Spin Master Q3 2024 Earnings Call Transcript

Quartr
Provided by Quartr
October 31, 2024

There are 11 speakers on the call.

Operator

Good morning, ladies and gentlemen, and welcome to the Spin Master Corp Third Quarter 20 24 Results Conference Call. At this time, all lines are in a listen only mode. Following the presentation, we will conduct a question and answer session. This call is being recorded on Thursday, October 31, 2024. I would now like to turn the conference over to Sofia Bisoukis.

Operator

Please go ahead.

Speaker 1

Thank you, and good morning. Welcome to Spin Master's financial results conference call for the Q3 of 2024. I'm 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 and A and interim consolidated financial statements are available on the Investor Relations section of our website at spinmaster.com and on SEDAR Plus. 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, level of activity, performance goals or achievements and any other future events or developments.

Speaker 1

Forward looking statements are based on information currently available to management and on estimates and assumptions made 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 those expected or implied by the forward looking statements. As a result, Spin Master cannot guarantee 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.

Speaker 1

For additional info on these assumptions and risks, please consult our cautionary statements regarding forward looking information in our earnings release dated October 30, 2024. Please note that Spin Master reports in U. S. Dollars and all other amounts to lead today are expressed in U. S.

Speaker 1

Currency unless otherwise noted. I would like to turn the call over to Max.

Speaker 2

Good morning. Thank you for joining us. We are pleased with our 3rd quarter results, increasing our total revenue by 25% driven by a strong performance in both Speedmaster's Toy Creative Center and Melissa and Doug. We generated sales growth across major markets reflecting our continued commitment to creating innovative products, powerful global brands and magical play experiences. Both entertainment and digital games revenue declined this quarter.

Speaker 2

In entertainment, we were lapping distribution revenue from the highly successful Ah! Movie launch last year. In digital games, we saw lower in game purchases within Toca Boca World. We will get into this later in the call. Excluding Melissa and Doug, the toy creative center had a strong quarter with gross product sales just up over 9%.

Speaker 2

Much of our growth is due to the strong customer support for innovation in our portfolio including the new Hatchimals Big Egg, Unicorn Academy, Disney Bitsy, the Hexbot Gecko and Miss Rachel. Many of these toys have landed on retailers most wanted toy lists for the holidays. Bliss and Duck grew gross product sales double digits for the 2nd consecutive quarter. Bliss and Duck's results demonstrate the strength of the brand not only for evergreen items, but also for new products such as Sticker Wow and Blockables. According to SIR Canada data, Speedmaster's POS excluding Melissa and Doug was down 1.3% in line with the G11 toy market and a significant improvement compared to the first half.

Speaker 2

We saw very positive POS for Millicentog in the quarter with growth of 7.4% versus Turkana. Millicentog saw strong POS during Amazon Prime Day and week with growth over more than 30% compared to 2023. Adding in ListenDocs POS, we ended Q3 up 23.3% globally. We maintained our position as a number 4 corporate manufacturer in the quarter. The highly anticipated Miss Rachel toy line has been an instant sensation exceeding our expectations.

Speaker 2

For Sarcana, Ms. Rachel was a number one new license in the U. S. Toy industry in Q3 and this is incredible. Considering these results only reflect online pre sales and one day of fully set product at retail.

Speaker 2

Walmart shared with us that Ms. Rachel was the most successful presale for any toy line in their history. Ms. Rachel marks the first collaboration between Spin Master and Melissa and Doug, where our team jointly developed a product line. The future looks really bright for Ms.

Speaker 2

Rachel in 2025. The combination of Spin Master and Melissa and Doug has made us a powerful player in the infant, toddler and preschool category. In the U. S. In September, for Surcana, we claimed 6 of the top 10 fastest selling new toys in the category, including 3 PAW Patrol and 3 Ms.

Speaker 2

Rachel items. As expected PAW Patrol POS was down 4.1% in the quarter as we are comparing against the movie line in Q3 last year. We have a robust Q4 global marketing campaign to support the entire PAW franchise, which is helping to drive purchase intent for the holidays. The results thus far have been very positive. As I mentioned, we saw really positive Melissa and Doug POS growth of 7.4% in the quarter.

Speaker 2

In the U. S, Melissa and Dog was also the top growing toy property in the quarter, in the 4 weeks ending October 12 and has solid momentum going into the holidays. The Melissa and Dog integration is going well and we have achieved several significant milestones on our journey to bring our 2 companies together. Earlier this year, we prioritized increasing Melissa and Doug's presence in Canada and Mexico, utilizing our footprint and customer relationships and are already seeing positive revenue growth. We recently announced our plans to accelerate distribution for the Melissa and Doug line internationally by leveraging our global footprint combined with Melissa and Doug's e commerce excellence.

Speaker 2

Within vehicles, Monster Jam continues to demonstrate outstanding performance, growing POS by 16.5% globally in the quarter and outperforming the category versus Arcana. In activities, Kinetic Sand had a very strong quarter with POS growing 19% compared to a decline of 3.6% in the arts and craft category for Surcana. Within dolls, Unicorn Academy is a completely new entry for us in a category where we have traditionally been challenged to compete. In Q3, Unicorn Academy Small Dolls and Unicorn assortment was a top 10 new item in the category and top 3 in the places, dolls and collectibles class in the U. S.

