Spin Master Corp.

Q1 2023 Earnings Conference Call


spk01: looking statements, whether because of new information, future events, or otherwise. For additional info on these assumptions and risks, please consult our cautionary statements regarding forward-looking information in our earnings release dated May 3, 2023. Please note that Spin Master reports in U.S. dollars, and all dollar amounts to be expressed today are in U.S. currency unless otherwise noted. I would now like to turn the call over to Max.
spk05: Good morning. Thank you for joining us today. Our first quarter performance was ahead of our expectations and reflects both encouraging entertainment and digital games performance, as well as expected toy performance despite tough comparables against 2022. Our three creative centers provide us with a strong integrated platform to create holistic play experiences for kids and families and help to enact our strategy to reimagine everyday play. In Q1, as expected, We experienced pressure on toy gross product sales resulting from excess inventories at retail carried over from Q4 2022. This in turn caused retailers to slow orders for the front half of 23. We are also lapping an unusually strong Q1 22 characterized by shipments from both our first Palm movie and the Batman movie. As a result, our toy revenue in the quarter declined 46.9% year over year in line with expectations. We see the industry's retail inventory situation improving steadily. From a Spin Master's perspective, our U.S. retail inventory at the end of 2022 was up $117 million compared to 2021. However, at the end of Q1 2023, our U.S. retail inventory was flat compared to 2022. Since the end of Q1, both industry and our retail inventory continues to decline, and we expect any remaining 22-related retail inventory overhang to unwind by the end of Q2, positioning us for a strong second half. While historically the toy industry has been resilient amidst economic downturns, the start to 23 for the industry has been soft from a POS perspective. According to Cercana, previously known as MPD, in Q1-23, consumers globally bought fewer toys and spent slightly less on the toys that they purchased. Global toy POS declined 3.1%, while our global POS was down 4.8% per Cercana. In the U.S., our POS declined 9.2%, compared to a decline of 4.7% for the industry. Conversely, our international POS performance fared better, and in Q1, POS was growing 3.9% compared to the industry, which was flat. We grew POS in seven of the 11 countries measured by CERCANA, outperforming the industry in most countries. It's important to remind you that the first quarter of any year is our seasonally lowest quarter, and this was exacerbated in Q1 23 for the reasons we have discussed. We believe that Q1 POS data, particularly in the U.S., may not be representative of full year performance. As we look to the fall, we have a strong toy lineup with breakthrough innovation and impressive launches within our core and licensed brand portfolios, coupled with exciting content releases. Our commercial teams are focused on working closely with our retail partners to deliver on the second half. Execution on shelf will be supported by measured investment in fully integrated marketing plans with digital campaigns and portfolio-led initiatives to incent and convert consumers. We have built an industry-leading preschool business, driven by globally acclaimed entertainment series and toy lines with deep character affinity. Paw Patrol, which is celebrating its 10th anniversary this year, continues to lead the way as a number one preschool toy property globally in Q123. According to Cercana, global POS for PAW declined by 7.1% in Q1 2023, mainly from declines in Europe. We expected this decline as we were lapping the continued consumption from the PAW movie in Q1 2022, and Europe had not yet benefited from the distribution of our Aqua Puffs theme or the Rubble and Crew product launch. While overall POS was down, The availability of the strong theme and rubble distribution drove POS gains in some key markets, including the U.S. In the broader infant-toddler preschool toys supercategory, as defined by Sarkana, we had three of the top 10 items in the U.S., including some of the new items for 2023. This demonstrates our ability to win by innovating our core brands, Another example of winning with innovation is Bakugan within our Wheels and Actions category. Bakugan was relaunched in 2019 after its first reign as a global phenomenon from 2007 to 2010 and has proven to be an evergreen brand with a strong following. In Q1, we introduced Bakugan Legends, and the brand reached number one in the battling toys and play sets class globally, up from number two in 2022 for Sharkana. We are excited to launch a whole new way to battle with Bakugan this fall, supported by new content. Speaking to all their successful IP, Hatchimals was a global breakthrough toy when it launched in 2016, creating a new play pattern with a toy that unboxed itself, generating over a billion in gross product sales from 2016 to 2018. Over time, We have evolved the brand beyond the initial big egg, extending it to a successful line of collectibles. As many of you saw in our LA short room in January, we are launching a new way to hatch characters this fall with the launch of Hatchimals Alive, using water to unveil the characters inside. We continue to explore infusing innovation into the Hatchimals line with exciting new product innovations in 2024 and beyond. We have invested in our ability to secure top licenses, And over time, we have steadily grown our reputation as an innovative and collaborative global partner. Licensed products now comprise just under 30% of our POS per cercana. Gabby's Dollhouse, in partnership with Universal DreamWorks Animation, continues to win the hearts of children everywhere. In Q1 23, Gabby was the number five preschool toys property, compared to number 10 in Q1 2022. And what's the largest dollar global growth property in the super category? Berserkana. Sales for the DC line softened in Q1 as we lapped the Batman movie toy line launched last year. However, we regained our number one manufacturer position in Q1 for DC Universe globally. With four new films in the DC Universe planned for 2023, we are excited about our lineup of action figures, vehicles, and role-play items to enable kids and collectors to bring their action and adventure from the big screen into their homes. Warner Bros. is committed to investing in these franchises with more theatrical releases and content extensions launching over the next several years. Our design teams are looking forward to working with the toy lines, which will accompany the upcoming Batman and Superman movies in 2025. The last major license I want to comment on is Monster Jam, in partnership with Feld Entertainment. Monster Jam had placed the category globally in Q1 and remained the number two property in the vehicles category and the number one license brand in vehicles. Within games, category growth is being led by the trading cards games and adult party games. Many of these games are inspired by social media trends and viral concepts. We are leaning into the popularity of these types of games in 2023 with several new titles, including If You Know, You Know and Dumb Ways to Die. The catchy song for Dumb Ways to Die was originally created to promote railway safety in Australia and has become a viral sensation on social media. Our Dumb Ways to Die