U.S. Markets close in 2 hrs 29 mins
  • S&P 500

    -4.44 (-0.11%)
  • Dow 30

    -101.27 (-0.30%)
  • Nasdaq

    -46.02 (-0.33%)
  • Russell 2000

    -6.47 (-0.29%)
  • Crude Oil

    +0.35 (+0.59%)
  • Gold

    -12.60 (-0.72%)
  • Silver

    -0.47 (-1.86%)

    +0.0014 (+0.1192%)
  • 10-Yr Bond

    +0.0100 (+0.60%)
  • Vix

    +0.66 (+3.95%)

    +0.0041 (+0.2997%)

    -0.2800 (-0.2554%)

    +216.21 (+0.36%)
  • CMC Crypto 200

    -13.22 (-1.02%)
  • FTSE 100

    -26.63 (-0.39%)
  • Nikkei 225

    -229.33 (-0.77%)

Edited Transcript of TOY.TO earnings conference call or presentation 2-Mar-21 2:30pm GMT

·74 min read

Q4 2020 Spin Master Corp Earnings Call Toronto Mar 2, 2021 (Thomson StreetEvents) -- Edited Transcript of Spin Master Corp earnings conference call or presentation Tuesday, March 2, 2021 at 2:30:00pm GMT TEXT version of Transcript ================================================================================ Corporate Participants ================================================================================ * Mark L. Segal Spin Master Corp. - CFO & Executive VP * Ronnen Harary Spin Master Corp. - Co-Founder, Co-CEO & Director * Sophia Bisoukis Spin Master Corp. - VP of IR ================================================================================ Conference Call Participants ================================================================================ * Adam Shine National Bank Financial, Inc., Research Division - MD, Head of Montreal Research & Research Analyst * Brian Morrison TD Securities Equity Research - Research Analyst * George Doumet Scotiabank Global Banking and Markets, Research Division - Analyst * Gerrick Luke Johnson BMO Capital Markets Equity Research - Senior Toys and Leisure Analyst * Jaime M. Katz Morningstar Inc., Research Division - Senior Equity Analyst * Martin Landry Stifel Nicolaus Canada Inc., Research Division - MD of Equity Research * Sabahat Khan RBC Capital Markets, Research Division - Analyst * Stephanie Marie Schiller Wissink Jefferies LLC, Research Division - Equity Analyst and MD ================================================================================ Presentation -------------------------------------------------------------------------------- Operator [1] -------------------------------------------------------------------------------- Good morning. My name is Lindsay, and I will be your conference operator today. At this time, I would like to welcome everyone to the Spin Master Fourth Quarter 2020 Earnings Conference Call. (Operator Instructions) Sophia Bisoukis, you may begin your conference. -------------------------------------------------------------------------------- Sophia Bisoukis, Spin Master Corp. - VP of IR [2] -------------------------------------------------------------------------------- Thank you, Lindsay. Good morning, everybody, and welcome to Spin Master's financial results conference call for the full year and fourth quarter ended December 31, 2020. I am joined this morning by Ronnen Harary, Spin Master's CEO -- Co-CEO; and Mark Segal, Spin Master's Chief Financial Officer. For your convenience, the press release, MD&A and audited consolidated financial statements for the full year and fourth quarter of 2020 are available on the Investor Relations section of our website at spinmaster.com and on SEDAR. Before we begin, please note that remarks on this conference call may contain forward-looking statements about Spin Master's current and future plans, expectations, intentions, results, levels of activity, performance goals or achievements or any other future events or developments. Forward-looking statements are based on 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 could be no assurances that such estimates and assumptions will prove to be correct. Many factors could cause actual results to differ materially from those expressed or implied by the forward-looking statements. As a result, 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 consult the cautionary statements regarding forward-looking information contained in the company's earnings release dated March 1, 2020. Please note that Spin Master reports in U.S. dollars and all dollar amounts are expressed today in U.S. currency, unless otherwise noted. I would like to turn the conference call now over to Ronnen Harary. -------------------------------------------------------------------------------- Ronnen Harary, Spin Master Corp. - Co-Founder, Co-CEO & Director [3] -------------------------------------------------------------------------------- Thank you, Sophia, and good morning, everyone, and thanks for joining us today. What a difference a year makes. At this time last year, we were coming off a year in which we faced significant operational challenges, and we had already started to see the early effects of COVID. Overall, I'm exceptionally proud of our team's focus, adaptability and agility to execute our (inaudible) data business as well as to simultaneously make significant progress in improving our operational performance. Through 2020, we adapted to a shifting and evolving landscape, and we are very happy today to have demonstrated concrete signs of our progress. Let me highlight a few key areas of importance. In the fourth quarter, our revenue grew nearly 4%, driven by dramatically higher digital games revenue. As we have indicated would be the case, we were able to show significantly lower distribution costs and sales allowances. We improved our gross margins and EBITDA margin in Q4 compared to last year, and ended 2020 with the lowest year-end inventory and accounts receivable levels since 2016. We established 3 creative centers: toys; entertainment; and digital games. We have strengthened these creative centers by putting leadership in place with broad and deep skill sets that will allow us to drive innovation and growth. These centers are operationally independent, but linked through cross-collaboration to maximize growth and optimize our return on investments. As a result of the evolution of these 3 creative centers and the rise in e-commerce, we are evolving rapidly into a fully-fledged children's entertainment company and are interacting with our customers more broadly and more deeply than ever before. Our customers can access our products and content through a wide range of channels, including brick-and-mortar retailers, subscriptions, our Games as a Service model, streaming services and broadcasters, in-theaters and directly through our direct-to-consumer websites. I want to update you on the progress we have made on the operational challenges we encountered in 2019. In Q4, we saw the benefits of the remediation efforts we spent much of 2020 implementing. From an operational perspective, we focused on 2 key areas in 2020, which will benefit 2021 and beyond. First, our supply chain optimization. After reducing our North American DC structure footprint from 18 to 4, 1 less than our target of 5, we are now well positioned to manage inventory and to address changing demands in our industry. This streamlined structure, along with our one SKU one location strategy inventory management approach, allow us to improve customer service, reduce inventory, eliminate waste, speed up the flow of products and reduce customer chargebacks. Our customer focus team strategy, with consumer-first internal hubs, focused on a single large customer group is working well. We're now performing at or better than the benchmark historical cost levels, when you also consider the growth in European domestic sales since 2018. We are typically higher than North America. We intend to continue to improve further in 2021 and beyond. Secondly, we focused on process simplification and automation, and we'll continue to do this year and beyond despite the significant progress made in 2020. The simplification and further automation of our business processes will increase efficiencies and drive cost improvements. We'll be focused more on data-driven insights, and we will aim to refine our systems to increase productivity. Overall, we believe that we have not only remediated the issues we have, but we are now in a stronger position operationally than we have ever been before. Looking at some of the factors that drove our revenue growth in the fourth quarter, one of the standout items was the performance of Toca Boca, our digital games business. Toca Life: World is a game that regularly evolves with new content and pay sets as well as creator tools that allow kids to express themselves and personalize their experience. Playing digital games has become an integral part of children's lives, and this trend is intensified during the pandemic as kids turn to gaming and to connect and communicate with their friends. With kids spending more time at home and with parents being more flexible with screen time, we quadrupled our digital games revenue in Q4, primarily due to the growth of Toca Life: World platform. Kids are playing games, videoing themselves and streaming the videos on to platforms such as TikTok, Twitch and YouTube for others to watch. Toca Boca