Spin Master Corp.

Good day and welcome to the Spin Master Corporation's second quarter 2023 results call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Sophia Basoukas. Please go ahead, ma'am.

Thank you, Chris, and good morning. Welcome to Spin Master's financial results conference call for the second quarter ended June 30th, 2023. I'm joined this morning by Mark Siegel, Spin Master's Chief Financial Officer, and Renan Harari, Chair and Co-Founder. Max Rangel, our global president and CEO, will unfortunately not be able to join our call today. We are saddened to share he has experienced a loss in his family as his father has passed away. Our thoughts and prayers are with Max and his family during this time. For your convenience, the press release, MD&A, and interim consolidated financial statements are available on the investor relations section of our website at spinmaster.com and on CDAR. Before we begin, please note, The remarks on this conference call may contain forward-looking statements about Spin Master's current and future plans, expectations, intentions, results, level of activity, performance goals or achievements, and any other future events or developments. Forward-looking statements are based on 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 certain estimates or assumptions will prove to be correct. Many factors could cause actual results to differ materially from these expected or implied by the forward-looking statements. As a result, SPIN Master 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 see our cautionary statements regarding forward-looking information in our earnings release dated August 2nd, 2023. And please note that Spin Master reports in U.S. dollars and all dollar amounts will be expressed today in U.S. currency unless otherwise noted. I would now like to turn the call over to Mark.

Good morning, everyone, and thank you for joining us. As Sophia mentioned, we're sorry to miss Max today, with the passing of his dad yesterday, but we are happy to have Renan join us today. I'm going to read the script, and then Renan and I will do the question and answer session. We are pleased to have delivered a solid second quarter, which was in line with expectations, despite last year's unusually front-end loaded shipping patterns. Our results reflect our commitment to building three thriving creative centers and investing in long-term growth. Together with a winning combination of toys, entertainment, and digital games, we are expanding our reach and providing kids and families around the world with magical experiences by reimagining everyday play. As expected, toy gross product sales in Q2 were challenged by the clearance activity of carryover inventory at retail, particularly in the U.S. These higher inventory levels caused retailers to slow orders in the first half of this year. resulting in Q2 revenue declining 20.9% in comparison to Q2 22. Retailer inventory clearance activities have now been concluded. The clearing of retail channels creates a pathway for new items to be launched for the holiday season. From a Spin Master perspective, our US retail inventory at the end of Q2 was down 17% over last year as of the end of Q2. Last quarter, We spoke about the expected softening of the toy industry in 23, specifically in the U.S., a region that has traditionally held up well during tougher economic periods. Global toy POS in Q2 declined 10%, and we trailed the market with a decline of 17% per second. As in Q1, most of our POS decline in Q2 occurred in the U.S., where POS declined 22% compared to the industry, which was down 12.4%. We are, however, encouraged that POS declines have begun to slow, and in late June and in July, we have started to see growth reemerge. For example, we had very strong results in the US for Amazon Prime Day, with POS well ahead of our expectations and ahead of market growth. Our Prime Day performance increased 130% year-over-year and is at an all-time high. Internationally, our POS declined 4.6% in Q2, outperforming the total industry, which was down 6.4% per Sukana. This result was in part due to less inventory clearance within Europe. On a year-to-date basis, we have gained share in over half of the countries in the G10, according to Sukana. The preschool category continues to be a key area of strength for SpinMaster, led by Paw Patrol, our leading preschool franchise, which is celebrating its 10th anniversary this year. In Q2, Paw Patrol was the number one preschool toy property globally and has held that position since Q1 of 2020 per Sukana. In Q2, we had three of the top 10 items within the infant-toddler preschool category in the U.S. per Sukana. Gabby's Dollhouse Perfect Playset was number four, Paw Patrol Aquapups was number five, and the Paw Patrol Big Truck Pups was number nine. In Q2, our global POS for Paw Patrol declined approximately 10% per sacana. In Q2, our U.S. POS for Paw Patrol was down slightly per sacana. However, in the U.S. on a year-to-date basis, Paw Patrol grew low single digits in the infant, toddler, and preschool category. We are optimistic for the toy line in the second half, coinciding with the release of our second feature film for the franchise on September 29th. We expect the second Paul movie to have a similar halo effect on the brand's performance as it did in 2021. Gabi's Dollhouse continues to produce incredible results, having built a strong consumer fan base around the world through the Netflix show and its robust digital ecosystem. First