of November. The more complete opinion did not get completed until I believe the end of December, so most of the work actually, the activity surrounding it, actually started in January.

So, we do again record the expenses in the period where the services have been rendered. It is just that the reconsideration motion, the response to WWE appeal both in the Federal Court plus the activities increasing in Connecticut actually that one is proceeding on a new track.

Jack Friedman

Fast track.

Joel Benneth

Fast track rather and so they are up in the quarter.

Sean McGowan – Needham & Company

Would you expect this level to be sustained then?

Joel Benneth

There are absolute flaws to it. Again, we believe that we have enough in the forecast to accommodate where we will be by the end of the year. But the flow of it is there is a fluid activity and drafting motions and presenting motions and then you wait for the Judges to read and consider. So there could be a two or three-month low in between significant upticks in activity.

Jack Friedman

The best thing that can happen, Sean would be the Connecticut Judge to throw everything out shortly and the expense will come down below what we have anticipated for the year.

Sean McGowan – Needham & Company

Okay.

Joel Benneth

Certainly, within our lowest volume quarter, I would take out a lot more commonly than it would if we have the same sense in Q3 or Q4.

Jack Friedman

And lastly on that Sean, we have had, which is an unthinkable sum, colleting from our insurance company and we do not calculate any of that until we receive it. So we are in the process of cutting papers back and forth to find out what we will get, but we pay it and when we get the money from the insurance, we collect it. We would accrue any of that anticipation from the insurance company.

Sean McGowan – Needham & Company

You mean, the legal fees are covered by insurance?

Jack Friedman

Some of it, yes.

Joel Benneth

We have a policy that covers the directors.

Sean McGowan – Needham & Company

Okay, that is helpful. Regarding closeouts. I mean, closeouts are common and normal part of the business and I seem to remember last year in the first quarter that you had some of these closeouts. Is it a factor affecting margins in the first quarter, so what specifically was there in the first quarter of 2008 that would have resulted in an unusual shift in margin?

Joel Benneth

So ordinarily, we aim to get certainly above cost. We did have a few items that were in need of greater price reduction.

Sean McGowan – Needham & Company

Were these items that were launched in 2007?

Joel Benneth

I believe 2006, now Speed Stacks was one of them and Doodle Bears and Trolls. We are saying the inventory certainly does not appreciate and I think Speed Stacks was actually the biggest. In this particular case, on the $3 million in closeouts, we had about $600,000.00 loss on that which is more unusual. Usually, it is either neutral to the gross margin, but as I have mentioned, adjustment for those sales, the gross margins would have been 37.6%.

Sean McGowan – Needham & Company

Were there any product categories that were significant in the first quarter of 2007 that were way down in the first quarter of 2008?

Joel Benneth

Not particularly, I think that Doodle has kind of slowed down. I mean, significant maybe percentage wise, but not in terms of dollar contributions, but the big year for Doodle was 2006.

Sean McGowan – Needham & Company

And I have got one more question and regarding kind of how things look at retail because I would have guessed, I did guess that given that Hannah being incremental over a year ago, Pokemon being incremental over a year ago, most of EyeClops incremental, Neopets incremental, huge increases in the pet line, all of which you could observe at the end of the first quarter at retail, seems to suggest a healthier than 5% increase in sales, should we conclude that most of that stuff actually shipped in the fourth quarter?

Joel Benneth

Some of it shipped in the fourth quarter and there is this desire that we have been discussing as it carries, and Neopets launched.

Jack Friedman

None of our new initiatives shipped in Q1 at all.

Sean McGowan – Needham & Company

Right, I know, but Hannah was certainly not there a year ago and it had a huge sale space, I think the pet supplies stuff was there at the very end of the first quarter, it would have shipped in the first quarter, right?

Jack Friedman

I think pets moved along as it moved along. It is a steady lower business. I did say and I do not want to get stuck in anything and make a big thing out of it, Sean, but the excitement of the retailers to get those in, there are a couple of our retailers that both said that got on their shelf later than anticipated some of the Hannah Montana stuff and therefore had it in January and worked off those inventories before buying new inventories. There is nothing dramatic in that, just a comment on it. There is nothing to read between the lines in that comment.

