"We learn a lot from our kids," goes the saying. Earlier this week, as I was sharpening my daughter's colored pencils for the umpteenth time, grumbling yet again at how easily the "lead" points break off, I got to thinking: I bet a lot of parents buy a lot of colored pencils for just this reason. Pencil point breaks. Pencil shortens. Sharpen the pencil a bit. Pencil shortens more. Repeat process until pencil evaporates -- then buy a new box.
It's a low-tech version of the "planned obsolescence" that we used to read about back when Ford (NYSE: F) and GM (NYSE: GM) first discovered that they could sell more cars if they designed them to fall apart every 10 years or so. So I began wondering whether this would translate into similar increases in sales for the pencil maker. Curious, I flipped the pencil box over and saw that it was made by a subsidiary of a company called JAKKS Pacific (Nasdaq: JAKK). Wonder of wonders, this very company released its annual earnings report yesterday.
As it turns out, JAKKS' sales are on the rise, and its profits, too. Both factors seem to owe more to the introduction of new toy lines and acquisitions of rival toymakers, so my initial, formative-stage investment thesis may have been flawed. But flawed or not, it served its purpose in putting me on the track of this interesting company.
In 2004, JAKKS grew its sales by 82% over 2003. Profits more than doubled to $45.8 million, despite a decline in gross margins by 60 basis points to 39.4% -- which was vastly outweighed by the company's restraining increases in its selling, general, and administrative costs to improve its operating margins 380 points to 9.8%. Net margins also naturally improved, coming in at 8%.
Not all that growth was organic. While the company failed to break this out in its earnings release, judging from previous quarterly reports, as much as roughly two-thirds of its year-on-year sales increase came from the acquisition of Play Along, which brought us Cabbage Patch Kids, in June 2004. That acquisition didn't come cheaply, costing JAKKS $71 million in cash and 749,000 shares of stock, and contributing to the company's torrid 14.5% rate of share dilution last year.
What really has me interested in JAKKS, however, is the fact that Yahoo! Finance reports that the company generated well over $70 million in free cash flow over the past 12 months. Because JAKKS didn't provide a cash flow statement with its earnings release, it's not easy to immediately double-check that statement. But tune in next week, when we'll do just that, and also take a closer look at the company's investability in general.
Fool contributor
Rich Smith
has no position in any company mentioned above. He'd like to share this hint with other parents of small children: Sharpen the pencils with a razor blade. You'll do less damage than with a rotary sharpener, and they'll last a lot longer. For more insights on child rearing and toy maintenance, visit the Fool's Parents and Expecting Parents board.
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