Speaker 2

Versus Surcana. As expected, entertainment revenue declined in Q3 as we were lapping revenue from the PAW movie launch in Q3 last year. PAW Patrol continues to be one of the top preschool shows globally, but we aren't taking our success for granted. We are continuing to produce content created specifically for YouTube, including 2 short form series, which are performing very well in terms of views and click through rates. In 2025, we are partnering with Nickelodeon and Paramount to launch a global franchise marketing campaign to ensure that PAW Patrol maintains its decade long run as a top preschool property globally.

Speaker 2

Unicorn Academy is a great showcase of how we are creating new IP. The franchise has exceeded our goals including awareness and the property reached 132,000,000 gross viewing minutes in Q3. This quarter, we announced Netflix as Greenlit Season 2, picking up an additional 16 episodes, which will debut in 2026. Unicorn Academy will have batch releases on Netflix for the next few years as well as complimentary short form digital content on YouTube and TikTok. We are disappointed in our performance in digital games this quarter, primarily due to the lower in app purchases within Toca Boca World.

Speaker 2

After coming off high engagement levels at the end of Q2, we saw weakness in Q3 with revenue down 16.8 percent and Q3 average monthly active users at 57,000,000 versus 60,000,000 last year. We believe that free content in competitive products has given players less reason to spend and lower in game purchases are driving revenue decline. Encouragingly, those consumers that are spending are spending at a slightly higher level than last year. We remain confident that we will get TOKA BOKA World back on track. Our team in Stockholm has been focusing on improving speed of delivery, including new features, brand collaborations and community activations that will make the content more appealing, especially to first time users and improve shop awareness to drive free versus paid conversion.

Speaker 2

While we are seeing some short term challenges, we just crossed a significant milestone of 1,000,000,000 downloads for Toca Boca World, a huge achievement for the Toca Boca Studio. Toca Boca World continues to be by a significant margin, the leader on premium and paid kids digital mobile game content. Our picnic subscription bundle grew subscribers and revenue in the quarter. In total, SEGO Mini grew subscribers by 25 percent from 340,000 last year to 434,000 this year. In Q1 2025, we will introduce the Poa Academy Gaming to Picnic, driving further value for the bundle.

Speaker 2

Poa Academy also increased subscriptions in the quarter and celebrated its 1 year global launch anniversary. Engagement metrics remain high and global play minutes grew sequentially. We released Rubik's Match globally mid September. We are now driving user acquisition and continue to adjust the play experience to adapt to consumer behavior within the game environment. Although broader economic conditions remain a challenge, we are seeing the consumer gaining confidence heading into the holiday season.

Speaker 2

We expect the timing of spending in the U. S. To be influenced by the U. S. Election and a shorter shopping period between U.

Speaker 2

S. Thanksgiving and Christmas, driving purchases later in the season. We have lined up the majority of our marketing to focus on when consumer intent is at its highest point within that window. Looking forward, we are reiterating our 2024 guidance and have continued confidence in the strength of our 3 creative centers and diversified portfolio. We are excited about our prospects for 2025.

Speaker 2

In toys, we have industry leading disruptive innovation coming in our line combined with new licenses including Ms. Rachel and Dora the Explorer as well as toys for theatrical releases including Superman, How to Train Your Dragon and the first feature film for Gabbi's Dollhouse. In digital games, we expect that our investments in game development to gain further traction to drive incremental revenue and expand our player ecosystem. We firmly believe we are well positioned to continue to grow market share through the execution of our long term strategy and focus on reimagining everyday play. With that, I will now turn it over to Mark.

Speaker 3

Thank you, Max, and good morning, everyone. We are pleased to report that our Q3 financial results were in line with our expectations and we are reiterating our full year 2024 guidance. This quarter illustrates the power of our diversified creative centers. Our Q3 revenue grew 25 percent to $886,000,000 including Melissa and Doug. Excluding Melissa and Doug, revenue increased 3% driven by growth in toys, which more than offset the decline in entertainment as we lapped last year's poor movie distribution revenue and the decline in digital games revenue.

Speaker 3

Adjusted EBITDA for Q3 was $277,500,000 with a 31.3 percent margin, including $49,400,000 for Miller Sur and DUG. Adjusted EBITDA, excluding Miller Sur and DUG was $228,100,000 compared to $234,900,000 a decline of $6,800,000 Adjusted EBITDA margin excluding Melissa and Doug was 31.2% compared to 33.1%. However, recall that Q3 last year included the accretive impact of the poor movie distribution revenue of $15,600,000 On an apples to apples basis, excluding both the movie distribution revenue and Melissa and Doug, adjusted EBITDA grew by $8,800,000 The increase was driven by higher toy revenue, partially offset by a decline in digital games profitability. Adjusted EBITDA margin excluding both Melissa and Doug and the Paul movie decreased by 40 basis points due to a mix shift with a higher proportion of adjusted EBITDA contributed by toys and the lower proportion by digital games. Q3 gross profit increased $82,400,000 to $469,300,000 Gross margin declined to 53% from 54.5%, primarily due to the impact of the Melissa and Doug inventory fair market value adjustment.