card game will launch this summer. We're also leaning into giant games. which are also becoming increasingly popular with the license of Monopoly, and we will launch Giant Monopoly late this fall. We have always been a disruptor in the toy industry known for our innovation. We expect to deliver exciting innovations for the holiday season as retailers look to differentiate themselves on shelf and in the hearts of kids and families around the globe. Looking forward, we are doubling down on innovation by starting a new internal group that will be solely focused on developing breakthrough innovation. Our most innovative and creative talents will be working in this group with a sharp focus to deliver significant disruptive breakthrough toys for the future. Entertainment had a very strong quarter with revenue increasing 69.4%, driven by higher distribution and licensing and merchandising revenue, primarily related to the Paw Patrol universe. Our strategy to invest in the creation of multi-platform content will result in the releases in 2023 and 2024 of our most diverse entertainment slate in our history. Part of that success can be attributed to Paw Patrol, a franchise which continues to expand its reach, attracting new audiences and connection to these heroic pups. This fandom has allowed us to grow the Paw universe with the launch of the Rubble & Crew series, which debuted on Nickelodeon in February. Rubble and Crew delivered top-performing ratings with the premiere ranked as the number one show on cable with kids 2 to 5 in its time slot, pacing double digits ahead of competition. Rubble and Crew also posted the strongest share for a preschool series launch since 2019, capturing viewership with over 20% of kids 2 to 5 in the U.S. PAW continues to perform well on both linear and streaming platforms. We have strong momentum heading into our movie launch and are looking forward to entertaining preschoolers and their families with another epic big screen adventure. We remain on track to deliver the second Paw Patrol movie, which is set to debut September 29th. We are launching two brand new properties in 2023. Vida the Vet, our new preschool series, is set to debut on BBC CBBs in the UK and on Chorus Treehouse in Canada this fall. In addition to these initial broadcasters, we are pleased to share that Netflix has acquired streaming rights for Vita for the U.S. market. The team is also closing a raft of other international distribution deals, which should be announced soon. We are also very excited for the launch of Unicorn Academy. Our Fantasy Adventure series, which is launching in Netflix in November, is amazing. We are putting our full franchise development and management support behind Unicorn Academy which will cross over from entertainment into both toys and digital games in 2024. We are building an expansive licensed consumer products program that will span apparel, publishing, accessories, and many other categories. We can't wait to show you Unicorn Academy. It is unlike any other property that we've created and is for sure to enchant kids and families. Turning to our digital games creative center, In March, we indicated we were seeing some positive momentum. The industry new baseline is lower than it was during the COVID years, but has stabilized at a much higher plateau than in pre-pandemic years. We are seeing a similar pattern in our own digital games business. We are actively expanding our digital games portfolio with several new digital games launching this year. We will be entering new and large mobile gaming categories that will increase our addressable market and broaden our audience base. Our anchor games, including Tokolive World and Sega Mini, have been created for children, but we are thinking more broadly in designing digital games play that will attract kids of all ages and spawn a growing player network anchored in safe and fun play. In Tokolive World, player engagement remains high, In early April, we hit a new record of 12.5 million daily active users in Toko Live World, beating our previous record in early 2022. This reflects the success of the Games as a Service model, where fresh and relevant content drives player satisfaction and engagement. We have more exciting content drops planned throughout 2023, including an exciting collaboration to be announced in June, as well as enhancements to our creator tools, which will allow players to express themselves creatively and share their stories. We've talked to you in the past about TOCA Days, our first 3D multiplayer game set in the same universe as TOCA Live World. At its core, the game is about social interactions between players, but also within a broader community. TOCA Days is currently in early soft launch, and we are testing cross-promotion between Toka Live World and Toka Days to drive traffic across the Toka universe. Player sentiment has been high so far, and based on the initial feedback and learnings, we are fixing bugs and prioritizing features. We will continue to roll out soft launch to additional markets in 2023 with a full go-live plan for 2024. In SEGO Mini, we are also focusing on new content and late in Q1, we saw indications of growth in subscriptions and downloads. We are launching our Sego Mini subscription bundle in Q3 to give families more access to content at a better value. Between Sego and Originator, we currently have around 330,000 subscribers, and the bundle will allow parents to make one streamlined purchase that will provide access to hundreds of games and activities, including all the Sego World, Sego School, SEGO First Words, and Originator developed endless learning and math tango apps, as well as the Toka Jr. app library content, with six titles growing to nine by the end of 2023. Leveraging Speedmaster's trove of IP is a key priority for our digital games creative center. Our new casual mobile game, Leveraging the Iconic Rubik's Cube, will soft launch this summer. We will also appeal to the deep global fan base for Paw Patrol, through the creation of our first in-house developed digital game, Paw Patrol Academy. The app combines hundreds of show clips that are unlocked through play, creating a seamless and immersive experience between our entertainment and game-playing content. There are also exciting missions and educational content that will keep preschoolers engaged in fun and emotional learning. Paw Patrol Academy will launch in tandem with a movie in October. and will also be available as part of the SEGL subscription bundle. In 2024, we will be launching the Unicorn Academy digital game, which will bring the magic of Unicorn Island into the digital world with an action-adventure game designed for mobile devices. We have an exciting 2023 and 2024 plan for digital games, and we look forward to sharing more details and live demos with you at our Analyst and Investor Day in Stockholm in late August. While we are investing for growth, we are also closely managing our costs. Our prudent fiscal management has put us in a strong financial position and allows us to invest in acquisition opportunities within each creative center. We remain confident in our strategy to reimagine everyday play, leveraging the power of our three creative and integrated creative centers to capture market share, deliver profitable growth, and create long-term shareholder value. I am now going to pass it over to our CFO, Mark Siegel, to provide further commentary on our performance in the quarter and our outlook. Mark?