has seen explosive growth in consumer engagement over the past year, and we believe that this major factor behind Toca Life: World growth. We generated over 4 billion views with Toca Boca hashtag on TikTok in 2020 and are at nearly 5 billion currently. We now have over 30 monthly -- 30 million monthly active users for Toca Life: World. In total, the Toca Boca ecosystem currently has over 40 million monthly active users compared to approximately 19 million last year. In addition, we saw strong growth in our Sago Mini subscription business, where we had over 240,000 subscribers across Sago Mini World, Sago Mini School and Sago Mini Box at the end of 2020 compared to just over 119,000 at the end of 2019. This large monthly active user and subscriber base is a tremendous asset for us to develop and direct -- to develop a direct relationship with consumers and to which can market and sell new digital games as we expand our product offerings. Socializing the digital universe is one of the major trends that has emerged from the pandemic. In this emerging digital universe, kids can hang out in multiple locations and geographies and interact together. We are now working hard on our next digital game product launches, including Toca Days, a multiplayer game going live in Q4 2021, and we just launched a new Toca Boca subscription box program targeted at kids 5 to 9. Sago will focus on edutainments, a way for young kids to play and learn simultaneously, another area which grew extensively during the pandemic as parents sought to ensure their kids do not lag academically. I want to briefly discuss 2 brands in the toy creative center: Kinetic Sand and Bakugan. One of the standout performance for the year was the Kinetic Sand brand. Kinetic Sand continues to solidify its status globally, but also increasingly in other markets. It's surging popularity and strong growth, paired with positive online reviews and extremely popular social media presence, has helped solidify the Kinetic Sand brand as a childhood activity compound in households around the world. For context, we have around 20 million social media views per day and have had over 14 billion total views. We are pleased with the response to the Bakugan franchise since its relaunch. Together, with innovative toys, we have built a multichannel content approach, encompassing television, SVOD, video games and YouTube. Bakugan toy sales were strong at the beginning of 2020, but slowed as the pandemic restricted social play for kids. Despite these restrictions, Bakugan still performed well in many countries, especially in Europe, including recently reaching #1 in its category in Germany. In 2020, we launched the second season of the TV show on Cartoon Network and Netflix, introducing a new theme and corresponding toy innovation. The second half of Season 2 launched on Netflix in early February. This spring, we have had 2 additional drops on Netflix with an hour-long special coming on March 15 and the launch of Season 3 on April 15. We're excited about growing and expanding the franchise in 2021, especially as we anticipate social play for kids significantly expanding. We're experiencing -- we are working on creating an all-new Bakugan experience in the world of roadblocks to help further engage with fans by bringing Bakugan to life in the game. For the past 2 years, we observed the changing consumer content consumption patterns, and have mobilized and established multi-platform approach to content production within our edutainment creative centers to stay ahead of the curve. Telling stories and creating engaging and enduring characters that resonate with kids around the world is important to us regardless of what screen they're watching. Our commitment to storytelling is working. PAW Patrol, currently in its eighth season, continues to be the #1 preschool show. Fans around the globe responded with excitement as we announced Spin Master's feature film debut with PAW Patrol: The Movie. The animated feature film, produced by Spin Master, includes the cast of world-famous voice and music characters, and is scheduled to debut in the theaters in late August 2021, in association with Nickelodeon and distributed by Paramount. Late last year, we launched our first-ever straight streaming series with Netflix Original, Mighty Express. We've taken a multifaceted approach to content creation for Mighty Express that includes the YouTube destination, with short-form content, music videos and character bios as well as a mobile app to further engage kids. Spin Master has retained the rights of the distribution of the series outside of SVOD, including licensing and consumer products and the toy line. While we currently have 10 series and multiple short-form series airing or streaming in 190 countries in 30 languages, the development team within the entertainment creative center is constantly searching for best stories and ideas that will captivate children and families alike. We are very proud that Spin Master is producing its first feature film, PAW Patrol: The Movie. The entertainment creative center is building on the feature film strategy, and will be bringing out other movies in the upcoming years. We also continue to partner with the best licensors to build their presence as a toy partner for high-profile brands. In addition to core franchises, such as the Monster Jam with FELD Entertainment and DC Batman with Warner Bros., we announced several new strategic toy license agreements in 2020, including Warner Bros. Harry Potter and the Wizarding World, FELD Supercross and Rise of League of Legends, all of which has scheduled toy launches in fall of 2021. We are proud of the trust that these IP partners have shown us, and look forward to creating and unveiling innovative toys for kids and fans around the world. Within the past year, the impact of the pandemic as profound economic and social effects has significantly changed the mindset of the consumer. Consumers are increasingly comfortable in accepting online and e-commerce. E-commerce penetration and usage grew exponentially with strong nuances by region, and we believe that as more consumers have experienced the convenience associated with these platforms through the pandemic, e-commerce usage will continue to grow. Consumers are concerned about and focused on their family's mental health and well-being. The pandemic has had an undeniable effect on the state of mind of parents and kids alike. While in the beginning of the lockdown, parents were mostly focused on toys that would keep their kids busy. Now, they're increasingly interested in ways to bring their kids joy, relieve boredom and bring specialness to an otherwise monotonous time. Toys, digital games and entertainment are the perfect antidote to that monotony and continue to play an important role moving forward. Parents have a renewed focus on togetherness. Families are finding new ways to bond and stay busy. Co-viewing content between kids and parents has increased over COVID, and is expected to carry on after lockdown. With social distancing restrictions subside, undoubtedly, traffic will return in-store, but in-store behaviors and interactions will likely be different. Customers are hungry for new and different. Classics were a safe choice in 2020, but we expect consumers may shift to newness. This will allow Spin Master to lean into its strengths in innovative product development. We continue to tour our marketing strategies to align with these consumer trends and to make marketing as innovative as our products. We're uniquely positioned to do that as a diversified children's entertainment company across 3 creative centers. Our goal is to use the strength of 3 -- of all 3 to build a fluid ecosystem that allows us to own and grow more of our own audience, in turn, generating organic growth for our brands. Digital now represents 50% of our marketing mix in the U.S. and will continue this mix into 2021. We will continue to operate digital-first, and we continue to increase spend supporting e-commerce, driving to our retailers, dot-com presence and maximizing sales online. In early January, we completed the acquisition of Rubik's Brand Limited, owner of the Rubik's Cube and one of the industry's most iconic brands. We're excited for the opportunity to put our innovation on the entire Rubik's portfolio and expand distribution through our global footprint. The acquisition of the Rubik's Cube further strengthens our presence in the Games & Puzzles category and gives us a platform for further innovation and global leverage. We're always on the lookout for accretive M&A opportunities that complements our organic growth strategy, and we continue to apply a disciplined approach to assessing all opportunities. We're increasingly focused on the entertainment and digital games area for M&A opportunities. Given our growth in digital games, our potential M&A universe has expanded dramatically. Let me conclude by addressing our recent executive leadership changes. The dual CEO structure we have had for decades has served us well, but we believe now -- my apologies. But we