Speaker 3

As a reminder, as part of the acquisition of Melissa and Doug, we acquired just under $180,000,000 of inventory, of which approximately $66,000,000 relates to a required fair market value step up adjustment, representing the difference between inventory costs and net realizable value. As this inventory is sold, the fair market value increment is recognized in COGS. In Q3, the inventory fair market value adjustments included in toy COGS was $21,500,000 $66,300,000 year to date, which means it is now fully recognized and we will no longer reflect this impact to gross margin from Q4 onwards. Adjusted gross profit, which removes the Millicentig inventory fair market value increment increased by $103,900,000 to $490,800,000 due to higher contributions from toys, including Millicentig. Adjusted gross margin was 55.4%, up 90 basis points from 54.5%, mainly due to the accretive effect of fewer content deliveries in the current quarter.

Speaker 3

As a reminder, content deliveries are gross margin dilutive because of the amortization triggered by the delivery of the content. Let's review each Creative Center's performance in a little more detail. Toy gross product sales in Q3 were up 36%, including Melissa and Doug. Excluding Melissa and Doug, toy gross product sales grew $61,800,000 or 9.1%, including $30,000,000 of custom orders, which shifted from Q2. We recorded initial shipments from our Miss Rachel lineup in the quarter.

Speaker 3

As Max said, we are thrilled with the Miss Rachel line and retailers have responded very positively. Melissa and Doug delivered toy gross product sales of $182,000,000 a double digit growth rate of the same quarter in 2023. September was Melissa and Doug's 2nd best month in total invoice sales in their history. In total, preschool, infant and toddler and plush gross product sales were up 55.8% with a positive impact including Melissa and Doug offset by declines in PAW Patrol, Gabby's Dollhouse and Firebirds. Activities, games and puzzles and dolls and interactive grew 75,800,000 or 34.7%, led by increases in Hatchimals, Bitsy's and Unicorn Academy, offset by a decline in Games and Puzzles.

Speaker 3

Wheels in Action increased by $1,700,000 or 1.1%, mainly due to Monster Jam and Hexbug, offset by declines in Bakugan, DC and Tech Deck. Sales allowances in Q3 were 12.2% of toy gross product sales, up from 11.4% as we continue to invest in Melissa and Doug retail trade promotions. Excluding Melissa and Doug, sales allowances remained flat to 2023. Adjusted EBITDA in Q3 for toys was $242,200,000 or 29.9 percent margin compared to 27.7%. The increase in margin was driven by organic revenue growth, the inclusion of Melissa and Doug and the resulting higher operating leverage.

Speaker 3

Turning to entertainment, revenue declined by $26,300,000 or 41.5 percent as we lapped content deliveries for the PAW movie and the initial deliveries of Unicorn Academy. However, adjusted operating income decreased by only $3,100,000 to $20,900,000 and adjusted operating margin increased to 56.3% from 37.9% due to the margin accretive effect of fewer content deliveries and more licensing and merchandising revenue as part of the overall revenue mix this quarter. Revenue in our digital games creative center declined by $7,600,000 to $37,700,000 While monthly active users in Tocoboku World and subscribers to Picnic and Paw Patrol Academy grew sequentially, in game spending in Tocoboku World declined. We are encouraged that engagement levels in Toca Boca World remain high. The number of average monthly users for Toca Boca World for Q3 was just under 58,000,000 up approximately 1,000,000 sequentially.

Speaker 3

Subscriptions at SAGO Mini for the picnic bundle and other apps were $434,000 an increase of 25% compared to last year and up 2% sequentially. Adjusted operating profit declined 53% to $7,300,000 and adjusted operating margin was 19.4% compared to 34.2%. This was driven by the decline in in game spending as well as high user acquisition costs for Rubik's Match, PAW Patrol Academy and the Picnic Bundle. Looking forward to Q4, we have a large amount of fresh content planned in Tocoboku World and a growing recurring revenue base in our subscriptions business. Turning back to consolidated results, adjusted SG and A increased by $39,500,000 or 20.7 percent to $230,500,000 As a percentage of revenue, adjusted SG and A was down 90 basis points to 26 percent from 26.9%, primarily from operating leverage due to the seasonality of Melissa and Doug's revenue profile.

Speaker 3

Adjusted net income was $169,700,000 or $1.60 per share fully diluted compared to adjusted net income of $143,600,000 or $1.34 per share fully diluted last year. We are executing our capital allocation plan to create shareholder value. We are generating free cash flow to reinvest in growth initiatives, returning cash to shareholders and strengthening our balance sheet. We are continuing to manage inventory levels tightly. Overall inventory is up 72% due to the inclusion of Melissa and DUG, which holds a high proportion of its inventory domestically.

Speaker 3

Excluding Melissa and DUG, inventory is just over $169,000,000 up $15,000,000 compared to $154,000,000 last year. Retail inventory in contrast is down 20% globally and down 12% in the U. S. We had $114,000,000 in cash and $410,000,000 of debt at the end of the quarter. During the quarter, we paid down $50,000,000 of our revolving credit facility.