spk08: Thank you, Max, and good morning. Against challenging comps, we delivered $271.4 million in revenue in Q1-23 across all three credit centers, down 36% from 2022. The year-over-year decline is primarily reflected in a shift in order timing in the toy creative center, offset by an increase in revenue and entertainment. In March, we discussed how the toy industry felt the impact of retailers entering Q123 with significant carryover inventory from Q422. Comparisons to Q122 look especially unfavorable since we had an unusually high sales as retailers brought inventory in early to avoid anticipated supply chain disruptions, as well as some large entertainment-related shipments. Thanks to the hard work of our commercial teams, we ended Q4-22 with very clean on-hand inventory, reducing the need for aggressive clearance activity in Q1, which, together with higher entertainment and digital games revenue, led to solid gross margins and a better-than-expected adjusted EBITDA margin. Looking at Q1 performance by Creative Center, TOI gross product sales were $216.3 million, down 45.6%. Foreign exchange did not have a material impact, and on a constant currency basis, gross product sales declined 44.7%. In 2022, 45% of our gross product sales occurred in H1, compared to 30 to 35% typically. which creates a tough H1 comparative for us. Difficult Q123 comps against last year are exacerbated further by the large volume of toys we shipped in Q122 for the Batman movie, as well as toys for the first poor movie from 2021, for which demand continued into Q122. We also had $11 million of sales in Russia in Q1 of 2022. Geographically in Q1, North America saw the biggest decline both in dollars and percentage terms, as the trends discussed earlier were more pronounced in this region. Revenue declined 133.1 million, or 56%, to 105.5 million and accounted for 48.7% of Q1 GPS, down from 60%. International sales, comprising Europe and the rest of the world, declined 48.1 million, or 30% to $110.8 million, comprising 51.2% of Q1 GPS. Preschool and dolls and interactive declined 44.7%, primarily from a drop in sales of Paw Patrol, Hatchimals, Wizarding World and Purse Pets, partially offset by an increase in Gabby's Dollhouse and Rubble and Crew. Activities, games and puzzles and plush were down 40%, mainly due to a decrease in the games and puzzles portfolio and kinetic sand. Wheels in action dropped 56.1%, driven by a decline in DC, especially Batman, as well as Bakugan and Monster Jam. Outdoor was down 37.9%. Q1 sales allowances were 13.9% as a percentage of gross product sales compared to 11.7%. Whilst higher than 2022, It was a good result considering the broader retail environment we were operating in. We continue to expect sales allowances of approximately 12% for 2023. Q1 adjusted EBITDA for toys was a loss of $21.4 million compared to adjusted EBITDA of $58.9 million, a margin of negative 11.5% compared to 16.8%. The lower volumes driving deleveraging was the main driver of the EBITDA margin differential. In Q1, entertainment revenue increased $15.4 million, or 69.4%, to $37.6 million from higher distribution and L&M revenue. Adjusted operating income was $29.9 million, up 162.3%, and adjusted operating margin was 79.5% compared to 51.4%. The increase in entertainment profitability was driven by higher distribution and L&M revenue and lower costs from fewer content deliveries. Q1 revenue in digital games was down 7% to $47.5 million compared to last year from lower in-app revenue in Toker Life World, but sequentially was up 25.3% compared to Q4 2022 from higher engagement and in-app revenue in Toker Life World. Over the last three years, our digital games revenue has grown significantly, and we have increased revenue by over 575% since Q1 of 2020. Digital games adjusted operating margin in Q1 was 40%, down from 42.3%, due to higher development costs related to investments in future games. Q1 consolidated gross margin was 58.4%, compared to 55.9%, an outstanding result. The 250 basis point increase arose primarily from high margin entertainment revenue and lower ocean freight, partially offset by higher sales allowances. The deleveraging I referred to earlier was evident in our SG&A of 149.3 million, representing 55% of consolidated revenue, compared to 158.6 million, or 37.4%. Marketing costs were down $2.9 million at 9% of revenue compared to 6.4%. Administrative expenses were up due to higher personnel and travel expenses offset by lower incentive comp. During the quarter, we implemented a global workforce reduction program and booked a restructuring charge of $3.8 million included in administrative costs. Adjusted SG&A was 139.5 million or 51.4% of consolidated revenue compared to 153.8 million or 36.3%. On the topic of restructuring, we are making good progress on our Calais, France facility shutdown project and will account for the one-time restructuring cost in Q2. Combined, our two restructuring projects will, when completed, result in run rate savings of approximately $15 million in 2024 and beyond. In Q1, our net loss was $1.9 million or a loss of 2 cents per diluted share compared to net income of 45.6 million or 43 cents per diluted share. Adjusted net income in the quarter was 12.3 million or 12 cents per diluted share compared to 57.5 million or 55 cents per diluted share. Adjusted EBITDA was $30.6 million compared to $95.7 million. Adjusted EBITDA margin was 11.3%, down from 22.6% in Q1-22 from low operating leverage, partially offset by higher gross margin. Turning to our balance sheet, our on-hand inventory at the end of Q1 was in very good shape. At just under $110 million, inventory was essentially flat to your end, but approximately $38 million lower than Q1 2022. Free cash flow in Q1 was $34.4 million negative compared to negative $79.4 million, primarily from changes in non-cash working capital. We ended Q1 with $569.3 million in cash, down $75 million from the year-end of $644 million, and which is in line with normal seasonality. In Q1, we deployed $26.5 million for the acquisitions