believe we now have a great opportunity to transition to a single CEO model and for Anton and I to transition to different roles. To that end, we appointed Max Rangel as Spin Master's new CEO, effective April 2021. Max is a seasoned executive, who has successfully led global businesses, generating growth across multiple consumer package categories. He's an effective leader with a well-established ability to unlock the potential of teams to boost organizational capability. Beginning in April, Anton and I will move into higher-level strategic growth-oriented forward roles, continuing to drive the long-term vision and strategy for Spin Master. I will maintain involvement in the creative process for entertainment and oversight of the digital games creative center. Anton will provide guidance on Spin Master talents and culture globally. We will continue to be actively involved in areas of the business we are passionate about, including external partnerships and a strong focus on acquisitions. Together, we are energized to be taking the next step in our journey. I believe, more than ever, our performance in 2020 demonstrates the power of a diversified portfolio of brands, entertainment franchises and digital games and the benefits of having a sound balance sheet. With a clear vision for the future and exceptional leadership and an exceptional leadership team, a solid operating platform and financial foundation and 3 thriving creative centers, we are optimistic for 2021. We are, however, mindful of the unknowns ahead of us, including the ever-evolving COVID situation. In the long term, our strategic direction and diverse geographic platform, combined with the commitment of our global teams, positions us to take advantage of the evolving opportunities to grow and build long-term value. I will now turn over the call to Mark. -------------------------------------------------------------------------------- Mark L. Segal, Spin Master Corp. - CFO & Executive VP [4] -------------------------------------------------------------------------------- Thank you, Ronnen. In the fourth quarter, we delivered significant year-over-year improvements in our financial results. At the outset of 2020, we entered the year acutely aware of the operational difficulties we needed to address and face additional challenges related to COVID. However, we committed to resolving the challenges we faced in 2019, and were able to methodically execute our plan and realize significant improvements in most areas, as evidenced by our Q4 adjusted EBITDA of $51.5 million, an increase of nearly $45 million over last year. This is a direct result of the operational improvement initiatives executed throughout 2020. We continued to strengthen our balance sheet, exiting 2020 with a net cash position of $321 million, after generating over $232 million in free cash flow. Our solid financial position, together with the achievement of our operational improvement initiatives, sets a very solid foundation for growth for 2021 and beyond. Our gross product sales in the quarter declined by 7.1% with a favorable foreign exchange impact of $4.3 million. On a constant currency basis, gross product sales declined by 7.9%. One of the factors contributing to the decline was the position we took on domestic inventory in Q4 based on retailer order patterns we were seeing. Consumers were more mission-focused in their shopping, looking to reduce the amount of time they spent in stores. We believe retailers have this in mind when they started offering their Black Friday discounts earlier and spread them out, resulting in consumer spending shifting earlier in the quarter. We believe around 20% of December POS was pulled forward due to both retailer price promotions in October and pull forward of Black Friday deals in November. Given this pull forward, we chose to avoid carrying domestic inventory too late into Q4 and potentially into 2021, and this affected our ability to fulfill some late-season replenishment and e-commerce orders, especially on hot items such as Megalodon STORM RC, Present Pets and Hatchimals Crystal Flyers. While this meant we did not maximize our sales, the position we took allowed us to achieve our best sell-through and the cleanest retail and Spin Master inventory levels in many years. This allowed us to exit the year with strong demand and brand momentum, which positions us well for 2021. Despite the decline in gross product sales, total revenue in the fourth quarter of 2020 was $490.6 million, up 3.6% or 2.4% on a constant currency basis. Contributing to the increase was the strong performance of digital games, with over 400% revenue growth as well as a decline in sales allowances. On a geographic basis, Europe was the strongest region as gross product sales rose 2.3%. Gross product sales in North America were down 11.8%. In the Rest of the World, gross product sales were down 8.1%. International gross product sales represented 46.8% of the total compared to 43.9%. Gross product sales in the Activities, Games, Puzzles & Plush category rose 1.9% over last year, driven by continued growth of Kinetic Sand. Games & Puzzles grew for the year driven by strength in this category during the pandemic. Growth came from classics, adult puzzles and evergreen family games such as HedBanz. Offsetting this growth was declined in Plush, which comprises Gund. Gund continues to be negatively affected by COVID-related specialty channel closures in the U.S. And the Plush category was one of the worst performing in the industry. The Remote Control and Interactive Characters category was down 43.6%, mostly attributable to the expected decline in Hatchimals, offset by strength in Monster Jam RC, where we saw exceptional performance from both the Mega Grave Digger and the Megalodon STORM trucks. The Boys Action and Construction category was up 1.8%, driven by sales of DC licensed products, Tech Deck and Present Pets, partly offset by declines in Bakugan, Dragons and Boxer. Overall, we are very pleased with our performance with the DC line this year. Our Pre-School and Girls segment grew by 1% in the fourth quarter with higher PAW Patrol and Pre-School sales more than offsetting declines in other products. PAW Patrol showed strength in the quarter in Europe and the Rest of the World. The PAW Patroller Dino Rescue was a standout item and won the Preschool Toy of the Year award. For 2021, we are excited about the upcoming Wizarding World Harry Potter Fantastic Beasts franchise license line in Girls. Let's look more closely at POS. According to NPD, the toy categories that performed best were Building Sets, Outdoor Sport Toys and Games & Puzzles. Our global POS in Q4 was up 5% compared to 7% for the industry/in Q4, our global POS, ex the U.S., was up 8% compared to 3% for the industry. This highlights the strength of our international platform, especially in Europe, where we performed very strongly, growing 9% in Q4 compared to 2% for the industry. We performed extremely well in key markets, such as the U.K., France and Germany. In the U.S., POS was flat for Q4 compared to a 13% increase for the industry. For the full year, global POS increased 9%, in line with the industry's 10%. Excluding the U.S., our global POS in 2020 was up 9% compared to 6% for the industry. For the full year, our U.S. POS was up 8% compared to 16% for the industry. The primary driver of our relatively weaker U.S. performance compared to the industry with the significant growth the industry saw in categories such as Outdoor, Fashion Dolls, Role Play and Building Sets, where we have a relatively insignificant presence, if one isolates the NPD categories in the U.S. where Spin Master has more than $10 million in sales, our U.S. POS grew 11% compared to 7% for the industry. Looking at some key brands in the U.S., we saw higher POS in both Q4 and 2020 for Kinetic Sand, Bakugan, Monster Jam and the games portfolio. On a full year basis, POS increases for these brands were strong double digits, and in the case of Kinetic Sand, POS was up nearly 100%. Turning to PAW Patrol. Globally, POS was up 4% for 2020. Excluding the U.S., global PAW Patrol POS grew 15% for 2020 and showed strong POS growth in most regions. In the U.S., POS for PAW Patrol declined 8% in Q4 and 6% for 2020. This decline was primarily driven by the very strong performance of higher price point PAW Patrol items, such as the Dino Patroller, offset by the reduction in POS for items with price points under $10, which lend themselves more to in-store impulse purchases and declined during the pandemic. Current global POS is solidly up 14%, while U.S. POS year-to-date is up 13%. Current POS in PAW Patrol is very strong. In the U.S., POS is now up over 18% year-to-date and 24% globally year-to-date. Kinetic Sand is up just under 50% currently and Batman is up 30%. We expect PAW to respond very well to new content in 2021, including our movie launch in August. From a channel perspective, the shift to e-commerce continued. In those markets where we sell directly, our e-commerce penetration was over 30% in 2020 and even higher in certain