Spin Master Corp.

Thank you and good morning, everybody, and welcome to Spin Master's Financial Results Conference Call for the second quarter ended June 30th, 2021. I am joined this morning by Max Rangel, Spin Master's Global President and CEO, and Mark Siegel, Spin Master's Chief Financial Officer. For your convenience, the press release, MD&A, and unaudited, condensed, consolidated interim financial statements for the second quarter 2021 are available on the investor relations section of our website at spinmaster.com and on CDAR. Before we begin, please note that remarks on this conference call may contain forward-looking statements about Spin Master's current and future plans, expectations, intentions, results, levels of activity, performance, goals or achievements, or any other future events or developments. Forward-looking statements are based on the information currently available to management and on estimates and assumptions made based on factors that management believes are appropriate and reasonable in the circumstances. However, there can be no assurance that such estimates and assumptions will prove to be correct. Many factors could cause actual results to differ materially from those expressed or implied by the forward-looking statements. As a result, SpinMaster cannot guarantee that any forward-looking statements will materialize and you are cautioned not to place undue reliance on these forward-looking statements. Except as may be required by law, Spin Master has no obligation to update or revise any forward-looking statements, whether because of new information, future events, or otherwise. For additional information on these assumptions and risks, please consult the cautionary statements regarding forward-looking information contained in the company's earnings release dated August 4th, 2021. Please note that Spin Master reports in U.S. dollars and all dollar amounts to be expressed today are in U.S. currency. I would now like to turn the conference call over to Max Rangel.

Thank you, Sophia. Good morning, everyone, and thanks for joining us today. This quarter marks our second consecutive quarter of increased profitability for Spin Master, resulting in a very strong first half. For the quarter, gross product sales grew over 27% and total revenue climbed by 39% to over 390 million. In reflecting on our performance, what stands out is the diversity of the growth we saw across all our creative centers and all our geographies. The efforts we've made to grow our global footprint, develop our entertainment capability, as well as the early investment we made in digital games through the acquisition of Toca Boca and Sega Mini are paying off. Approximately 20% of our Q2 total revenue resulted from digital games and entertainment. Much of the success we are seeing is due to the passion that our global teams have for our vision of creating magical experiences for children and their families. I want to thank all our employees around the world who have helped us achieve and exceed our revenue and operational targets while working under very difficult circumstances caused by the pandemic. Digital games growth was driven primarily by the Toka Live World platform and our Sega Mini subscription base. The sharp increases in growth we experienced starting in Q2 2020 have been sustained. Kids are spending more time socializing with their friends in these expansive digital playgrounds through the new content releases and tools that allow them to create, connect, and share. Toka Live World is a game that regularly evolves with new content, new playgrounds, and creator tools that allow kids to personalize their experience. And kids are playing and creating games, videoing themselves, and streaming these videos onto TikTok, Twitch, and YouTube for others to watch. TokaLife World has seen explosive growth in consumer engagement, and we believe this is a major factor behind its growth. TokaLife World has now over 38 million monthly active users, and the entire TokaWorld ecosystem has over 57 monthly active users compared to 33 million last year. We are seeing growth in core markets such as the U.S. and Western Europe, but also increasingly in countries such as Russia, Mexico, and Brazil, and in Eastern Europe as well. The Sego Mini subscription business also grew to over 294,000 subscribers across Sego Mini World, Sego Mini School, and Sego Mini Boxes compared to 184,000 last year. The continued expansion of our monthly active user and subscriber base provides us with a tremendous asset to develop a direct relationship with the consumer, further deepening our relationship with them, and expanding their loyalty with our digital games offerings. We are continuing to make progress on the opening of Noid, our new studio in Stockholm that will actually focus on developing digital games leveraging Spin Master's own IP. We have already hired a general manager and some key talent and are actively recruiting in Stockholm well known for its density of game development talent to complete the team. We expect NOI to be operational by the end of 2021 and will begin developing digital games during 2022 for launch in 2023. One of our key 2021 priorities is to accelerate digital games through acquisitions. Parents and teachers are increasingly turning to engaging digital solutions when it comes to education. We see an opportunity to expand our presence in the digital games edutainment market, an