of 4D brands and hex bugs. We also invested $23.4 million in intangible assets for entertainment and digital games content. We continue to be in an extremely strong liquidity position with available liquidity of over $1 billion. From a capital allocation perspective, investments in innovation, content, and M&A remain our priorities. In addition to our dividend, regarding which we will introduce a dividend reinvestment program in Q2, we initiated a share buyback program. The program has been executed through a normal course issuer bid, which was approved by the TSX in early Q1. We repurchased 241,500 shares in Q1 for $6.3 million. In April, we repurchased a further 156,200 shares for $4.2 million. Repurchasing shares at current market prices represents an attractive investment opportunity for us, given our strong liquidity position and growth prospects. We will continue to opportunistically use the NCIB and believe that it, together with the dividend, represents a prudent use of capital and an important part of our efforts to create value for shareholders. Turning to our outlook, there remains a long way to go for 2023, but current trends in our business are matching the expectations for 2023 we communicated in March. We continue to expect 2023 toy gross product sales to be flat to slightly down compared to 2022. We expect H1 2023 toy gross product sales to be toward the low to midpoint of the seasonality range of 30% to 35% in H1 we guided to in March. We are maintaining our expectations for 2023 revenue to be in line with 2022, excluding the $17 million Paw Patrol movie distribution revenue expected in Q3. Foreign currency translation is expected to have a neutral impact on revenue based on current rates. We discussed the primary revenue and cost drivers in detail in March, and there have been no major changes. We are maintaining 23 adjusted EBITDA margin expectations, which should be flat to slightly above 2022, excluding the $17 million Paw Patrol movie distribution revenue. To remind you, total depreciation and amortization for 23 is expected to increase from $68 million in 2022 to just under $150 million in 2023, primarily from more deliveries of entertainment content. From a phasing perspective, DNA will be approximately $33 million in Q2, $53 million in Q3, and $44 million in Q4. To conclude, we continue to execute on our growth strategies and build our integrated Creative Center platform to generate above-industry growth in the medium to long term. We have the scale and talent across our creative centers combined with a strong balance sheet to capitalize on both organic and acquisition opportunities and in doing so, build long-term shareholder value. That concludes our prepared remarks. We will now be pleased to take questions. Operator, please open the line.
spk06: Thank you, sir. Ladies and gentlemen, if you would like to ask a question, please signal by pressing star 1 on your telephone keypads. If you're using a speaker phone, please make sure your mute function is turned off to allow your signal to reach our equipment. And again, that is star one. We'll take our first question from Martin Landry from Stiefel. Please go ahead.
spk12: Hi, good morning. I was wondering if you can touch a little bit on your entertainment segment. It had a really strong quarter. Operating income was up almost 3x versus last year. You did touch on some of the reasons, but I was wondering if you can expand a little bit as to what explains this nice profitability uptick here.
spk08: Good morning, Martin. Thanks. I'll take that one. Entertainment is an interesting segment for us and is quite sensitive to revenue mix. In the first quarter, we had a really strong increase in high margin licensing and merchandising revenue. and also distribution revenue, which is actually characterized as part of the income we get, the rev share income we get from the first poor movie in 2021, which was still flowing through in the first quarter of this year. So that is very high margin accretive revenue and essentially flows straight down to the bottom line. And that's what you saw. It impacts gross margin and adjusted EBITDA margin in EBIT in a very positive way. I do want to call out, Martin, that It's going to be hard to replicate that kind of performance every quarter, although I would love to. And we are going to see some amortization flowing through in Q2 to Q4, which is going to lower that margin because that distribution revenue and the associated amortization from it is actually lower margin revenue for us. And that's why in our outlook section we called out those amortization numbers so you know how to model that.
spk12: Yeah, okay, that's helpful. You also talked in your opening remarks about Gabi's dollhouse. It continues to perform extremely well. I was wondering, how long is that license going to be ongoing with you guys? When does it expire, and is there a likelihood of renewal?
spk05: Yeah, so... Good morning, Martin. Gabby's Dollhouse has been with us. It started in 21. We basically have another year and a half to go with it. And we're in a really great place with Universal DreamWorks with regards to Gabby's. And if you think about it, so far the success of Gabby's from a toy perspective has been mostly in the U.S., and we're just now beginning to get that going internationally as So as Universal expands Gabby Beyond the U.S. for obviously the content, we are also expanding that. So you can expect we're in a great place with them and we will continue to reap the benefits of this relationship into the future.
spk12: Okay. And then maybe last question for me, just broader outlook, you know, Wondering if you can talk a little bit about the discussions you're having with retail buyers right now. How are they approaching the summer and the back-to-school season? I would expect at some point with retail inventories being right-sized, is there a potential for replenishment in the back half? Just trying to get a sense as to how they're approaching the coming months and all the way up into the holiday season.