markets in Europe. For 2021, we're continuing to expand our e-commerce focus with our customers globally as well as through major retailer marketplaces. Turning back to the P&L., a significant contributor to our revenue growth and improved margin in the quarter was the decrease in our sales allowances. Sales allowances for the quarter declined to 15.1% of gross product sales compared to 19.8% last year. This is the lowest level of sales allowances we have seen in the first -- fourth quarter since 2016. This decrease was mostly due to the strong sell-through of our fall 2020 lineup and lower markdowns, promotions and noncompliance charges compared to Q4 '19. The improvement in sales allowances was most pronounced in North America, where we experienced significant logistics and warehouse issues, and came as a direct result of the steps we took to address these operational issue -- these -- sorry, these operational challenges throughout 2020. Furthermore, the significant improvements were made despite a relative increase in our sales in Europe, which typically has higher sales allowance rates. Another important contributor to revenue growth and improved gross margin was the increase in other revenue, which grew $24.4 million or 76.5% to $56.3 million. This quarter, we provided further details on the primary components of other revenue: digital games revenue and entertainment and licensing revenue in our financial statements and MD&A. Other revenue growth was largely attributable to the 405% increase in digital games revenue to $31.8 million, primarily from in-app purchases in Toca Life: World and growth in the Sago Mini subscription platforms. Entertainment and licensing revenue was $24.5 million for the quarter, down 4.3%. Gross profit for the quarter was $241 million or 49.1% of total revenue compared to $226.1 million or 47.8% of total revenue last year. This 130 basis point increase in gross margin was the result of lower sales allowances and higher digital games revenues, partially offset by a change in product mix to lower gross margin products, such as outdoor Games & Puzzles and higher closeout volume in the quarter compared to last year, directly related to our goal to reduce inventory levels. SG&A decreased 570 basis points in Q4 compared to last year. As a percentage of total revenue, SG&A was 43.2%, down from 48.9%. The reduction in costs was primarily related to lower distribution costs. Distribution costs declined by approximately $24 million to 4.6% compared to 9.8%. This sharp decline was a direct result of all the initiatives we implemented to remediate the operational issues arising in 2019. In Q4, we recorded adjusted net income of $14.6 million or adjusted diluted EPS of $0.14, over $22 million better when compared with an adjusted net loss of $7.8 million or a loss of $0.08 per share in Q4 '19. Adjusted EBITDA was $51.5 million in the quarter compared to $6.7 million. EBITDA margin was 10.5%, up 910 basis points from 1.4%. Free cash flow in Q4 was $123.7 million compared to negative $19.3 million. Turning now to our full year 2020 performance. I will call out a few key items. Sales allowances for 2020, as a percentage of gross product sales, were 12.8%, down from 13.5%. At the end of H1 2020, sales allowances were 250 basis points -- were up 250 basis points compared to H1 2019, but ended 2020 70 basis points down. This highlights our strong sell-through and improved operational performance, which drove lower markdowns and noncompliance charges. Other revenue increased by 31.5% to $155 million. Higher digital games revenue of $76.8 million, which nearly tripled compared to 2019, was offset by lower entertainment and licensing revenue, which declined 14.7% to $78.2 million. Gross margin represented 46.3% compared to 49.6%. The decrease in gross margin was a function of product mix, closeouts of excess and obsolete inventory and higher freight costs, especially in the first half of 2020, which more than offset the benefits of lower sales allowances and higher digital games revenue in the second half of the year. SG&A decreased by $10.9 million or 1.7%. Lower marketing and distribution costs more than offset higher administrative expenses. 2020 was an anomaly from a marketing spend perspective as we spent less than 9% of our revenue, driven by a focus on fewer items in the COVID world. Our marketing ROI was double the rate of previous years with significantly higher sell-through. In 2020, we will be back at the traditional 10% marketing to revenue ratio by supporting more brands and going deeper in core brands compared to 2020. Adjusted net income for 2020 was $53.4 million, with adjusted diluted EPS of $0.51 compared to $92.8 million or $0.90. From a tax perspective, we generated an income tax recovery of $36.1 million in 2020. This comprised a one-time $33.3 million recovery arising from an internal transfer of intangible property in Q1. Excluding this one-time recovery, the effective income tax rate for 2020 was negative 29.8% compared to 24.4% in 2019, driven by jurisdictions, where pretax income or losses arose, which generated a net tax benefit of approximately $2.8 million in 2020. Adjusted EBITDA for 2020 was $180.6 million, a decline of $38 million over 2019. Adjusted EBITDA margin was 11.5% compared to 13.8%. The year-over-year decline in profitability was primarily caused by the carryover of operating issues arising in 2019 Q4, which continued into 2020. We estimate that the impact on 2020 adjusted EBITDA relating to these operational issues was approximately $50 million, of which $40 million was felt in H1. We are very pleased to have seen significant improvement in the second half profitability with H2 2020 adjusted EBITDA at $191 million, up $35 million or 22% over H2 2019. Free cash flow for the year, including changes in net working capital, was $232.1 million compared to only $4.7 million in 2019. The increase in free cash flow is primarily attributable to significantly higher cash flow from operations, driven by the reduction in core working capital. Core net working capital for 2020 was 13.1% of revenue compared to 21.5% last year. Inventory was down from $185 million in 2019 to $102 million at the end of 2020, and we ended the year with very clean inventory, both in our warehouse and at the retail. This strong performance allowed us to end 2020 with $321 million in cash compared to $115 million. With this ample liquidity and very strong balance sheet, we are well positioned to take advantage of strategic acquisition opportunities. Turning to our outlook, we are reinstating guidance for 2021 following the withdrawal of guidance in March '20. As discussed, our focus was to be structurally well-positioned by the end of 2020 to be able to enter 2021 at a run rate that allows for a return close to or at our historical performance levels. I'm pleased to say, we achieved our goals and are entering 2021 with strong operational momentum. As a reminder, our guidance cycle is phased over the course of each year in line with our reporting: today, May, August and November. At each stage, we revisit our guidance with increasingly solid data based on the flow of orders and shipments. With respect to COVID, we'll continue monitoring the environment very closely and assess the impact of Spin Master as information becomes available. For 2021, we expect gross product sales to grow low to mid-single digits. In terms of phasing, we expect the split between revenue to be 32% to 34% H1 and 66% to 68% H2. In terms of our domestic versus FRB mix, we expect that to be around 50-50 for 2021. We are introducing a new guidance metric for 2021. This new metric, total revenue, incorporates revenue from digital games and entertainment. We expect 2021 total revenue to increase mid- to high single digits. From a profitability perspective, we expect 2021 adjusted EBITDA margin to be mid- to high teens. In addition, we expect depreciation and amortization to be up approximately $18 million compared to 2020. Of that, $16 million results from more deliveries of entertainment content. We expect interest expense to remain in line with last year, and our effective tax rate to be between 24% and 25%. We expect capital expenditures of approximately 5% to 6% of revenue. To conclude, as we look to the balance of 2021, our team is fully aligned, and we remain deeply committed to disciplined cost management, operational efficiency and productivity gains as we set the foundation for a return to even further growth and margin improvement. We will continue the momentum we developed in 2020, leveraging the significant improvements in our operations to propel us forward to 2021 and beyond. We continue to believe in our long-term financial framework, and that at its core, our formula for innovation and growth across toys, entertainment digital games is stronger than ever. That concludes the formal element of our call. We'll now be pleased to take questions. Operator, please open the line. ================================================================================ Questions and Answers -------------------------------------------------------------------------------- Operator [1] -------------------------------------------------------------------------------- (Operator Instructions) Our first question comes from Brian Morrison with TD Securities. -------------------------------------------------------------------------------- Brian Morrison, TD Securities Equity Research - Research Analyst [2] -------------------------------------------------------------------------------- Maybe start with Ronnen, I want to talk about the digital initiatives. You've seen this big uptick on Toca Life and you guide for it to continue its upward trajectory. I heard the prepared remarks, but maybe, you can just update us, what's the next iteration to build on this success? Is it more depth within the current apps and services such as Toca Life or is there expanded breadth? I guess, I'm just trying to get, what are the means of your 40 million users to build on this momentum? Could you see some decline in users as the pandemic eases? And then lastly, can you just update us what the geographic breakdown is of the digital contribution? -------------------------------------------------------------------------------- Ronnen Harary, Spin Master Corp. - Co-Founder, Co-CEO & Director [3] -------------------------------------------------------------------------------- Yes. Sure, Brian. Thanks, and nice to hear your voice. I think, the one thing that became very evident this year is that Toca Life is -- its been game that's been out for now over 3, 4 years. And the thing about the Games as a Service business is that you're constantly able to iterate within the game and constantly put out new and fresh aspects to the game. So when you look at our product roadmap, every couple of months, we add a new crater tool or a new place for kids to visit in the game or a new destination. And so, the game is just -- it's like an ever-expanding universe. It's not like traditional games when we grew up, you played the game and whatever was in the box, whatever you got is what you got. This is a live service that we're giving to children. And they're able to enter it for free. And then, as they spend more time in the universe, they're able to add-on different packs that they want to buy for $1.99 or $4.99 or $3.99. And so, the game has just gotten better, and it's just gotten a lot richer. I wouldn't even call it a game. I'd call it -- it's a creative universe for kids, and it's a way for them to interact and actually create their own stories. And what we saw coming into August and September was there was a crazy amount of people that were actually filming themselves with -- playing in the game and then uploading it to TikTok. And that exposure and the expansion of the game really start to increase the amount of users that were in the world. And so, if you look at things like world blocks, you look at things like Minecraft, Toca Boca Life is similar in the sense that it's an evolving game that just gets better over time. And so, that's what the team is constantly looking to do is bring out freshness and newness within that universe and within the game. And I think, there's a multiplier effect that happens when you have that many people seeing the product, playing with the product, telling their friends and it's just -- there's a bit of a -- there's a multiplier effect. And also, there's a multiplier effect when you have that many people coming in to play the game. And so that's with Toca Life. And then we're very excited with Toca Days, which is going to be our first ever multiplayer game for mobile. So kids can actually play together similar to the way they play in rolled blocks and in these metaverses. And the interesting thing that I talked about earlier, Brian, was just how kids are playing games now. But not only are they're playing, but they're actually socializing in these metaverses and they're using these games to tell stories and share experiences with their friends. And so, Toca Days is really our way to enter into this whole social way that kids are actually interacting today and doing it in our own Toca Boca way. And then the last thing is that, the nice thing is that it's very hard to launch games and to get audience today. But once you have a large user base, it's kind of like a moat. And so, at least you're able to get trial for your games like Toca Days. -------------------------------------------------------------------------------- Mark L. Segal, Spin Master Corp. - CFO & Executive VP [4] -------------------------------------------------------------------------------- And Ronnen, just talk about the global nature that Brian asked from the... -------------------------------------------------------------------------------- Ronnen Harary, Spin Master Corp. - Co-Founder, Co-CEO & Director [5] -------------------------------------------------------------------------------- Yes. Sorry, Brian. Brian, were you able to hear me okay? -------------------------------------------------------------------------------- Brian Morrison, TD Securities Equity Research - Research Analyst [6] -------------------------------------------------------------------------------- Perfectly. -------------------------------------------------------------------------------- Ronnen Harary, Spin Master Corp. - Co-Founder, Co-CEO & Director [7] -------------------------------------------------------------------------------- Okay. Fantastic. And in terms of the -- we can maybe share that with you guys in the future. It is -- Toca Boca is extremely global. I think, its remarkable, it's remarkable. Let us come back to maybe in the investors -- on Investor Day on the 9th, we can give you a little bit more detail on the global breakdown. The majority -- there's -- I wouldn't say the majority. I mean, I'd say, under 50% in the United States, so it is very much a global, global brand. I mean I'd probably say that it's bought and played in over 100 countries around the world, but let us get back to you on that. -------------------------------------------------------------------------------- Mark L. Segal, Spin Master Corp. - CFO & Executive VP [8] -------------------------------------------------------------------------------- Yes. Ronnen, just specifically, Brian, Sago Mini, just as a data point, is played in over 170 current -- countries currently. But we'll provide you more data on March 9, as Ronnen said. -------------------------------------------------------------------------------- Brian Morrison, TD Securities Equity Research - Research Analyst [9] -------------------------------------------------------------------------------- Okay. And then, Ronnen, the DC optimization, well done on making the necessary changes. I think you said you're down to 4 now, your prior target was 5 in terms of DC's. Are there more opportunities now that you're uncovering now that you've made the success? And you need -- are you where you need to be on this initiative? Is there more room to go here? -------------------------------------------------------------------------------- Ronnen Harary, Spin Master Corp. - Co-Founder, Co-CEO & Director [10] -------------------------------------------------------------------------------- No. I think -- first of all, thank you. It was a lot of hard work, and the team did an amazing job. And Paul Blom, my partner on this initiative, he did a great job. So I would say that -- I would say, I think we're where we need to be. I think we're where we need to be, and I think that we're going to continue to work with DCs and strengthen our relationships and prepare ourselves for this ever-evolving landscape with e-commerce. -------------------------------------------------------------------------------- Brian Morrison, TD Securities Equity Research - Research Analyst [11] -------------------------------------------------------------------------------- Okay. And then, in the interest of time for others, Mark, just one last quick one. Your cash resources, obviously, they're a war chest here. Is there anything outside of M&A opportunities that you might consider like a return of capital such as a special dividend or is there just too many organic opportunities out there? -------------------------------------------------------------------------------- Mark L. Segal, Spin Master Corp. - CFO & Executive VP [12] -------------------------------------------------------------------------------- Brian, not at this time. We have an evolving M&A strategy, and we feel very confident in that M&A strategy, particularly as we continue to focus now even more so on digital games and the entertainment area. So we're going to play out our M&A strategy, and we see a lot of opportunities there. If -- in a couple of years, if this doesn't actually work out for us, and we're sitting with significant excess cash, then we'll have to have a discussion about a special dividend or something along those lines, but that's not on the horizon at this point. -------------------------------------------------------------------------------- Operator [13] -------------------------------------------------------------------------------- Our next question comes from Sabahat Khan with RBC Capital Markets. -------------------------------------------------------------------------------- Sabahat Khan, RBC Capital Markets, Research Division - Analyst [14] -------------------------------------------------------------------------------- Just a question on the margin guidance that you provided, the range is pretty broad from mid to high teens. Can you maybe share some thoughts on what you need to do to get to the high end of the margin guidance range? And in what scenario would you be sort of at the low end? -------------------------------------------------------------------------------- Mark L. Segal, Spin Master Corp. - CFO & Executive VP [15] -------------------------------------------------------------------------------- Okay, Sabahat. Thank you. Look, we typically talk to around 7 levers when we talk about our margins. I just want to say, we gave you the guidance range. At this point, it's early in the year. We have to be measured. And so, I would say, the midpoint of that range is something that we'd be targeting as a reasonable point at this time of the year. But typically, we look at pricing as a key option. We look at our mix of products, and particularly, where we own the IP. And we look at sales allowances as an area that we focus on. We did very well in Q4, as you saw. We had strong sell-through. We had lower markdowns as a result of that. Our operational infrastructure improvements have driven significant reductions in noncompliance charges, and that's a big impact on margins as well. We also look at L&M income, entertainment income with a PAW movie coming up. And then, digital games is an area which drives significantly accretive revenue when we're able to generate that. And so when you combine that with all of our productivity initiatives on COGs, strategic sourcing, volume rebates, reengineering and our continued focus on operating efficiencies and overhead costs and driving operating leverage, those were all the factors that we considered when we increased our guidance for 2021. And those are the things that will continue to either drive us towards the low end of the range, the midpoint of the range or the high end of the range. It's a little bit early to be too specific at this point. -------------------------------------------------------------------------------- Sabahat Khan, RBC Capital Markets, Research Division - Analyst [16] -------------------------------------------------------------------------------- All right. Great. And then just on PAW Patrol, you shared some color earlier on some of the trends you're seeing into Q1. Can you maybe talk about how you expect that franchise to evolve this year? There seems to be a bit of variance in U.S. versus international trends. Maybe some color on what caused that? And then, I guess, for this, should we really expect most of the growth in, I guess, call it, Q3 around the movie launch? How should we think about that platform? -------------------------------------------------------------------------------- Mark L. Segal, Spin Master Corp. - CFO & Executive VP [17] -------------------------------------------------------------------------------- So I'll give you some POS and other specific data, and then I'll pass it back to Ronnen to give his views on the overall franchise and the movie. But if you look at PAW Patrol, PAW Patrol was a very interesting situation in 2020. There's really 5 key points that you have to understand. Firstly, at the end of 2019 -- Q4 2019, we shipped in too much into the U.S., and we landed up with heavy end of the year retail inventory at the end of 2019. So we had to carefully manage our sell- in 2020 and also manage our media spend very carefully. Throughout the year, COVID hurt PAW as many gifting occasions like birthdays were lost, especially in the second and third quarters. In the fourth quarter, higher price point items did very well. But less than $10 price points did not do well because those tend towards more impulse shopping opportunities, and those lagged in the U.S. The interesting thing is that the decline in PAW, from a shipments perspective, really only affected the U.S. In the Rest of the World, PAW was up strongly in Europe, in Australia, in Canada and all other regions. So it was a little bit of a tale of 2 stories, but we feel pretty confident in PAW for 2021. Current POS is very strong, up 18% in the U.S. and up 24% currently. And so we are excited about PAW for 2021, especially with the movie coming up. Ronnen, would you like to comment on that? -------------------------------------------------------------------------------- Ronnen Harary, Spin Master Corp. - Co-Founder, Co-CEO & Director [18] -------------------------------------------------------------------------------- Just briefly, I mean, we're -- Sabahat, we're very fortunate to have very beloved characters. And our strategy since the beginning has been to constantly tell new and innovative stories with those characters, and we're going to continue doing that. And we're now doing that in the traditional PAW Patrol. We do it with 2 new themes every single year. And as you saw with Dino, Dino Rescue, I mean, it was super innovative. How do you bring together rescue pups and dinosaurs together and tell that story without bearing too far from the tone on what the franchise is all about, and the team did an exceptional job with that. And now, you have the third -- what I call the third aspect to how we tell stories with these beloved characters, which is bringing them to the big screen and telling an 80-minute long-format fully produced movie, and that's the third way that kids can actually enjoy their beloved characters. And so you're going to continue to see us plan all 3 of those areas. The traditional PAW Patrol, the themes on television and then the movie. And we're going to continue that year in, year out and really entertain kids in all those formats and make sure that PAW is very visible and the stories are rich in their currents and they're relevant to today. And so that's our long term, and we're going to do that year in, year out and really entertain the kids. -------------------------------------------------------------------------------- Sabahat Khan, RBC Capital Markets, Research Division - Analyst [19] -------------------------------------------------------------------------------- Okay. And just maybe, Ronnen, continuing with you on the entertainment side, whether it be the PAW Patrol movie or the DC Comics license, just with some of the theater closures and things like that, how are you guys thinking about maybe backup plans, perhaps doing what some of the other entertainment companies have done? And also, have there been any discussions with DC Comics on maybe extending the terms of your license, given that there just wasn't a big movie audience in the last, I guess, year and over the course of this year? -------------------------------------------------------------------------------- Ronnen Harary, Spin Master Corp. - Co-Founder, Co-CEO & Director [20] -------------------------------------------------------------------------------- Yes. I mean we're -- we started this relationship with DC, and I think that everybody is very happy with the results. I'm very happy with the POS and the total sales. The team has done an incredible job with the line. And I think the consumer is really appreciating the newness and the freshness to it. And so we've gone into this partnership with DC with a long-term lens. And that's our goal is to be long-term partners with them. We'd like to be partners with them for life. So that's our goal and we'd love to execute on that. And we're understanding with movies, things change and the environment changes and movies come early and they come late. And so we just have to be good partners with them. And -- but we're looking at this relationship for the long term. We always want to be a partner of DC. We don't want to go in and out of this relationship. It also takes a long time for the teams to gel together. And we also have Wizarding World now, which is fantastic. So that solidifies our relationship even deeper. And in terms of the movies and stuff like that, what's going to -- it's still too early to call what's going to happen. But there's lots of options on the table, whether or not it's theatrical or a combination of theatrical and PVOD, but there's lots of options on how we can actually get the PAW movie out to the consumer come August. And we're very keen in on that date and not wavering from it. -------------------------------------------------------------------------------- Sabahat Khan, RBC Capital Markets, Research Division - Analyst [21] -------------------------------------------------------------------------------- All right. Good. And if I could just squeeze one last one in, maybe for Mark. We just heard some commentary from other consumer companies on some congestion at ports. Can you maybe share any color? Are you hearing anything like that or a distribution