Speaker 3

A year to date basis, we have reduced our borrowings by $115,000,000 Our net debt to adjusted EBITDA ratio was 0.9 times at the end of Q3. We repurchased 952,000 shares in Q3 for approximately $21,400,000 under our NCIB. Year to date Q3, we have allocated $47,000,000 to acquire just under 2,100,000 shares. And after the quarter, we repurchased a further 213,000 shares. Free cash flow in Q3 was just under $45,000,000 compared to $119,000,000 Free cash flow declined due to lower cash from operations and slightly higher cash used in investing activities.

Speaker 3

Turning now to our 2024 outlook. We expect toy gross product sales, excluding Melissa and Doug to be in line with 2023. The outlook for 2024 reflects our continued view that retail inventories are in good shape and we have a strong innovative deep and value focused line, tempered by the reality that consumer behavior is likely to continue to be volatile in Q4 with the election and 5 fewer shopping days leading into Christmas 2024. Total revenue for 2024, excluding Melissa and Doug, is also expected to be in line with 2023 with lower revenue from entertainment and digital games, offset by higher toy revenue. We are managing costs tightly and we continue to expect adjusted EBITDA margin excluding Millicentrug to be in line with 2023, excluding the PAW movie.

Speaker 3

In connection with Melissa and Doug for 2024, we continue to expect gross product sales of between $420,000,000 $430,000,000 with revenue of $370,000,000 to 375,000,000 dollars We continue to expect Melissa and Doug's adjusted EBITDA margin to be approximately 19.5%. Integration activities are progressing well. We are successfully identifying cost synergies with $4,500,000 in net cost synergies realized year to date. We continue to expect at least $6,000,000 of net cost synergies in 2024. A few specific outlook call outs for 2024.

Speaker 3

24. Sales allowances will be approximately 13% of gross product sales. Marketing will be 10% of revenue. Net interest paid will be around $26,000,000 Our consolidated effective tax rate estimate remains at approximately 26%. CapEx is expected to be just under 6% of revenue.

Speaker 3

Depreciation and amortization excluding Melissa and DUG is expected to be approximately $105,000,000 of which $65,000,000 will hit COGS. Liza and DUG depreciation and amortization is expected to be approximately $27,000,000 We expect to end 2024 with a net debt to adjusted EBITDA ratio of approximately one times, including capital leases. We remain on track to achieve our financial targets for 2024 and are confident in our ability to manage our capital effectively. We remain well positioned strategically, financially and operationally and are fully committed to continue to execute our long term strategy for growth and shareholder value creation. That concludes our prepared remarks.

Speaker 3

We'll now be pleased to take questions. Operator, please open the line.

Operator

Thank you. Ladies and gentlemen, we will now begin the question and answer Your first question comes from Brian Morrison at TD Cowen. Please go ahead.

Speaker 4

Okay. Good morning, Max. Good morning, Mark.

Speaker 2

Good morning, guys. Good morning.

Speaker 5

So there are a lot

Speaker 4

of numbers in there, Mark. Can you just repeat what Melissa and Doug POS was 7.4% for the quarter. What was the year? Did you say 23%?

Speaker 3

23% was the increase in POS for Spin Master and Melissa and Doug combined relative to last year. But that obviously includes the incremental Melissa and Doug sales.

Speaker 4

Okay. So just let's focus on Melissa and Doug. So it was certainly a positive surprise this quarter, especially for those that listened to your seasonality guidance. That said, it's fair to say investors have been quite disappointed with it to date that I think weighs on your valuation. You've said last quarter that Q3 and Q4 should be similar contribution.

Speaker 4

I'm wondering if there's a pull forward in Q3 because if not, if they are similar, it appears that there's some upside with your Analyst and Doug guidance. So can you just answer that? And then what's resonating with retailers and consumer now following the PE underinvestment last year? Is it new products resonating, which it certainly seems it is? Is it the support to retailers?

Speaker 4

And lastly, how should we think about your expansion next year?

Speaker 3

I'll let Max pick up the Melissa and Doug first part of your question and then I'll pick up the second piece, Brian.

Speaker 2

Good morning, Brian. I think we are super excited about Melissa and Doug since we put the investments in place when we met with you guys about 6 months ago, we have had 6 consecutive months of market share growth. Okay, that's point number 1. And that is incredibly important because it culminated in that week of prime where we were up significantly versus last year. A year ago base of course, you guys know the story.

Speaker 2

But that really is positioned is incredibly strong into Q4 and we are very confident. That's number 1. So what's driving this? 2 things are driving this. Number 1, great retailer and marketing investments to basically generate demand at the point of sale, which is reflected in the market share.

Speaker 2

Number 2, not just the evergreen items doing well, but the impact of new innovation like Sticker Wow and now we just launched Blockables 2, we have Play Gym. And so in Q3, the impact of innovation into the Melissa and Doug portfolio would have produced about double digit 12%, 13% of the revenue. If you look back to the 1st 6 months of the year, that would have been really about mid single digit in terms of contribution to the revenue. So innovation is really playing a role and is showing up in a big way in the numbers. StickerWow!

Speaker 2

Specifically has been absolutely a standout. And as we launch blockables, that will also be a standout as the early feedback is really very motivating. So I think as we go into the Q4, we have a lot of confidence, use the word upside and we believe strongly in our plan and so we will go execute that. That leads me to quarter 4 outside of the U. S.