area that has been the primary focus of SEGO meeting. This past quarter, we took a step forward in this direction with the acquisition of Originator Inc. Originator is a digital game studio based in San Francisco and is a creator and publisher of entertainment education mobile apps for kids and families. all of which have reached the number one position in their categories in the Apple App Store. This acquisition will complement SEGO Mini's edutainment offering while leveraging our substantial subscription user base to expand the Originator apps to new audiences. We continue to actively look for further accretive digital games acquisitions and investment opportunities globally. Now turning to our entertainment creative center, Telling stories and creating engaging and enduring characters that resonate with kids around the world is important to us regardless of what screen kids are watching. We are rapidly approaching a major entertainment milestone with a highly anticipated release of our first-ever feature film on August 20th. The excitement for Paw Patrol the movie is really building. On August 20th, the film will be unleashed in theaters, distributed by Paramount Pictures, and on Paramount Plus streaming in the U.S. Paramount has begun an extensive global marketing campaign, and in partnership with Viacom, we have over 200 consumer goods partners leveraging the Paw Patrol movie and franchise. In addition to our feature film debut, the entertainment team continues to work on the development and production of new content. Paw Patrol will be entering its ninth season on Nickelodeon this September and continues to be rated as the number one preschool property, broadcasting in 160 countries into 350 million homes. We continue to take a multi-pronged approach to our entertainment content creation, led by exceptional storytelling that we know will resonate with kids globally. The team has a rich slate of new entertainment series and feature films in development and are on track to produce and introduce one to two new entertainment properties a year. We continue to expand our distribution strategy to ensure that we touch multiple screens and platforms to reach kids wherever they are consuming content. Finally, within our toy creative center, as mentioned earlier, our retail customers have responded positively to our portfolio, propelling our gross product sales well above the same quarter last year. Gross product sales in the quarter grew to over 27%. This increase was driven by preschool and girls and boys and can be attributed largely to our evergreen brands, Paw Patrol, and Bakugan, as well as kinetic sanding activities. Mark will provide more detail on our category performance. I will now provide perspective and details on our POS. When we look back to last year's second quarter, we were at the height of COVID lockdowns globally. Kids weren't going to stores with their parents. They weren't going to school in most cases, and the transitional social gatherings like birthday parties were not permitted. As a result, impulse rate related items and those more aligned with social play experience and negative impact to POS. A year later, we've seen these lines rebound. According to MPD, in-store sales in the US have not only recovered from 21, but are ahead of 2019. Toy industry growth continues but is slowing as we lap the first full COVID quarter in 2020. Our data suggests that globally, the toy industry is up mid-teens on a quarter-to-year-to-day basis, which has slowed since Q1. In comparison, our global POS share and growth is flat on a year-to-day basis. Internationally, for MPD, our Q2 POS is up 10% year-over-year, well ahead of the industry. On a year-to-day basis internationally, we are ahead of industry growth at 8%. In the U.S., our POS declined 12% for the quarter due to retail inventory gaps in Q1 and Q2, that we described in May. We expect that through Q2, we saw continued gaps in inventory at retail, but we are now seeing strong signs of recovery with in-stock levels rising, which will improve further as the new fall line arrives at retail. Despite lagging the industry growth rate in the US, momentum continues to accelerate on our core and franchise brands. Paw Patrol in Q2 was up 5% globally and flat in the US, Year-to-date, per NPD, POA is up 17% globally and 14% in the U.S. This bodes well for the health of the franchise long-term and in advance of the movie launch later this month. Bakugan continues to drive the battling toy segment and has grown by over 50% year-on-year every week. POS for Bakugan in the second quarter increased 62% on a global basis and over 80% in the U.S. per NPD. Bakugan's strong growth in the quarter was driven by an integrated content and marketing plan that included an innovative new gaming experience in Roblox, which has now seen over 68 million plays since April. The combination of the new Netflix content, media, and Roblox gaming yielded significant POS lifts that is driving Bakugan's growth. Bakugan will go into deeper metaverses fall with and will become the first ever property to premiere a full-length series episode on Roblox. An interesting data point in the voice product category is tech tech. According to MPD in Q2, POS increased 76% globally and 49% in the US in anticipation of skateboarding making its Olympic debut, which is sure to incite more skateboarding and fingerboard fandom. From a DC Comics license perspective in