Encounter Gabby's Dollhouse was the number five preschool toy property globally in Q2, compared to number nine in Q2 of 22, and was a top 10 property in preschool toys for the sixth straight quarter. Within Dolls and Interactive, we are very excited about the launch of Hatchimals Alive beginning this August, which will give kids a whole new way to hatch using water to bring these characters to life. The price point of this line lends itself well to parents seeking value during the holiday season. As many of you have seen, we have another exciting launch within the dolls and interactive category this fall. Bitsy, the digital pet you can touch, embodies the best of our innovation and leverages our brilliance in creating engaging interactive toys. While the product only just set in the US on August the 1st, we are seeing early signs of very strong performance. Initial launches in China, Japan, Spain, and Portugal have shown strong reaction and very positive sell-through results, and Bitsy is already nominated for a number of industry awards. We have several strong properties within our wheels and action category, including Monster Jam, Bakugan, DC, and Tech Deck notably. Bakugan became the number one property in the battling toy category globally on a year-to-date basis, compared to number two last year, according to Sukarno. We are excited to reinvigorate the brand this fall with a new season of our anime adventure series hitting Netflix beginning September 1st, featuring a revamped anime style and a fresh storyline and new characters. The new season will first be revealed in Roblox, given our past success with leveraging the metaverse to reach kids, and will be complemented by a new toy line with an enhanced way for players to battle. Spin Master became the number one manufacturer for the DC Universe globally, up from number two in Q2 of 22, according to Sakana. As we have mentioned previously, the DC Universe continues to bring new films to fans throughout 23 and through to 26, which will have a halo impact on our toy lines. Within games, Rubik's Cube continues to grow. Rubik's was up 16.9% year over year, and was the number seven brand, according to Sukana. While recognizing that the first half of the year has been challenging from a comparison perspective, we have strong confidence in our diverse toy portfolio moving into the fall. Infused with our signature innovation, popular franchise items, and evergreen staples at solid price points, we believe we are in a good position to succeed. We expect that consumers will be looking to purchase at more modest price points, and we'll be shopping even later in the season, given that Christmas falls on a Monday this year. We have created robust marketing plans that cater to the current consumer and marketplace realities. Our paid media activities are in line to key tentpoles, retail activations, and promotional activity, and we have ensured maximum flexibility to remain agile in our targeted marketing campaigns to meet the consumer where and when they shop. Turning to entertainment, we had another strong quarter with revenue increasing by over 19%, driven by higher distribution revenue. Previously, we shared that we have launched or are launching three brand new entertainment properties in 2023, Rubble and Crew, Vida the Vet, and Unicorn Academy. Vida, which is a new animated preschool series, is set to debut on BBC's CBeebies in the UK and on Chorus' Treehouse in Canada this fall. Since we last spoke, we have signed close to 10 new international distribution deals for Vida, including the U.S. We are also approaching the launch of Unicorn Academy, a new fantasy adventure series that will start streaming on Netflix globally in November. The full franchise marketing plan will begin in September as we preview the content via Roblox, start paid media, and execute our influencer and YouTube content strategy. We have already made tremendous progress on building our licensed consumer product program, signing several licenses within fashion, publishing, bedding, sleepwear, health and beauty, and accessories. We are aligning our franchise marketing efforts to regions where Netflix has the deepest reach. Additionally, our digital games team is currently developing the Unicorn Academy Mobile Action Adventure digital game that encapsulates the magic of the series and expands overall engagement in the franchise. Earlier this year, we introduced our first spinoff for Paw Patrol, Rubble and Crew. I'm pleased to share that Rubble and Crew continues to be a top performing series on Nickelodeon. The show debuted very strongly and has maintained a leadership position as a top 10 series on Nick Jr. with kids two to five. Given its impressive showing in its inaugural season, Nickelodeon has greenlit a second season for Rubble and Crew. Our original Paw Patrol series also continues to perform well, ranking in the number one spot on Nick Jr. in May and has been greenlit for its 11th season. Of course, we are approaching the release of our highly anticipated second feature film, Paw Patrol The Mighty Movie, set for theatrical debut on September 29th. in association with Nickelodeon movies and Paramount Pictures. The trailer was released on YouTube in June and has accumulated more than 70 million global views already. Finally, within digital games, total revenue increased slightly over 2022, driven by higher in-app purchases in Toka Life World. This is the first year-over-year quarterly increase we've seen in digital games since