channel is generally okay for you? -------------------------------------------------------------------------------- Mark L. Segal, Spin Master Corp. - CFO & Executive VP [22] -------------------------------------------------------------------------------- Sabahat, yes. Just to add one point before I answer that, to what Ronnen just said, on the Batman movie, just to be clear, that is moving to 2022, Sabahat, which is within our license window currently, just to complete the question there. So no, no issues on that front. With regard to congestion and shipping, yes, it's an industry-wide issue. It's not specific to any one sector. We are seeing that as well. It's come from a reduction in shipping capacity in the market and also waiting times and unloading times of ports have increased due to much larger ships that are carrying more containers. And so, that is actually causing some congestion and inflation right now. We did expect some of that in 2020 when we were planning for 2021. But to the extent that it continues for the rest of the year, there might be some impact on margins for us and for everyone else because the rates are up right now around 20% compared to where they were about 6 or 8 months ago. -------------------------------------------------------------------------------- Operator [23] -------------------------------------------------------------------------------- Our next question comes from Adam Shine with National Bank Financial. -------------------------------------------------------------------------------- Adam Shine, National Bank Financial, Inc., Research Division - MD, Head of Montreal Research & Research Analyst [24] -------------------------------------------------------------------------------- Maybe, I'll start with Ronnen, building on some of the Sabahat questions. On the entertainment front, we heard a lot a week or so ago from Mattel and Hasbro really looking to accelerate their exploitation of their IP. I imagine, you'll speak a bit more to this, Ronnen, maybe next week at the Investor event. But can you speak about at all some of the effort to maybe accelerate some of the activity on the entertainment side moving ahead? And then, for Mark, a couple of questions. But just on the back of the entertainment one, you've given some additional detail on depreciation and amortization related to entertainment. But is there any further accounting metrics you can provide us with or sort of guide us on in regards to how to properly account maybe in H2 for that PAW Patrol movie? And then, I'll circle back, Mark, if you don't mind for a few more guidance questions. -------------------------------------------------------------------------------- Ronnen Harary, Spin Master Corp. - Co-Founder, Co-CEO & Director [25] -------------------------------------------------------------------------------- Our approach is slightly different to some of our competitors. But we have -- and as we've been saying to you guys for years, and we've always been working on a rich pipeline and developing new television shows and bringing them out. So we actually have shows that are greenlit and that are in production, that are coming out in the future. And so we'll be sharing that with you guys. I don't know if we'll share it with you guys in March 9, specifically what they are. But I can tell you that the pipeline is robust and the slate of development properties is robust. And we're looking to always greenlight 1 to 2 new properties every single year. And so, I would say an acceleration would be to try to get to that 2 new properties a year would be an acceleration for us, over and above keeping all the existing properties maintained and fresh in the marketplace. And then, I would say the other thing that -- is I'm very proud of the team is the ability for us to produce our first ever feature film. And I think it's really important for everybody to understand that are actually producing the film. We didn't license the film out to Universal or Paramount and take a royalty on it. Our team, internally in Toronto, produced the films. We hired the writers, we hired the directors. We casted -- we did the whole casting with all that amazing voice talent for PAW Patrol. We got the stars. We found the best people in the industry to do the music. You guys are going to love that. I will tell you more on March 9, who's singing the main song for the movie. So the team's really proud of them to actually to go to a different aspect of storytelling and produce a full animated feature film. And so, in terms of increasing our output, you will see more films coming from Spin Master in the future. And I think that gives us a whole new way to actually entertain kids, which we've never had before in the past. And that gives us just -- it's an extra quiver or extra arrow in the quiver. I think that's more about the -- I wouldn't call it acceleration, I would say, more consistency and also now diversity in how we can act. -------------------------------------------------------------------------------- Mark L. Segal, Spin Master Corp. - CFO & Executive VP [26] -------------------------------------------------------------------------------- Adam, in terms of your question around accounting for the movie, just in general, if you recall, when we actually produce entertainment content, what we do is we capitalize it, and it sits on our balance sheet until we deliver it and then we amortize it. Up until this point, we've only done TV shows and we deliver those TV shows in episodes, and we amortize proportionately. There's not a real difference as it relates to the movie, except that it's more condensed in the sense that there's one delivery as opposed to 26 episodes of delivery. So we've been capitalizing the cost of the production onto our balance sheet. And then when we deliver it, we will amortize that. And then in addition to that, we'll have receipts from the movie in terms of our deal with Paramount. We also have licensing and merchandising income that flows in. We'll have toy sales. Obviously, that will continue to go in. And most of that will actually happen in Q3. And so, what I'm going to suggest we do is that maybe Sophia can work with you offline, together with you and all your -- all the other analysts to make sure that your models accurately reflect what's going to be happening in Q3 as it relates to the accounting, but that's the principle in general. -------------------------------------------------------------------------------- Adam Shine, National Bank Financial, Inc., Research Division - MD, Head of Montreal Research & Research Analyst [27] -------------------------------------------------------------------------------- Great. And then, just in terms of some of the guidance elements, I mean, with the marketing spend moving up towards 10% as you alluded to, Mark, it sort of speaks to the fact that there's going to be some, let's call it, efficiencies elsewhere in the mix. We know that distribution, as you called out $50 million of additional spend in 2020. So maybe I'll push you a little bit on that. Is that a metric per revenue that ultimately is destined to go back towards the 2018 level where we go to 4% or maybe even lower. And then as well, when I think about the other key lever notwithstanding some of the other 7 levers you sort of hinted at before. But the other lever being gross profit with some of the benefits you alluded to coming out of other revenue. By implication, gross profit margin, I'm not going to say has to, but it certainly looks very likely to get back to 50% at a minimum. And I don't know if you want to further qualify that. Are we ultimately moving back to a level of gross margin that can push a pointer to above 50%? -------------------------------------------------------------------------------- Mark L. Segal, Spin Master Corp. - CFO & Executive VP [28] -------------------------------------------------------------------------------- Yes. Okay. So Adam, I mean, the short answer is yes. I mean, that's definitely a level that we've achieved in the past and that we want to meet and beat. So the gross margins that we've seen in the 40s are not numbers that we're happy with or satisfied with in any way. And so we want to be at 50% or even higher, and that is going to be a big driver of increased profitability in 2021. In addition, we see our distribution costs coming down. We're entering with a strong run rate, and we feel very comfortable about our distribution infrastructure. It will tick up a little bit compared to 2018, for example, because we do have a higher European footprint and the costs in Europe were a little bit more. So we will see some mix shifts happening in distribution. In the case of marketing at 10%, we see us driving a stronger ROI on that 10% than we have in the past. If you look at what we did in 2020, we spent less, but we actually generated a very strong ROI, and we've retooled our marketing group, and we're much more nimble, much more agile now, much more able to move more quickly and drive spend to where it needs to go. And so we're comfortable that at the 10% level, we'll