Q2, our DC Universe POS was up 41% globally and up 15% in the U.S. We have successfully implemented price increases for our fall line effective July 1 that provide a partial offset to the sharply rising input and ocean freight costs that we are seeing. In addition, we are seeing logistics disruption driven by congestion in key ports combined with rising COVID cases in some areas of Asia. The supply chain team is doing tremendous work with our partners from manufacturing to logistics to our retailers to ensure we deliver product to meet demand. This macro supply chain and cost pressures are meaningful, but given the actions we have taken and continue to take, we believe we can meet our full-year customer commitments. As a reminder, approximately 20% of our revenue that comes from digital games and entertainment is insulated from the impact of supply chain disruption. Mark will speak to this in more detail in a moment. As you know, SpinMaster is renowned for its innovation. While we have successfully built evergreen brands like Paw Patrol, Bakugan, and KineticSan, what sets us apart is our innovation mindset and our ability to surprise kids with magical experiences. This season, our team of designers have created a terrific line that will spark imagination while leaning into current trends and evolving play patterns. Some of the most innovative items launching this fall include pursepets, an interactive fashion accessory that you can wear and play with. A new Sonic Fin football, which was featured on the Today Show with our ambassador, NFL quarterback Russell Wilson. A new fashion forward plush line from Gunn, Pee Luscious, has shown very strong POS so far. We believe we have several strong top toy contenders. In addition to our intellectual property, we are also launching several newly acquired licensed toy lines in the back half of the year, in addition to Monster Jam and DC Comics, which continue to perform really well. Our toy line of Gabby's Dollhouse, a top 10 preschool show on Netflix, has already debuted at retail, and initial POS results show strong pent-up demand for the toys. Our take on Wizarding World, in partnership with Warner Brothers, is also hitting shelves this month. From an interactive Hedwig to a Hogwarts Castle replica, our new range of toys celebrates and reimagines the beloved characters from the Harry Potter film series. Finally this fall, we are launching our line of action figures, play sets, and role play items from Riot Games' League of Legends, the most played PC-based game in the world. We are excited to move into this category to leverage the attention of this loyal and international fan base and capture our share of sales in this rapidly growing kidult market. We continue to evolve our approach to marketing, starting with a focus on consumer centricity to enable an insights-driven approach. We expect consumer behavior to continue to be dynamic through the balance of 2021. We're keeping an eye on the following key trends. First, the economic recovery. While there's no expected future COVID-related stimulus, the U.S. child tax credit and lower unemployment could contribute to higher consumer spending. We are focused on marketing to capture interest in new items and increase presence in our brands. Across much of the world, children will return to school this fall, which will see a return to word of mouth on the playground and a craving for newness. We are focused on early execution around the back-to-school season leading into holiday. We will benefit from the return to physical retail as we are over-indexed in brick and mortar. We will continue to mix our spend against both kids and shoppers in line with shifts we've made last year to support an omni-channel experience. For many families, there won't be a full return to work with parents, increasingly given hybrid work options. For those still working from home, they'll need toys to keep kids occupied. To comp strong early promotion in 2020, we expect retailers to begin early price promotions. If in-store traffic grows continuous, the season could extend later into December, with last-minute shoppers having the option to buy in-store. We are continuing to build our digital-first in-house capability with 50% of our US marketing focus on digital channels. We have an e-commerce omnichannel focus evidenced by a substantial increase in e-commerce marketing spend with a strong physical retail program to complement it. We are focusing on creating innovation on programs like Bakugan and Roblox, live selling commerce, experiential retail, TikTok co-creation, and location-based mobile advertising. To conclude, We are extremely proud of our Global Speedmaster team. Our founders have set a clear vision for our future as a fully imagined children's entertainment company, and this vision is being realized. We are very well positioned entering the back half of the year with an amazing toy lineup, strong momentum on our digital games offering, and the highly anticipated release of our first feature film in less than three weeks. Looking to the future, we are ready to adapt to the changing dynamics of play through innovation customer-driven decision-making, partnerships, and a relentless drive to reimagine where imagination can take us. With these goals well in our sights, we will deliver profitable growth and continued value for our shareholders. I will now turn it over to Mark to provide some further detail.