Speaker 2

We picked up Canada and Mexico and Spin Master with our salespeople and our footprint. That's producing new revenue, which we're taking into 2025 abroad. And so 2025, our European team and rest of world team will take Melissa and Doug and commercial ISAT. We're ready. We have warehouses ready.

Speaker 2

And so we will execute that in 2025 and that represents a very exciting growth building block for the brand.

Speaker 3

So to pick up on the other part of your question, Brian, on seasonality and what that implies for guidance. As I said to you in August, Melissa and Doug is a H1 20%, H2 80% company and roughly H2 split equally between Q3 and Q4 around 40% each. So if you actually look at our results and then do the math, that would imply that there is some upside potential for Melissa and Doug. But look, this is the 1st year we actually have owned the company in Q4. We want to be a little bit prudent and cautious.

Speaker 3

We'd love to beat our numbers if we can, but we're not calling them up at this point. But we're obviously going to do our best to make sure that we beat them. I will say one thing, which is a little different to Spin Master as it relates to Millicent, Doug and Q4. They ship right up until the end of the year, literally December 30 because they have drop shipping capabilities. So they have week to 10 days after Christmas to really actually get incremental revenue in and that's new for us.

Speaker 3

And so that's part of the equation as well. That's just to be considered and understood for the future.

Speaker 4

Okay. That's encouraging. So I feel pretty good about Melissa and Doug now. Certainly, I think that the trends are positive. I want to turn to the incumbent business.

Speaker 4

If I look at guidance, Eximus and Doug, for you to hit your numbers, it's about 5% revenue growth and maybe 50% in terms of EBITDA for Q4 relative to last year. I think the drivers are explainable and certainly sales allowances and synergies and higher volumes from the toy segment. Just maybe give us some comfort to investors how you can get your EBITDA margin up 500 or so basis points in Q4?

Speaker 3

So Brian, look, obviously Q4 is always an interesting quarter because you have less revenue than Q3, but you have a lot of your marketing flowing through. So we have at least 50% of our marketing flowing through in the Q4. That's when consumers are in stores or online actually shopping. So as you said, we have to manage our marketing dollars very carefully. We have to manage our sales allowances and markdowns very carefully.

Speaker 3

We're really encouraged with our retail inventory levels. They're in good shape both at on the Spin Master side and on Melissa and Doug side. And so I think the markdown risk is less this year than it was last year for sure. But clearly, we have to deliver the volume. We have to get the volume through both for toy, Spin Master Toy and for Melissa and Doug.

Speaker 3

And that really comes down to November onwards, making sure that consumers actually pull through because we are in the hands of consumers from November onwards through replenishment orders. And so that's going to be the key driver. I will tell you that, that entertainment will be down from a revenue perspective. The revenue mix will be more favorable, but we were comping against significant distribution revenue from Unicorn and Vida the vets and PAW Patrol last year. So we are going to be down on the entertainment side and then we'll be up on digital games as well.

Speaker 3

We have lots of new content dropping in Toca Boca World. We actually see a lot of strength in the SAGO Mini Picnic area on the subscription side together with some enterprise opportunities in that area. And so that's how I think we're going to get to where we need to get to for the quarter and for the year.

Speaker 4

Okay. Thanks very much.

Operator

Thank you. Next question comes from Adam Shine at National Bank Financial. Please go ahead.

Speaker 5

Thanks a lot. Good morning. Can we just maybe start with the margin? I think, Mark, you touched on a few key drivers, obviously, a better top line, the contribution of M and D and of course, the impact of lesser entertainment deliveries as well as the context of mix overall. But can you zero in a little bit more in terms of help around freight costs and other key cost elements and how things may or may not have changed in the early days of Q4 compared to Q3?

Speaker 5

And then I'll have one more follow-up question.

Speaker 3

Thanks, Adam. Good morning. I will say on the margin side, at least on the toy side, we didn't see any unusual activity on things like ocean freight. I think it was relatively status quo. As we described last quarter, the area around the Red Sea is under pressure, but we didn't see a major shift either up or down in relation to what we described in Q2.

Speaker 3

I would say overall as a comment, if the key thing for me here was our performance on an apples to apples basis from a margin perspective, from an EBITDA margin perspective. We actually grew EBITDA margin $9,000,000 approximately with just under from $219,000,000 last year to $228,000,000 excluding the poor movie and actually excluding Melissa and Doug. And that to me was a key indicator of the underlying performance of the business. We had less entertainment deliveries, which are margin dilutive. And so we had a higher mix of licensing and merchandising revenue.

Speaker 3

So even though the top line in entertainment was down over 40%, adjusted EBIT was only down a few $1,000,000 and our margin was actually much higher. The biggest impact in the quarter was actually in digital games because the Toca Boca World in app purchases are higher margin purchases and high margin revenue for us. And so that decline was margin dilutive. If we didn't actually have that decline, I think we would have had a spectacular quarter.

Speaker 5

That brings me to the follow-up question. You and Mark, sorry, you and Max have already talked a bit about optimism going into the Q4. Obviously, in Q4, the presumption is that whether it's Toka Days additional content and or Rubik's Max that there's going to be a return to growth in Q4. Can you maybe talk a little bit more about your expectations for digital games overall for the year? And then of course, as part of what the prior questions touched on in terms of the Q4 lift in EBITDA, there's got to be some heavy lifting going on also, I presume, around digital games EBITDA, unless I'm wrong.