Q2 of last year. This was driven by new content releases, including the launch of our second licensed theme pack with SpongeBob and higher engagement with monthly active users up 3% year over year to 58 million. We now have 76 million monthly active users across the Toka Boka ecosystem. We think the fan community within Toka will be super excited with Toka Days, our first 3D player multi-game, which is currently in soft launch. Toka Days will allow the opportunity for open-ended play and creativity, coupled with the ability for social interactions between players. Player sentiment so far has been high. Based on the initial feedback and learnings, the team is making continuous improvements to ready for a full go live in 2024. We are launching a Paw Patrol app, Paw Patrol Academy this fall, to coincide with the movie. This will be our first in-house developed Paw Patrol app focused on integrating show content with fun learning experiences and missions for preschoolers. Our new Rubik's Cube casual game, officially known as Rubik's Match, will have its worldwide release in early 24 in line with the Cube's 50th anniversary. With the continued popularity of Rubik's as a physical toy, We believe this mobile digital game will resonate with fans, young and old, and will attract new gamers to the brand. We've previously discussed Seigo Mini's plans for a subscription bundle that will launch later this month, branded as Picnic. This comprehensive bundle of apps will include thousands of top-rated activities created by parents, child development experts, and kids. Technic will provide unlimited access to all the Sago Mini properties, as well as Toka Boka Jr. apps, a new collection of fan-favorite apps like Toka Pet Doctor, Toka Kitchen, as well as the endless learning apps, including Math Tango. At just $11.99 a month, parents will have access to the very best touchscreen content with one single membership at significant savings. Leveraging our IP across our creative centers is core to our strategy, and we are excited about the opportunities for growth stemming from the initiatives underway in and across each of our creative centers. Turning now to our financial performance in more detail, as I mentioned, total revenue in Q2 was 420.7. Against challenging year-over-year comparatives, This reflects a 17% decline in revenue compared to Q2 2022. This decline can be primarily attributed to the return of traditional seasonal order timing in our Toys Creative Center. As a reminder, in May, we discussed how the toy industry in the first half of 2023 felt the impact of retailer clearance activity after ending 2022 with significant inventory carryover. Comparisons from the first half of 23 to the first half of 22 look especially unfavorable, since we had unusually high sales in Q2 last year, as retailers brought inventory in much earlier than normal to avoid anticipated supply chain disruptions. On top of this, our toy sales in H1-22 were inflated by the DC Comics Batman movie launch, and we were still shipping in Russian. Outside of the top-line performance, we continue to develop consistent operational and financial results, achieving a strong earning and margin profile, with EBITDA at over $88 million for the quarter at a 21% margin. Looking at Q2 performance by Creative Center, toy gross product sales were $390 million, down 19.5%. Foreign exchange did not have a material impact, and on a constant currency basis, GPS declined 20%. Geographically in Q2, North America was responsible for the decline, both in dollars and percentage terms, as the trends discussed earlier were more pronounced in the US. Preschool and dolls and interactive declined 20.8%, primarily from a drop in sales of Paw Patrol, Hatchimals, Wizarding World, and Perspets, partially offset by an increase in Bitsy, Rubble and Crew, and Gabby's Dollhouse. Activities, Games and Puzzles, and Plush was down 24.4%, mainly due to a decrease in the Games and Puzzles portfolio and Kinetic Sand. Wheels in Action dropped 12.8%, driven by a decline in DC and Bakugan. Outdoor was down 11.7%. Q2 sales allowances were 11.2% as a percent of gross product sales, compared to 9.7%. a solid result considering the broader retail environment we were operating in. Due to adjusted EBITDA for toys was 47.7 million compared to 83.2 million at 13.8% margin compared to 19%. The primary factor behind the lower EBITDA margin was the deleveraging effect of the reduction in toy revenue relative to administrative marketing and distribution expenses. In Q2, entertainment revenue increased $5.5 million or 19.4% to $33.9 million from primarily higher distribution revenue from the first Paw Patrol movie, as well as new content deliveries of Vida the Vet, Rubble and Crew, and Unicorn Academy. These increases were offset by lower licensing and merchandising revenue. Adjusted operating income was $16.3 million, down 9.4%. and adjusted operating margin was 48.1% compared to 63.4%. The decrease in entertainment profitability was driven by higher amortization of content production costs and lower licensing and merchandising revenue as a percentage of total entertainment revenue. Due to revenue, digital games were slightly higher at 40.5 million compared to last year. This was a strong result for digital games as mobile gaming in Q1 and Q2-22 continued to benefit from COVID factors. Token Life World was particularly strong in Q2 this year. Digital games adjusted operating margin in Q2 was 31.6%, up from 24.8% because of lower marketing