Thank you, Max, and good morning, everyone. We started 2021 with strong financial results and extended these improvements through the second quarter. Q2 reflected the continued strength of our diversification efforts with very strong digital games and entertainment growth, significant improvement in gross margin, and continued operational improvements. These factors combined to produce a $60 million improvement in our Q2 year-over-year adjusted EBITDA. In addition, we continued to strengthen our balance sheet, ending Q2 with net cash of $311 million. Our core business is healthy, and we continue to actively leverage our assets to deliver value to shareholders. Gross product sales in Q2 rose 27.2% to $359 million, with a favorable foreign exchange impact of $6.5 million. On a constant currency basis, gross product sales were up 24.9%. Total revenue, including other revenue, climbed by 39% to $390.8 million, up from $281.1 million. Other revenue for the quarter grew $35.9 million, or 126%, to $64.4 million. Both primary components of other revenue, entertainment and licensing, and digital games, were up strongly. Entertainment and licensing grew 50%, driven by growth in TV distribution revenue as well as licensing and motionizing income. In Q2, digital games revenue increased 262% to $36.9 million, driven primarily by growth in Toka Life World and our Sega Mini subscription base. On a year-to-date basis, digital games revenue grew 315% to $71 million from $17 million for the same period last year. The gross product sales increase was driven by all geographic markets and exceptional sales growth in both preschooling girls and boys. On a geographic basis, the rest of the world was the strongest growth region as gross product sales rose 58.2%. and in Europe and North America, gross product sales were up 23.7% in both regions. International gross product sales for the quarter represented approximately 30% of total gross product sales, up from 28%. Our preschool and girls segment grew by 56.1 million, or 60%, to 149.6 million in Q2. driven primarily by strong sales of Paw Patrol, Gabby's Dollhouse, and present pets. Paw Patrol is performing well, accounting for a significant portion of the growth. Retailers are extremely enthusiastic about the movie toy line, while the core line continues to perform. In boys, gross product sales were up approximately 44% driven by higher sales of Bakugan, Monster Jam, and Tech Deck. This increase follows a year where we saw a decline in action figures and collectibles, which was affected by restrictions from COVID. Gross product sales in the activities, games and puzzles and plush category declined slightly by 1.8% to 98 million. The decline was driven primarily by the games and puzzles portfolio, which had unprecedented growth in Q2 2020 during the height of the pandemic. Relative to 2019, our games and puzzles business is strongly up. Sales of Kinetic Sand, Orbeez, and Influencer all positively contributed to sales. Included in activities, games and puzzles, and Flush were gross product sales of Rubik's products of just under $5 million and $7 million on a Q2 and year-to-date basis, respectively. From a channel perspective, retail is experiencing a shift back to in-store and online growth, while still strong, is moderating. As Max mentioned earlier, industry in-store sales in the US have not only recovered in 2021, but are ahead of 2019 levels by 30%. Overall, on a year-to-date basis, our e-commerce POS is up 5% compared to last year. Looking over a longer period, e-commerce sales in Q2 2021 are 84% ahead of where they were in Q2 2019. Sales allowances in the quarter were 9.1% of gross product sales, down 140 basis points from 10.5% last year. Our improved inventory management led to reduced markdowns. In addition, Year-over-year operational improvements drove significant reductions in non-compliance charges over the last year. These improvements were offset to some extent by continued growth in Europe, which has a higher overall sales allowance rate than the global average. On a year-to-date basis, sales allowances are 11% versus 12.7% last year. Historically, we have operated in the 10% to 12% range. We expect to be within that range, but towards the upper end of the range for 2021. Gross profit for the quarter was $209.9 million, or 53.7% of total revenue, compared to $118.2 million, or 42%. This significant improvement in gross