Speaker 2

That's correct. So Adam, good morning. First of all, digital games in Q4 is basically as follows. We have a picnic business, a subscription business that is doing really well. It's ahead of our expectations and we'll continue to deliver that into Q4.

Speaker 2

And so we're riding on that via increased subscribers, increased monthly recurring revenue because of a higher LTV. And that is incredibly positive and that is one of the big shining moments for us through the year and as we actually exit the year and enter 2025. That's number 1. Number 2 is we have on Toca Boca World, a number of interventions that we had planned and are coming November December, 2 of which are really important and we actually believe are going to help the business recover. Number 1, we have 2 new features on the app.

Speaker 2

Features have not been necessarily leveraged over the last few quarters. So this will be the new feature to the gaming community in quite a while. And we just tested one of the features before dropping it. And we got about 20,000 respondents within 9 hours excited for the feature drop that comes in like 2 to 3 weeks. The second feature drop is in December and that will be a revenue driver and an engagement driver and a monetization driver.

Speaker 2

The second one in tocoboca world is the fact that we have a very strong collaboration with Puxin. We've known that before when we've done those. They actually have driven our revenue very positively. And so that is coming down the pike. So I think those two things are going to help us on Toca Poca World.

Speaker 2

And on Rubix, as you alluded to, it's early days. We launched that end of September. So far, we're getting good reviews, but it's really early to basically judge the top of funnel and obviously the conversion yet is something that we're waiting to in the quarter to basically get the results we expect, but more to come on that and we're going to have to wait a little bit longer.

Speaker 5

Okay. I appreciate that color. I'll queue up again. Thanks.

Operator

Thank you. The next question comes from Luke Cannon at Canaccord Genuity. Please go ahead.

Speaker 6

Thanks. Good morning. I know we're going to talk a little bit more about the outlook for 2025 when you guys report your Q4 results. But I just wanted to ask from a high level specifically on digital games. So I realized that this was a fairly heavy launch year.

Speaker 6

But as we move forward in the next year, and you can correct me if I'm wrong, I think the next major launch that you guys have planned in digital will be Unicorn Academy. Is there anything else to be thinking about? I guess the main question here is we should see a step function change when it comes to the digital games, margins, operating margins in 2025, all else equal?

Speaker 2

Yes. Luke, good morning. The way we're actually approaching not just closing the year, but into 2025, Two things that are really exciting for us is the number of subscribers we're getting on the business and we see significantly more revenue potential and longer term potential by focusing on that and that will be for us a key driver of the future. So think about Picnic and the success we've had with Picnic and that basically carrying us significantly more than we expected because it's doing really well. And in January, just to kind of get into 25, we'll bring PAW Patrol into Picnic and that's going to be a significant step change.

Speaker 2

And we have a step change. And we have a number of initiatives on subscriptions that we believe are going to continue to drive that. And it's a moment in time and we are very focused and very intentional to step change that business. That's number 1. Number 2, we've seen on totoqueboca world, obviously as we navigate this recent softness, an opportunity to step monthly active users via 2 or 3 tech driven and feature driven and content driven strategies that we believe are going to once again step change that business well beyond.

Speaker 2

So those are the 2 key focus areas. And then as we get the other games, obviously KPI and ready to launch, we are doing those too. We don't expect Unicorn Academy to launch in 2025. It will likely be delayed. And that is because we're focusing on these other two priorities because the size of price and return to us is significantly bigger.

Speaker 2

And Luke, just to add

Speaker 3

to what Max said, the economics of digital games and digital games launches, If you recall, when a new game is launched, it's actually margin dilutive because you have to pick up the amortization of the previously capitalized intangible asset that had been sitting on your balance sheet while you were developing. Once you hurdle that amortization, then your margins return to a more normalized level. But just keep that in mind as you think about new games. And that's why in terms of what Max said, the games that we're very heavily focused on for 2025 Picnic and Toca Boca World especially, we've amortized most of that a long time ago and those are highly margin accretive for us and the primary focus as makes sense.

Speaker 6

Okay. Thanks. And then for my follow-up here, we'll stick with digital games. There was commentary in the MD and A about there being increased competition in the marketplace. I know that you guys have talked about part of that is just not having content in there for folks to be able to pay for.

Speaker 6

But I mean, is there anything else to read into there? Are you seeing other folks encroach on the same sort of territory that you guys are? Are you seeing user attrition at all into other large properties like Roblox, for example, or Minecraft? Is there anything else to call out there when it comes to competition specifically?

Speaker 2

No. The competition we would have alluded to in the footnote would have been in mobile digital games and it's just a couple of properties that have come in and quite frankly just offer content for free. And as we had not been providing features obviously, consecutively, then obviously, we saw that attrition as you well pointed out. But we've seen that with the feature strategy that we have and our vision to get a feature a quarter. I think we have a path and a roadmap to get back on track with those users coming back to us.

Speaker 2

That was all that that was intended for.

Speaker 6

Okay, got it. All right. Thank you very much.