spk05: Sure. I think Mark has, in his remarks, referenced a return to historical weightings between the quarters and the halves. And so retailers are, just to answer your question, planning for that exact condition. And therefore, quite a bit of the shelves are being set in the summer, which coincides with what Mark and I have said, again, regarding retail inventories, which should be down by the end of the summer. So as you think about back to school and people resetting shelves and a few theatrical releases, including ours on PAW, correct, September 29th, you're going to begin to see that activity. And yes, you know, when things begin to do well, there's an opportunity for replenishment. And this year, unlike last, and it only dates back to 2016-17, Christmas falls on a Monday and it has basically therefore two previous weekends of purchasing. And that last weekend is really important. So retailers are also planning accordingly.
spk13: Okay, that's helpful. That's it for me. Thank you. Thanks, Martin.
spk06: Thank you. And we'll take our next question from Adam Schein from National Financial.
spk11: Hi, good morning. So, Mark, I don't want to push you on guidance. Heard your comments, and it's certainly very early in the year, but maybe, you know, just in the context of digital games and entertainment, and then maybe perhaps one more for you later, Max, but specifically. on digital games, you know, we had seen three prior quarters, you know, of a step down and the step down in Q1, you know, wasn't to the same extent as you alluded to, and there's sort of more product flowing into the back half of let alone this summer. So can you talk about some of your expectations starting with digital games? Is this a revenue line that frankly should see some degree of growth as compared to what perhaps some people might have assumed would be a decline for the year?
spk08: So Adam, we're encouraged by what we saw in Q1 for digital games. Even though we were down relative to Q1 last year, we were 25% more than 25% up sequentially relative to before. And so we're actually encouraged by that, and we saw some of that flow through into our performance in Q1 in terms of that segment's EBIT. Now, obviously, we would love to see that trend continue. We're not calling that out specifically. It is to some extent built into our outlook for the year, but there may be some upside. Hopefully, we'll be able to give you more of, you know, views on that as the year progresses. Um, but certainly we're excited about what we're seeing in, in digital games. We've got a lot of new content in token life world. We're excited about the one sub bundle in Sago. There's, um, a number of products in soft launch, the new products, Rubik's and, and, and the others in token days are not going to have an impact on revenue in 2023. Those will really be 24 and beyond, but overall, uh, It's a good news story so far, but it is early days. Max, would you like to add anything to that?
spk05: Yeah, Adam. We're super thrilled about the start of the year. I won't go into what Mark said. I'd just like to add some color. We kept the engagement, correct? And so the kids were in the ecosystem. What changed for all of you is that we are monetizing now better. So now the kids are spending more while in the app. And that's a reflection of the quality of the content being released, and the engagement it drives with social channels. We saw TikTok, we saw a number of things that gives us quite a bit of confidence that the content's resonating. And vis-a-vis last year's base, we now have content every month going forward, including in the summer month, which is one key period for this property. So we're very encouraged and we are aggressively looking forward to carry the year ahead.
spk11: Perfect. Thanks for that, Max. And Just, Mark, next on entertainment, I mean, I think you alluded to it and you addressed some of the Martin questions specific to that. But, you know, clearly there's going to be some lumpiness inherent in entertainment, sometimes for episodic deliveries and sometimes for, you know, the L&M dynamic. should arguably continue to build through the year in the context of a lead up to the movie. Can you speak a little bit more to how you see entertainment progressing, acknowledging the lumpiness and the upside called out for the movie distribution revenue in Q3? How should we be thinking about entertainment overall for the year?
spk08: So, Adam, it's a great question. And, you know, entertainment is at essentially a nexus point in 23 because we're actually still dealing and getting the benefit of content that we've delivered in the past, which represents a lot of poor and other content that we've released. And that's actually flowing through the P&L. At the same time, we've built and are launching a lot of new content in 23. Now, That content, including the movie in the latter part of the year, we have Vita the Vet, we have Unicorn Academy, that is really not going to be generating much licensing and merchandising or toy revenue until 24 and 25. So you have the impact of the distribution revenue and the amortization associated with that flowing through in the latter part of the year, which is actually margin dilutive. And then as that content builds in the marketplace, both toy and licensing and merchandising for Vida the Vet and Unicorn and the Paul movie actually kick in in 24 and beyond. So, you know, that's the dynamic that I've been talking to quite extensively now for some time in entertainment. And so we're going to see that really starting to shift a little bit in Q2 and Q3 and Q4 relative to what you saw in Q1.
spk11: Okay. And just I'd be remiss not to ask a quick question of Max on toy. I mean, you were very clear in regards to your positioning in terms of inventory and the nature of destocking, which we obviously heard from your peers last week in terms of working its way through the Q2. But can you talk at all about... some early signs of any replenishment activity from retailers? Because it does sound like you guys, maybe I'm being presumptuous, it sounds like you guys might have been a bit ahead of the game than your two peers in the context of the destocking exercise.
spk05: Yeah, I think we were the prettiest house in a not-so-good-looking neighborhood. And so, you know what I mean? So I think as we've gotten into the year, We have benefited from that, but the neighborhood is still pretty flooded. So I think as they work through that, we just have to continue to chug along and do our best. But I think the retailers have done a nice job of clearing the industry. And as that happens, we benefit. So that's where we are. Recall that there's a second component to the inventory, which is our own inventory. And I think we would have told you last time we were together that we did a terrific job managing that so that we can be in a position to then attack. And as we actually end the Q1, we are still in a great position to do that. So it's getting now very sophisticated as we go into the second half because we just have to basically get our, you know, showing the road, but I think we're in good shape.