margin is the result of the growth in digital games and entertainment and licensing, as well as the year-over-year cost reductions from our operational improvement initiatives. These cost reductions include lower scrap and obsolescence, reduced closeout sales, reduced reconfiguration costs, and lower sales allowances. In Q2 2020, we identified approximately $13 million in costs within gross profit, which related to inefficiencies from our operational issues, which have now been remediated. Selling, general, and administrative expenses decreased as a percentage of total revenue to 38.2%, down from 40.8%. The 260 basis point improvement was driven by a significant reduction in distribution costs, which declined by 5.1 million to 3.5% of total revenue, compared to 6.7%. Offsetting these improvements was higher marketing, selling, and administrative costs. Marketing costs increased $15.8 million to 7% of revenue, which represents a more normalized level of marketing spend for Q2 when compared to 4.1% last year as a result of COVID. We now expect our full year 2021 marketing spend to be at approximately 10% of revenue in line with 2018 and 2019. We will invest in marketing strategically to support sell-through, share growth, brand momentum, and channel country mix goals. Selling costs as a percentage of total revenue declined from 7.3% of revenue to 6.2% due to a lower proportion of licensed product in our mix this quarter. administrative expenses increased over last year by $22.3 million, or 40.4%, to $77.5 million. The increase was primarily due to personnel-related costs, including higher incentive compensation accruals driven by improved operating results, as well as higher professional service expenses. Administrative expenses as a percentage of total revenue increased slightly to 19.8% from 19.6%. Adjusted administrative expenses increased by $19.5 million to $72.9 million. Adjusted administrative expenses as a percentage of total revenue decreased to 18.7% from 18.9%. In Q2, we recorded net income of $33.5 million or $0.32 per diluted share compared to a net loss of $14.9 million or a loss of $0.15 per diluted share. Adjusted net income in the second quarter was $41.6 million or $0.40 per diluted share, an improvement of $51.1 million when compared with an adjusted net loss of $9.5 million or $0.09 per share. Adjusted EBITDA was $81.8 million in the quarter compared to $21.5 million, an improvement of $60 million. The significant increase in adjusted EBITDA was driven by higher gross profits and lower distribution costs, partially offset by higher selling marketing and administrative expenses. Adjusted EBITDA margin was 20.9%, up from 7.6%. From a tax perspective, we had an income tax expense of $11 million in the quarter at a rate of 25%. Free cash flow was $62.5 million compared to $40.2 million, driven by higher cash flow from operations. Inventory at the end of the quarter was $135.7 million, down by $18.6 million compared to $154.3 million in Q2 2020. Regarding acquisitions, as Max mentioned, we acquired Originator during the quarter for $15 million plus further performance-based payouts, assuming certain financial and operating performance thresholds are met over the next five years. Originator will continue to operate from San Francisco and will be reported within our Digital Games Creative Center. Turning now to our view for 2021. We are holding our growth product sales growth outlook for the full year at high single digits, consistent with our guidance in May. Whilst we have continued optimism for 2021 based on orders on hand and retailer demand, we are seeing some headwinds which require us to be cautious about our expectations for growth. A significant headwind we are experiencing is from the global delay in shipping caused by a variety of factors, including logistics disruptions from COVID-related shutdowns at key ports in China, the ripple effect of the Suez Canal blockage, and from COVID-related labor shortages in certain areas in Vietnam and China, all of which has resulted in a shortage of empty ocean containers in Asia, which is disrupting and delaying customer pickups. We are working hard to mitigate this. Our efforts include sourcing products earlier, increasing the number of ocean carriers we work with, and utilizing more ports to expedite the delivery of our product. We continue to anticipate some port congestion and ocean container capacity