spending. Overall Q2 consolidated gross margin was 54.9%, down from 56% because of lower entertainment licensing and merchandising revenue. Higher amortization of entertainment content and higher sales allowances as a percentage of toy GPS, partially offset by favorable toy product mix. Consistent with the deleveraging we saw in Q1, SG&A in dollars was down year over year, but higher as a percentage of revenue. SG&A was $179.5 million, representing 42.7% of consolidated revenue, compared to $192.4 million, or 37.6%. Marketing costs were down $4 million, at 7.3% of revenue, compared to 6.9%. Administrative expenses were flat, with lower incentive compensation, personnel, and consulting costs offset by higher restructuring costs. We continued executing on our plan to close our last remaining manufacturing facility in Calais, France, which we inherited in 2013 with the acquisition of McKenna. As a result, we booked a restructuring charge of $9.7 million in Q2, which is included in administrative costs. Adjusted SG&A was $163.5 million, or 38.9% of consolidated revenue, compared to $181 million, or 35.7%. In Q2, net income was $28 million or $0.26 per diluted share compared to net income of $88.1 million or $0.83 per diluted share. Adjusted net income in the quarter was $48.8 million or $0.45 per diluted share compared to $72.4 million or $0.68 per diluted share. Adjusted EBITDA was $88.4 million compared to $113.7 million. Adjusted EBITDA margin was 21%, down slightly from 22.5% from lower operating leverage. Turning to the balance sheet, our on-hand inventory at the end of Q2 was in very good shape, at just over $150 million, down $34 million compared to $184 million last year. We ended Q2 with $554.9 million cash, down $89 million from $644 million at the year end. Free cash flow in Q2 was negative $5.9 million compared to positive $84.1 million, primarily from low operating cash flow. Free cash flow was in line with our normal seasonality, where we consume cash in H1 as we build towards our seasonal peak and then generate most of our free cash flow later in the second half each year. 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 top priorities. In addition, we continue to look at all avenues to maximize total shareholder value. In Q2, we repurchased 156,200 shares for 4.2 million, bringing the total to 397,700 shares year-to-date. We will continue to use the NCIB opportunistically and believe that, Together with the dividend, this represents a prudent use of capital and an important part of our efforts to create value for shareholders. Turning to our outlook, 2023 has played out as we expected so far, and we are pleased to confirm our guidance for the full year. We should recognize that this is a unique macro environment, and that makes forecasting a challenge. But despite this macro backdrop, we are confident in our innovation, the strength of our entertainment and digital games content, and new toy launches planned. We continue to expect the 2023 toy gross product sales to be flat to slightly down compared to 22. In 22, 45% of our gross product sales occurred in H1 compared to historical seasonality of 30% to 35%, which created a difficult H1 comparative for us. This headwind will act as a tailwind in H2, especially in Q4, as the reversion to traditional seasonality combined with a jam-packed toy entertainment and games release schedule works in our favor. We expect sales allowances of approximately 13% for 2023, higher than our normal range of 10-12%. This will allow us to ensure we meet our sell-through and year-end inventory targets but will not negatively impact gross margins due to strong cost control measures and productivity within our supply chain. We are maintaining our expectations for 2023 revenue to be in line with 2022, excluding the $17 million Paw Patrol The Mighty Movie distribution revenue expected in Q3. For the year, foreign currency translation is expected to provide a slight tailwind on revenue based on current market rates. We are maintaining 2023 adjusted EBITDA margin guidance, which should be flat to slightly above 2022, excluding the 17 million Paw Patrol Mighty Movie distribution revenue. As a reminder, total depreciation and amortization is expected to increase from 68 million in 2022 to just under 145 million in 2023, primarily from more deliveries of entertainment content. From a phasing perspective, DNA will be approximately $47 million in Q3 and $55 million in Q4. Our capital expenditures are now expected to be 6% of revenue, down from 7% we communicated earlier this year. We continue to invest in entertainment and digital games content, and this change is simply a timing shift between 23 and 24 for certain entertainment and digital games content. Later this month, Some of you will be joining us in Stockholm, Sweden for a deeper dive into the incredible work taking place within our Digital Games Creative Center. The purpose of our trip is to highlight in more detail the incredible development that the teams have done in the lead up to the launch of several new digital games. We know it's a big investment, but for those of you not yet signed up who may be interested, please contact myself or Sophia. To conclude, we will continue to leverage our integrated Creative Center platforms to generate above-industry growth in the medium to long term, and to leverage our IP, scale, and talent across our creative centers. Combined with a strong balance sheet, we intend 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.