Speaker 2

Thanks, Luke.

Operator

Thank you. The next question comes from Martin Landry at Stifel. Please go ahead.

Speaker 7

Hi. Good morning, guys. I wanted to touch on the upcoming holiday period. Just trying to get some color on how the retailers are approaching the holidays this year? Where do they stand on inventory?

Speaker 7

How much promotional activity are they requesting from vendors? And how price sensitive are they in terms of price point threshold? Any color would be helpful.

Speaker 2

Yes. Good morning, Martin. I think the retailers are really leaning into basically getting food traffic into toys for the holidays. And that is very intentional and that is across the globe. Most importantly in North America, that intention is manifested in basically a lot of the orders they brought in themselves through direct imports.

Speaker 2

So we see a healthy balance of that, which is terrific. And knowing that we have to wait till after the election to get the activations going, we also have a lot of merchandising queued up to basically after election for the following 6 weeks headed into the holidays into Christmas. And I think we're basically lockstep with retailers to make sure that happens. We have at the same time, our marketing queued up to make sure that the marketing is impacting consumer purchase and influence their behavior in those same weeks. So everything is basically for us lined up very much locking step.

Speaker 2

So we expect, obviously that the investment into the category will be there, both from the retailer and from us. And so far that's the plan and that's what we're actually planning to do. In terms of the portfolio, the price points and the price sensitivity, just to address your second question. We have we're super well positioned. A lot of what drove our success in the Q3 and in the market share significant step change in the Q3 is a lot of the new innovation, most of which, if not all, came at really good price points.

Speaker 2

We're talking about $19 to $39 by and large, and that will continue to be the case in Q4. And in Q4, you have the larger ticket items, but no such ticket item is really exceeding between $70 $99 So I think we're well positioned to do that. I would tell you the last thing is we have a number of items that are in the lower price segment too, whether it's sticker Wow or items on PAW Patrol and the value channel initiative that will also position us well to compete in that segment. From a promotional standpoint and percent of items on promotion, we're not seeing an escalation thus far. And so I hope that helps with your question.

Speaker 3

And just to add one piece of data to reemphasize what I mentioned in the script on your retail inventory question. Global retail inventory at the end of the quarter was down 20% and was down 12% in the U. S. So I think from an inventory perspective, the retailers are in good shape. And in particular at Melissa and Doug, the retail inventories were down quite significantly relative to last year.

Speaker 3

And so we're encouraged by the position that the retailers are in from the inventory perspective.

Speaker 7

Okay. That's super good color. Thank you so much. And then maybe one quick question on Ms. Rachel.

Speaker 7

It's been a success so far. Just trying understand how is your inventory position with Ms. Rachel right now?

Speaker 2

It's tight, which is a good thing. The demand is absolutely crazy. And so we have great plans in place to fulfill the demand and importantly getting to 25 with a lot of strength. And so that would be the best thing I can tell you. It's a top item in the U.

Speaker 2

S. Particularly is 4 of the items are in the top 10 for the infant toddler preschool category, both for Melissa and Doug items and for Spin Master items. So we're incredibly optimistic.

Speaker 3

And Mac, just to add it was the number one license in the industry in the Number one license. Yes, in the entire industry in Q3.

Speaker 7

Okay. Well done and best of luck.

Speaker 2

Thank you.

Operator

Thank you. The next question comes from Kiley Kohu at Jefferies. Please go ahead.

Speaker 8

Awesome. Thank you guys so much for taking my question. And I apologize if this is kind of already been covered. But following on from the last question on the miss rate, obviously, it's been a huge success. I was just kind of curious how you guys were thinking about this longer term without getting into too much specifics about just where the product line could go.

Speaker 8

Any details there would be helpful.

Speaker 2

Yes. Miss Rachel has launched in basically the U. S, UK, Canada so far. It will go into English speaking markets 1st and foremost. And so that part of the rollout is going incredibly well, but it's early days, right?

Speaker 2

I think as I said in the script, it was only pre sell and just maybe a week or so of retail. So, we are firmly executing the plan we have. 2025 is a really important year for Ms. Rachel. And so you can expect a significant step change in 2025 from our Ms.

Speaker 2

Rachel performance, both in revenue driven by innovation and footprint expansion. So that's the answer to that.

Speaker 8

Okay, great. And I guess as a follow-up to that, I was wondering if you could talk a little bit more about different licensing opportunities specifically with, Vida the Vet, especially in Europe, any color there would also be helpful.

Speaker 2

Yes, great question. Vida de Vette just got picked up by a number of broadcasters in Europe. So we're going to see a lot of Vida de Vette in 2025, which I think is terrific. And I'm thinking about France and Germany and other places where we would have not been necessarily broadcasting the line. It was recalled mostly the UK.

Speaker 2

So, so far it's a great show. In France, just to give you some color, it just already became the 2nd show in the category since it went live. And you can expect that we can follow-up with Toys next year.

Speaker 8

Perfect. Well, thank you guys so much.

Operator

Thank you. The next question comes from Jamie Katz at Morningstar. Please go ahead.

Speaker 9

Hi, good morning. You guys touched on this briefly, but can you talk a little bit more about the rollout in the value chain, how that's done, how that's been received, I guess, relative to, the mass market channel to start? Thanks.