spk13: Okay, I'll leave it there. Thank you very much.
spk06: Our next question comes from Luke Cannon from Canaccord Genuity. Please go ahead.
spk04: I just wanted to get a better sense of I appreciate that there was a lot of cost inflation in Q1 in the toy business. I'm just curious to know how much of a headwind that acted as in the quarter and how you see it progressing thus far into Q2, specifically any color on resins or other input costs as well as freight.
spk08: Yeah, so, Luke, we actually provided a lot of color on that in March, and I would say to you not a lot has changed on that front. The one call out was actually on ocean freight. We did see some tailwinds on ocean freight. Ocean freight rates came down from where they were in Q4, and we continue to see that trend for the balance of 2023. So we will get some tailwinds from that. I think not a lot of news on resin or electronic components or on paper and packaging. That was pretty much in line with what we said in March. And for the most part, we see tailwinds in our cogs, not headwinds in terms of increases.
spk04: Understood. And then switching gears here to Hatchimals, Max, you called out that we are going to be seeing some innovation towards the end of the year and beyond. I'm just curious to know how you guys are going to be approaching the sort of lifecycle management of this brand going forward, maybe areas where you're going to be a little bit deeper in relative to the last time where the brand was very successful.
spk05: Yeah, so as we... As we said in the prepared remarks, and let me go deeper for your question, we have now, we went through collectibles, right? And we're now getting ready to reset the shelf ahead of the Hatchimals Alive launch. And that's a really important launch for us. And that precedes us once again disrupting play with that brand in 24 and beyond. So we are basically going back to what the brand did so well and the magic that it brought to the category, including creating new play. And that's what you can expect from us without me, unfortunately, not being able to tell you a lot more in terms of what those innovations are. And hopefully you'll get to see those next time you come to the L.A. Shore Room in 2024. But I apologize that I can't go further, but you can expect that you'll see something potentially bigger than what you're seeing this coming fall.
spk04: Understood. Last one for me, and then I'll pass the line, Max, again, for you. You've given a bit of color in the past about performance by price point when it comes to your SKUs on shelf. I think you've called out those toys costing less than $10, those above $100, and then there's that big happy middle. You did also mention that for Cercana, there is a bit of softness when it comes to the amount of toys in the basket and the amount spent per toy. Curious to know how to reconcile all that together. Are you still seeing softness on either side of the spectrum or any trends to call out there?
spk05: Yeah, it's a great area and there has been some change. So the $70 plus bracket has declined. It has likely had the longest or the largest decline. The price compression on the 0 to 10 continues to be the case. What's happened differently is that we've seen more middle of the pack price points that have actually compressed this time. And we've seen, for example, toys that would have been 99 basically dipping because people are trying to get the inventories flushed. And those are now coming into the 59 to 79. And then, you know, that's driving a little bit of growth in that area. Or toys that would have been between 50 and 79 have been promoted deeply. So they've gone into another. And so that's what you're seeing. But by and large, There's an interplay in those middle price points, some declining, some increasing. And I will tell you that the noise in those results is strictly driven by promotions, not by new items that are doing super well. I hope that's clear.
spk04: It is. I appreciate it. Thank you.
spk06: Thank you. And our next question comes from John Zamparo from CIBC.
spk03: Thanks. Good morning. I wanted to get back to the inventory reduction process of retail partners and appreciate the color on what you've given so far. I think you'd said you're flat year over year at retail partners. I wonder where does that have to get to by the end of Q2 or where do your retail partners want it to get to on a year over year basis? And really the goal here is just to try to get a sense of how much more progress needs to be done in an attempt to do stock.
spk05: Sure. I think it varies by channel and it varies by customer, and we obviously won't get into what each customer wants to do. But I think there's a combination of customers wanting to get maybe a week of supply out of their system, others trying to get the fact that shipping lanes have gotten more efficient and getting working capital obviously shortened as well. And so when it all basically gets summarized, people are trying to get maybe a week or so out of the inventory. And so you have to, by virtue of that, be flat or lower. And that's what we're trying to get to. I would tell you that if I were to say in two out of three places, we see really positive signs already. So we're actually incredibly encouraged. There may be one or two pockets of issues that are basically working themselves out, and we can see clearly that they will be done by the end of the summer. And that's where we are. And it's a combination of continued promotions, a combination of, you know, basically people moving items into other places. The whole omni-commerce and omni-channel play has deepened. There's a lot more people coming to stores, so a lot more out-of-aisle placement for toys. So everyone's doing their job to try to get these things sorted. So that's what we're seeing.
spk03: Okay. That's helpful. Thank you for that. On the international business, Spin Master outperformed the industry on POS pretty meaningfully here, but you'd also mentioned that Europe hasn't seen the benefit from some of your Paw Patrol releases. So can you add some more color on what's driving international performance?