constraints for the second half of 2021. From a timing perspective, we are working extremely hard to ensure full product availability during the holiday season, and we're doing all we can to meet demand. We anticipate experiencing some shifts in timing of revenue between Q3 and Q4. Overall, given all the above, we want to maintain a cautious bias when it comes to GPS growth expectations. Turning to total revenue, we continue to see an acceleration of our momentum in entertainment and in particular digital games. Based on this momentum, we are pleased to raise our guidance for total revenue and now expect it to increase mid-teens compared to our prior outlook of low double digits that we shared in May. Regarding the poor movie, in May we advised you that in Q3 we expect to reflect in our results the distribution revenue received from Paramount and a portion of the amortization previously capitalized. Our previous guidance was based on a release schedule that provided for an exclusive theatrical period followed by the subsequent release on other delivery platforms. due to the uncertainties of covert a ship was made in q2 in the movie's u.s distribution strategy to a simultaneous release in theaters and on paramount plus as a result we now expect distribution revenue of approximately 23 million dollars in q3 compared to 13 million dollars previously advised as well as approximately $22 million of amortization of the capitalized intangible asset compared to $12 million previously. The net impact of this distribution strategy change on our gross profit will not be material, but it will positively impact Q3 adjusted EBITDA by $10 million. Consistent with what I described in May, both licensing and merchandising revenue from the movie will continue to flow into Q3 and Q4 and into 2022. And depending on the movie's ultimate box office performance, we could see additional revenue in late 2021 and possibly in 2022. Turning now to profitability, consistent with what is being experienced across the toy industry and many other industries, we continue to see increases in input costs, primarily from plastic resin, paper and cardboard packaging, and more recently from electronic chips and particularly ocean freight, which has nearly doubled as a percentage of our COGS compared to prior years. These cost increases accelerated significantly in the latter part of Q2. In early May, we advised you that we have implemented cost containment and productivity programs to offset cost increases, but where necessary, we were implementing price increases to help us offset inflationary pressures. These price increases became effective early in Q3 as planned. Normally, if we were raising our guidance for total revenue, we would also expect to raise our EBITDA margin guidance. Gross profit and adjusted EBITDA are benefiting from the remediation of our operational issues and the positive mix effect of digital games and entertainment revenue growth. However, given the incremental cost pressures the industry is experiencing and which are expected to continue, we're maintaining our adjusted EBITDA margin guidance and we continue to expect our 2021 adjusted EBITDA margin to be towards the higher end of the mid to high teens range. Capital expenditures and our effective tax rate are expected to be consistent with previous guidance. To conclude, we have advanced our strategic initiatives and made great progress across all three creative centers, continuing to demonstrate our ability to produce compelling entertainment and digital content, magical toy experiences, and to be a great partner for the licensed toy lines. We have built a strong and focused global platform and are incredibly proud of the effort and results that our employees have delivered. We are committed to our long-term financial framework for value creation, underpinned by our formula for innovation and global growth across toys, entertainment, and digital games. Our solid financial position, together with the achievements of our operational improvement initiatives, sets a very solid foundation for growth for 2021 and beyond that concludes the formal part of our call we will now be pleased to take questions operator please open the line okay thank you at this time if you have a question please press star 1 on your telephone keypad if you wish to withdraw your question press the pound key we'll pause for just a moment to compile the q a roster