Speaker 2

Yes, I'll start and then Mark can complement. We focus first in the U. S. We have about 40 SKUs and the key thing has been for us kind of make sure we have a representation of those lines that kids really want, but may have not been able to buy before. So it's beyond PAW Patrol into Gavi's into obviously Tech Deck and other things that are very popular and people want.

Speaker 2

And so that's the first thing. We're just beginning in the U. S. And importantly for us as we look forward, there's an incredibly large segment of discounters abroad and that line will roll out into 25 beyond the U. S.

Speaker 2

And that gives us a lot of confidence that we have an upside in 2025 behind this execution.

Speaker 3

Yes, Max, I think you've covered it. What I would just add to that Jamie is, we have 40 to 50 SKUs in the line as Max said. At the beginning of the year, I think I said that our expectations were relatively modest for this year because it was a partial rollout somewhere in the $20,000,000 to $30,000,000 range for the year. And I think we're going to meet those expectations. And then next year, we'll see it significantly higher as we roll out globally with more SKUs.

Speaker 3

When I say globally, it's mainly the U. S. And Europe that I'm talking about, but more SKUs into more doors. And so we are treating the value channel as an important initiative. We have set up a specific supply chain in Asia to manage the production of the line and it's not margin dilutive because we were actually manufacturing for that price point.

Speaker 3

So we feel good about it for next year.

Speaker 9

Okay. And I don't think it's been mentioned maybe because it's into 4Q, but how did the launch of Hatchimals Day go? And was that as well received as expected? Any color on that product launch at the beginning of October would be interesting to hear. Thanks.

Speaker 3

Yes.

Speaker 2

So far it's going well. To your point, it just basically was Hatchimals Day was in quarter 4. So there's nothing in the script or the obviously data yet. We're very optimistic about the start. All the marketing activation is happening following the PR effort.

Speaker 2

So far we're optimistic about the outlook for Hatchimals in the quarter.

Operator

Your next question comes from Drew McReynolds at RBC. Please go ahead.

Speaker 10

Yes, thanks very much. Good morning. A couple for me. Maybe for you, Mark, just back to Q4 and the visibility that you have overall in the quarter. Obviously, we had the election, the late Thanksgiving and then you commented on the shorter shopping period.

Speaker 10

Would you characterize the visibility as less versus kind of previous years just given what is kind of unusual events and timing here? Or are you just see the similar visibility that you've had in prior years? And then 2 housekeeping items just on M and D synergies. Good to see you'll reach your target of $6,000,000 by the end of the year. When you think about the timing of the remaining targeted synergies through 2026, how should we be thinking about what you realize next year relative to 2026?

Speaker 10

And then lastly, just on leverage, you mentioned a target of approximately one times by year end. I think that was previously 0.8 times. I'm assuming the difference here largely is the buyback, but if not, if you could just break that down for us. Thank you.

Speaker 3

Okay. Thanks, Drew. We're going to have to make this last question, operator, just FYI, but I will answer those. Drew, great questions. Visibility, I would say to you on the visibility, I don't think it's changed dramatically versus prior years.

Speaker 3

Obviously, we do have the U. S. Election in the mix this year. But as Max described and as others have described, we expect that to just really be a timing impact as opposed to an overall impact for the quarter. Drew, you have to understand that in Q4, really at some point, this becomes a replenishment issue.

Speaker 3

And it comes down to consumers either in store or online pulling through. And so any guidance that we give you for Q4 as it relates to toys, for Spin Master or Melissa and Doug, it really revolves around consumer takeaway. We do control marketing activities. We control sales promotion activities markdown. But at the end of the day, the consumer has got to be pulling the inventory through.

Speaker 3

And so as much as we give you guidance, it's always tempered by the reality of the consumer takeaway as it relates to toys. Entertainment, we have a little bit more visibility because it's just not as volatile in the quarter. And digital games, we have some visibility as it relates to subscriptions, but really a very important part of digital games, which is Toca Boca World will be the period of kids playing and buying around Christmas. And so we have expectations, but we don't have a huge degree of visibility there. So I just want to just give you the reality of what our visibility looks like, but that is not significantly different from what it would have been in prior years.

Speaker 3

As it relates to synergies, I think we're doing well on the synergies front for Melissa and Doug. If you recall, our target for this year was around $6,000,000 $25,000,000 to $30,000,000 run rate by the end of 2026. I think you'll see synergies accelerating further in 2025 and then also significantly in 2026 as some other activities structural activities start flowing through. But we'll get back to you in the end of February on the 2025 synergies number, but you can expect that to be up over the $6,000,000 As it relates to leverage, yes, we gave you a range of around 0.8 in August. We think it's going to be around one time just in relation to the buyback program and our debt pay down activities and cash flow timing.

Speaker 3

So I think just to feel models think about it in that range of around 0.9 to 1 times. And I think that's where we're going to land up.

Speaker 2

Okay. Fantastic. Thank you.

Speaker 3

Okay. Well, thank you, everyone. We look forward to talking to you again with our Q4 results at the end of February. Thanks for your interest again and we'll talk to you in February. Thank you.

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Earnings Conference Call
Spin Master Q3 2024
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