spk05: International is a really strong market for us. The market channel structure is a little bit different. You don't have concentration as you might in the U.S., And so we have a really experienced team in Europe that's doing a terrific job with our core brands. And we are gaining in the majority of the categories and brands where we play. So it's a bit of execution. And I just don't want to leave you with a, what does that mean? But there's a lot of blocking and tackling with our brands in Europe that doesn't just get determined by one or two large players. And so that's really encouraging. It allows for our know-how to be brought to the market and expressed into share gains. That's number one. Number two, we have been able to take our global properties and market them locally in a relevant way for that child and his or her family. So that's also working well for us. And last but not least, we do our inventory management and how we handle Europe differently than we do in the U.S., and that has also helped us. So we have a really good thing going in Europe. What I mentioned earlier about Paw Patrol specifically is just to demystify that. When we actually did the movie two years ago precisely, that movie would have actually launched. And in Europe, depending on the market, might have happened a little bit later. And so the Toys Trail, what it would have happened in the US, remember August 2021 was the movie year in the US. And so in Europe, the remaining stock that we had to clear in 22, basically pushing to 23. So Aqua Puffs and or Rubble would have not gotten to Europe on time. And those two things have done really well. So that's really what we're seeing. But We've seen a sequential improvement in Europe on Paw Patrol, just to not leave a concern on Paw in Europe.
spk03: All right, that's great. And then one last one back to the industry. The POS and Q1 was pretty soft overall industry-wide, most of that from the U.S., and I think you've made a comment, Max, that you don't expect that to be indicative of the full year. Correct me, but I think that was referring to the industry rather than solely Spin Master. So if that's the case, I wonder if you can elaborate a bit on that and what you attribute it to. Is it just an assumption of economic recovery and healthier spending among consumers, or is there something more in-depth to that?
spk05: No, I think the comments stand on parents bought less, spent less per purchase, and so that's a fact. And the spend less per purchase is also driven by the ASP, the average selling price, and all the inventory glut and how that has to get consumed. But I just want to give you some confidence that when you extract the two or three big things that drove whatever growth was in the market, right, whether it was squish mallows or strategic trading cards, the US POS is in line with, obviously, Spin Master's POS. So that's one fact. And so when you then take a look at that and then get into our properties... Paw Patrol in the U.S. did well. We've talked about it. It grew more than a single digit, which is positive. We actually have some really good things going. Gabby's Dollhouse is on fire still. So we're talking about double-digit growth. We're talking about strong double-digit growth a la Gabby's Dollhouse and Rubik's Cube. So we have that property on fire. We're talking about Monster Jam growing high single digit in the U.S., which is incredibly positive. So we have some of our core brands doing well, which give us confidence. Those lines have innovation in the back half too. And that's not to say that we have one or two pockets of opportunities that we're working through, but that's the color I want to just give you beyond what's on the remarks so that you understand from our position as we look to the fall, that's where the game is won or lost, and we are standing to gain, and we want to win.
spk13: All right, I'll leave it there. I appreciate the color. Thank you very much.
spk06: Thank you. And our next question comes from Brian Morrison from TD Securities. Please go ahead.
spk10: Thank you, Max. Can I just follow up on that POS question? So the relative POS, the way that I think of it is this is just really who had more hangover to clear rather than real market share gains. Is that correct? And then you would expect SpinMaster from a relative perspective to have a material reversion in the second half.
spk05: Yeah, I think that's a very fair way to put it, Brian. So I can comment further, but you've nailed it. So, you know, just look at the gross margins by players and how to invest more to clean up more. And they basically bought share, but they really bought share because they had to clean up, right? So if you look at our gross margin, our profitability, and we entered a year better, then we didn't have to do that. So that's a very logical conclusion on your part.
spk10: Okay. I want to go back to digital because of the opportunity there. But you mentioned the Paw Patrol app within the Sago subscription model, if I understood it correctly. So how should we think about this? Is this a monthly fee for parents? What is the price? And probably putting it in a spot, but from a high level, what's the impact this could have on your subscriber base? And can you confirm that it's a global movie launch for September 29th?
spk05: It is a global movie launch for September 29th. It's different than last movie because obviously we don't have knock on wood and we expect that to be the case in September, the lockdown conditions. So we are in a bit of a different place. And so that's just to set the record clear, it's different. Second, from an eyeball and getting this property exposed to more kids outside of network and TV or streaming TV. It is, right? As many parents are logically in digital spaces. So we would actually have the property brought to kids digitally as well. And we're basically utilizing the content of the Paw Patrol property to basically immerse kids in missions and what the actual property is really all about. And then having the kids experience, you know, getting in a car or doing... also doing that and also providing education as we go along. So it will be more about engagement, and there's obviously an opportunity to monetize. So there's all that going on. I think beyond that, what I would say is that Paw Patrol, the app, as it belongs in our sub-bundle, is an opportunity for those families to be exposed with one monthly fee to great content beyond Paw Patrol. And that's where Sego Mini... Endless Learning Academy, MacTango, and the list goes on, offer families this variety of play in a very convenient way. And we're very excited about that. And PAW, because of its notoriety and awareness, has the ability to bring new subscribers to our model. So the combination of all those things give us a lot of hope, as Mark expressed, on our subscription business for the back half. And those two coincide. The subscription bundle will kick off in September, and the PAW will be September 29th, and the PAW game will be in early October. So I think everything is converging around that time. I hope that answers your question.
spk10: Yeah, that's very good. Thanks very much, guys.
spk06: Thank you. And we'll take our next question from Sabahat Khan from RBC. Please go ahead.
spk02: Great. Thanks and good morning. I think, Max, earlier you mentioned there's a number of DC movies that are probably being released or that are being released later this year. Maybe can you talk about your expectation for those and any ones that you think could be maybe more of a meaningful contributor than others?
spk05: Sure. So we have The Flash coming up in June. That's the earlier one. We have one later in the summer, which is Blue Beetle, and that's basically late summer. early fall, and then we have Aquaman 2, which will be for Christmas. So December, late December. And as you know, we have all those story rights. The Flash is a huge push from Warner Brothers and has two strong Batman characters. So we actually have a lot of hope for The Flash. And so we're excited about that. And then Aquaman 2 is a sequel to the biggest DC movie ever. So there's a lot of strong toyetic appeal for that movie and connection to our toys. And so we're excited about everything, but those two, to your question, hold the largest opportunity for us.