Joel Benneth

And then lastly, Neopets line launched as an exclusive target initially, the roll out to other retailers later in the year.

Sean McGowan – Needham & Company

I would have thought that the increase in Toys R Us is pet line alone would account for the entire increase in the pet line. It just looked like there was a lot more shipment than in fact occurred, anyway, go ahead with the next question.

Jack Friedman

Thank you.

Operator

Your next question comes from the line of Arvin Bhatia from Sterne, Agee.

Arvind Bhatia – Sterne, Agee & Leach

Good morning, thanks for taking the question. I just want to make clear in terms of your EPS guidance for the year, so in the 291 that you are guiding, you are using Q1 reported EPS of $0.03, you are not adding back the $0.10. Is that right?

Jack Friedman

Correct.

Arvind Bhatia – Sterne, Agee & Leach

Okay, so you are guiding for the balance of the year for EPS to be at least $2.88.

Joel Benneth

You are good.

Arvind Bhatia – Sterne, Agee & Leach

And the street, I guess, before the wave, the South sided model was nine months that are roughly $2.78 based on the consensus of $2.97 for the year and $0.19, so I guess what you are implying is, a lot of it is timing and the way the people had modeled et cetera and you are not seeing anything to suggest softness in your business despite the economy. I just want to be absolutely clear.

Jack Friedman

And again, we did not got out with the lofty forecast taking into account the economy and everything else. We do have a lot of initiatives that are going to result in launch of some key items that we have mentioned a number of times, so we definitely have the product flow to achieve the forecast.

Arvind Bhatia – Sterne, Agee & Leach

And then also, last quarter, I believe, you had indicated that you were expecting contribution from WWE to be down having you set 20%, is that still how you are looking at it, or has that changed?

Jack Friedman

No, the 20% down is what we are forecasting for the JB.

Arvind Bhatia – Sterne, Agee & Leach

That is what I meant.

Jack Friedman

I think that, last year, I think it was $21 million since she was I think only forecasting a little bit down and sales for the WWE video games were in excess of $230 million or $240 million. We are just being conservative with the new competition from leaving their own portfolio licenses. They have UFC coming out, so out of an abundance of conservatism we just forecast it down.

Arvind Bhatia – Sterne, Agee & Leach

So, similar with your model now is that saying what you had indicated last quarter.

Jack Friedman

There has been no change. These are things that there is a lot of time spent in drafting and following motions and responding to each other’s motions. Then there is a law while the judge contemplates every fair judges, since we have got the suits going. So it is really a timely thing and considering that the federal case has been going on for almost four years. You can imagine that there are a number of months where they are low also. It is more of a timing thing.

Arvind Bhatia – Sterne, Agee & Leach

And then with the Olympics this year, I am wondering, should we be building any extra cost or have you built any extra cost in the event of any kind of distraction during that time from China shipment wise, as any extra cost that you are looking at this year?

Jack Friedman

A lot of our production is done in the South and the Olympics are in the North. I think this conclusion concerns, plus the manufacturing that we have is pretty clean. We are not involved in dirty manufacturing so any limitations on production should not really affect those factories in the South.

Arvind Bhatia – Sterne, Agee & Leach

Going back to the guidance thing a little bit, you know you guys always stay up in giving annual guidance, is there any thought or consideration that perhaps one, you know, could you be giving guidance one quarter out, because I think it would help analyst models, the shipment, et cetera much better?

Jack Friedman

I think the problem is JAKK, and I think the problem with that particularly is certain products get ready for shipment near the end of the quarter or miss the end of the quarter or retailers shift it, at first they wanted it June 20th and then they do not want it until July 10th and those millions of dollars that come close to the end or beginning of a quarter could affect it too much in our opinion for us to give guidance by the quarter.

Arvind Bhatia – Sterne, Agee & Leach

Well, I think, I just feel like your business from retail things and you know, I hate to see the stock being affected just because of the timing issues but if you can maybe quantify the best you can and then whatever is on the cost can be also talked about a little bit so we can have a better idea. I am just giving my sense on that.

Jack Friedman

I think the best answer we can give you for that is, you have asked the question is the $0.10 that was missing from the quarter, we anticipate picking that up to still meet our forecast for the year, so confidence in that. There are also two things going on. If you look at the increase in sales, there was 5.5%. We had a 4% forecast, what we could not have anticipated is the timing of the legal so if just hypothetical so you increase sales each quarter by the 4%, you would actually been pretty close but we never would have forecasted legal to maybe way up in Q1 and down in Q2, that becomes too arbitrary.

Arvind Bhatia – Sterne, Agee & Leach

Great! Can you tell us what price point your Ulti-Motion Product will be coming out at?

Jack Friedman

Yes, the Ulti-Motion will retail probably in the$59.00 to $69.00. I guess, safer if we would say $79.00. We might see it on ad and certain places lower but $79.00 would be the initial target price worth.

Arvind Bhatia – Sterne, Agee & Leach

Okay great, those are my questions, thank you guys.

Operator

Your next question comes from the line of Gerrick Johnson with BMO Capital Markets

Gerrick Johnson – BMO Capital Markets

Hi good morning. Can you discuss your retail take-away, at your expectations for the quarter ahead below?

Jack Friedman

We are pretty well on target for the quarter. There are a little bit of ups and a little bit of downs but overall on target.

Gerrick Johnson – BMO Capital Markets

Okay, and historically, you do most of your shipping FOB, so I was wondering if your order flow has been affected by any changes and perhaps the way retailers are choosing to be fulfilled this year.

Jack Friedman

No, I would say it is similar to the last couple of years and I do not know if I have used the word majority on LC, probably closer to 50/50.

Gerrick Johnson – BMO Capital Markets

Okay, so thank you.

Operator

Your next question comes from the line of John Taylor with Arcadia Investment Corporation.

John Taylor – Arcadia Investment Corporation

Good morning. I have got a couple of questions, mostly kind of focused on the supply side of things rather than on retail, so with all the quality concerns, there have been some cut backs and excess capacity out there, particularly in China and I am wondering if how you guys are thinking about potential upside. A lot of your key products are shipping relatively early and if you get positive reads, I am interested in whether you think you can capitalize on that with getting production above sort of where you put it in your plan, so that is one side of the question and the other side of the question is, are you having any trouble in China getting all your items manufactured, there has been some comments that the factories are in a position to pick and choose which ones they want to do? So I wonder if you could just talk about that a little bit.

Jack Friedman

I will answer the second one first. We are not having difficulty on that. Over the years we spent a great deal of time cultivating our relationships with factories. I think Joel mentioned we used over 80 factories to produce our goods on the important products, our potential important products, this first quality of question John, what we do is we look at the overall situation if there are chips as example necessary and that has been quite a long time. We will take some risks on the items that have upside potential and thank those and it is built into our numbers if we need to eventually throw them away.

Hopefully that does not happen but all of those things are built in. We will double and triple tuning on the slower components. It is something that I think we do quite sophisticated but the overall answer to your question is, yes we are in a decision to jump on upside potential and we work extremely hard and we will then decide through this conversation and other conversation of this conference call that we are shipping our new products earlier than ever because we do want to get those reasons and see what the velocities are and try to grab an upside. But for our overall forecast to the year. They are reasonably conservative forecasts.

John Taylor – Arcadia Investment Corporation

So, if you get in the position where the conservative forecast go up, you are feeling like you have got some flexibility and can monetize some of that.

Jack Friedman

Absolutely.

Operator

There are no further questions at this time.

Jack Friedman

Okay, thank you all very, very much. I appreciate your time this morning and we look forward to giving you great numbers in the future. Goodbye.

Operator

Thank you for participating in today’s conference call. You may disconnect at this time.

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