spk02: And would that be part of your Q3 shift?
spk05: Yeah, so some of it is going to be shipping here in a month or so, and the other one will be shipping in Q3. And let's not forget, I think we, as we do that, also draft and then get Batman put into that bundle. And that's always going to be the biggest by far property we have from DC. So you can imagine that Batman will be a play as we do those two other properties. And we have great innovation on Batman for the back half. Recall, you may have seen that in LA. So think of DC as that effort by us drafting on those two movies.
spk02: Okay, great. And then just one quick one, maybe for Mark. Over the last year, I think you've indicated maybe a greater focus on M&A there, establishing sort of division leads for M&A. Is there any sort of progress update there, how the pipeline is looking and your willingness to transact, just given all that's happening in the backdrop right now?
spk08: Good morning, Sab. I would say our willingness to transact is high. We're actually seeing a fair bit of activity in all of our creative centers from an M&A perspective. The teams are working well. generating a lot of leads. We have not done any M&A in entertainment yet, but I suspect that we will at some point in the near future. And then in the toy area, we'll continue to look at both tuck-ins and larger deals as well. There's activities, ongoing activity across all of these areas. And we have seen valuations become a little bit more reasonable, a little more moderate than they were in the past, particularly as interest rates have gone up and stayed high. So we are confident in our strategy, and our team is working very well, Saba.
spk02: Great. Thanks very much for that.
spk06: Thank you very much. And our next question comes from Garrick Johnson from BMO Capital Markets. Please go ahead.
spk07: Hey, good morning. Thank you. I wanted to get back to the subject that Adam was talking about, lumpiness in entertainment. You know, in the quarter, you beat us by a significant amount in entertainment as a majority of the beat. I mean, you beat us on a lot of metrics, but that was the biggest beat. And, you know, honestly, it's how do we know how to manage our expectations, or I should say, how do we know what we should build in for things like rubble and crew, the distribution revenue, what kind of tail does it have? So, Maybe just some sort of help in how we look at these entertainment properties, like Vita, the vet, when it comes on, what kind of upfront distribution revenue do you get and what kind of tail do you get and how do we account for that?
spk08: So, Garrick, again, this is a conversation that we can continue in more detail offline in terms of how it all works from an accounting perspective. But in general, the way it works in entertainment is that When the show is developed and we launch it, we actually recognize distribution revenue that we get from our distribution partners. That's our initial partners and then our second window distribution as we extend distribution around the world. That is what gets recognized upon delivery. And then the amortization is essentially the cost of goods sold against that distribution revenue. And we've actually provided the amortization on that. And Sophia can actually give you more details insights into how that hits COGS and SG&A because amortization does hit different pieces of the P&L. So we're happy to explain that more. But in general, Geric, the thesis is that you have relatively low margin distribution revenue as you launch the property. And then as the property becomes more established, you launch your toy line, you launch your licensing and merchandising program, typically within 12 months of the entertainment launch. And then you start developing that creative center revenue across the board. With Unicorn Academy, for the first time, we're actually doing a digital game as well. So we'll have distribution revenue when we launch Unicorn in 23. We'll have toy revenue in 24. And we'll have digital games revenue in 24 because we're doing that across all three creative centers, which we're very excited about. But that's generally the thesis. of how it works. Okay. And we're happy to spend more time offline with you on that. It is a big part of our financial model.
spk07: Yeah. I guess you're suggesting we can back into what the revenue is based on the amortization that you guys just provided. Yeah, you got it. Okay. All right. Let's all head. Thank you.
spk13: Thank you.
spk06: And we'll go to our last question from David McFadden from CoreMarket Securities. Please go ahead.
spk09: grown quite a bit, and I'm just kind of wondering of the magnitude. I know you don't like to give out revenue on a per-property basis, but I was just wondering if you can give us sort of relative size. How would it compare to State Paw Patrol right now?
spk08: Sorry, David. We heard you kind of cut out at the beginning. What property were you referring to in the first part of your question? Could you just repeat that?
spk09: Yeah, sorry. I'm sorry about that. Gabby's Dollhouse, you know, that property has experience quite large growth. And I'm just wondering how that property would compare in terms of revenue if you compared it with Paw Patrol.
spk08: Well, look, we can't give specific revenue. We don't typically do that. I mean, we have in the past talked about Paw Patrol being around 20% to 25% of our sales as the number one property in the whole company. But look, Gabby's is meaningful. And it's certainly growing, as Max alluded to, with the international launch, which we're very excited about as well. But we can't be specific. All I will say to you is that it's meaningful and it's high margin for us. And it's great content as well. So it's driving some good business for us in the preschool area.
spk09: Okay. I mean, you can't give any indication as to... 25% a pod, 50% a pod, just anything like that?
spk08: Typically, since we've been public, we've never given out individual product line revenue, so we can't start with that, fortunately. Okay. All right. Thank you.
spk06: Thank you. And I'll now turn it back to our speakers for any closing remarks.
spk08: Well, thank you, everyone. Appreciate your attendance and interest in Spin Master, and we look forward to talking to you again for our Q2 results in early August. Thanks, and have a good day.
spk06: Thank you. Ladies and gentlemen, that does conclude today's conference. We appreciate your participation, and have a wonderful day.

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