drive even better sell-through and better results. In terms of the other costs, we'll obviously be watching our admin costs very carefully, trying to drive as much operating leverage as we can. Product development costs will stay at around 2% of revenue. No major change. And then you've got the selling costs, which are purely variable and are driven off of our mix and licensing mix. So I don't see any major changes on those fronts. But hopefully, between higher gross margin and all the other factors I mentioned, we'll be able to get our adjusted EBITDA margins back to where we were historically and hopefully even better as the years progress. -------------------------------------------------------------------------------- Adam Shine, National Bank Financial, Inc., Research Division - MD, Head of Montreal Research & Research Analyst [29] -------------------------------------------------------------------------------- And if I may, I just saw admin because you did bring it up. I guess, it ticked up a little bit higher in 2020. Certainly, it looked as though there were some consultancy fees that help elevate that at a minimum in the Q4. Is that something that we'll likely see more of or that was just a function of some of the retooling in regards to the reorg that Ronnen sort of spoke about and perhaps, I don't know, anything related to resolving some of those remediation issues? -------------------------------------------------------------------------------- Mark L. Segal, Spin Master Corp. - CFO & Executive VP [30] -------------------------------------------------------------------------------- Adam, we are investing in people to drive further growth, but we're also looking at operating leverage. We have a significant ability to grow our sales footprint without adding any additional people, particularly in our 28 offices around the world. The one thing to keep in mind in 2020 was the approximately a $6 million legal settlement that is sitting in admin costs, which was added back for adjusted EBITDA, but is sitting in those costs and some incremental recruiting and consulting costs that we incurred in 2020, which will not be repeating in 2021. So overall, I'm comfortable that our admin costs are within the range that we need them to be. And as I said to you, we continue to focus on driving as much leverage as we can. -------------------------------------------------------------------------------- Operator [31] -------------------------------------------------------------------------------- Our next question comes from Jaime Katz with Morningstar. -------------------------------------------------------------------------------- Jaime M. Katz, Morningstar Inc., Research Division - Senior Equity Analyst [32] -------------------------------------------------------------------------------- I'm hoping you guys can help us think about capital demands of the business and how that might trend over time. So I think, when we look at CapEx, it obviously bumped up pretty significantly. But as we think longer out, what sort of level should we think about is really required to protect the company's competitive position? -------------------------------------------------------------------------------- Mark L. Segal, Spin Master Corp. - CFO & Executive VP [33] -------------------------------------------------------------------------------- Typically, we've guided to around 5% to 6% of revenue for CapEx. About 2/3 of that relates to entertainment and the remaining 1/3 relates to toy and digital gaming, most of it being toy. I would say to you that's a reasonable level for 2021. Looking forward, that might tick up towards the 6% level more consistently. As we grow our entertainment footprint, we'll spend more on CapEx. Our tooling for the toy business won't change dramatically. But what we are starting to see is as our digital games business grows, we are investing more into digital games. And so there might be increased spend on digital games driving a slightly higher CapEx rate. But I think for your models, for 2021, stay with 5% to 6%, and then in the longer term, may be trending more towards the upper end of that range. -------------------------------------------------------------------------------- Jaime M. Katz, Morningstar Inc., Research Division - Senior Equity Analyst [34] -------------------------------------------------------------------------------- Okay. That's really helpful. And then as we think about the RC and Interactive Characters business getting largely consolidated, it looks like into that girls business. Does that imply to us that this is sort of a new base level for Hatchimals going forward, or can you talk a little bit about maybe how you're thinking about reinvigorating demand there so that it grows sort of more quickly back to historical levels? -------------------------------------------------------------------------------- Mark L. Segal, Spin Master Corp. - CFO & Executive VP [35] -------------------------------------------------------------------------------- Well, just keep in mind, we've seen a major unwind in Hatchimals over the last 2 years from the levels that we saw in 2018. In 2019, if you remember, Hatchimals was down over $230 million. In 2020, it was down another $70 million, and that dragged down the RC category quite significantly and our overall sales for that matter. But we see Hatchimals at a level now where any further decrease will not be material to our overall business numbers. And we're continuing to focus on building the line, both the low price points and high price point, Hatchimals Crystal Flyers did very well in 2020. It was sold out. We actually were out of stock, and we couldn't get enough. But it's still a meaningful part of our business, but certainly not to the levels that it used to be before. Ronnen, would you like to add anything to that? -------------------------------------------------------------------------------- Ronnen Harary, Spin Master Corp. - Co-Founder, Co-CEO & Director [36] -------------------------------------------------------------------------------- No. I think that's fine. -------------------------------------------------------------------------------- Operator [37] -------------------------------------------------------------------------------- Our next question comes from George Doumet with Scotiabank. -------------------------------------------------------------------------------- George Doumet, Scotiabank Global Banking and Markets, Research Division - Analyst [38] -------------------------------------------------------------------------------- Congrats on a strong quarter. I had 2 questions I wanted to ask you guys about GPS guide of low to mid-single digits. Just wondering, within that guide, is there anything embedded for outperformance or underperformance within our toy segments or do you see that as pretty homogeneous? -------------------------------------------------------------------------------- Mark L. Segal, Spin Master Corp. - CFO & Executive VP [39] -------------------------------------------------------------------------------- When you say outperformance, just to clarify specifically what you meant, please? -------------------------------------------------------------------------------- George Doumet, Scotiabank Global Banking and Markets, Research Division - Analyst [40] -------------------------------------------------------------------------------- Yes. I think, you guys guided for like low to mid-single digits. So I'm wondering, what fuels your one segment materially above that and one materially below that, or do you expect all the segments to kind of be within that kind of bracket? -------------------------------------------------------------------------------- Mark L. Segal, Spin Master Corp. - CFO & Executive VP [41] -------------------------------------------------------------------------------- Yes. So when we guide our GPS, George, we typically don't guide below that level in terms of the individual product groupings that we publish. So what I would say to you is that we look at our business as a portfolio, some up and some down. And so overall, our guidance is for low to mid-gross product sales for the toy business. And there will be things that go up and there will be things that go down, and that's just the nature of the industry that we're in. But that's on a blended basis, portfolio basis, the way that we see the business moving for 2021. -------------------------------------------------------------------------------- George Doumet, Scotiabank Global Banking and Markets, Research Division - Analyst [42] -------------------------------------------------------------------------------- Okay. And it was a pretty impressive working capital reversal in the quarter. Can you talk to that a little bit in terms of kind of the inventory levels? And how should we think of that moving into 2021? -------------------------------------------------------------------------------- Mark L. Segal, Spin Master Corp. - CFO & Executive VP [43] -------------------------------------------------------------------------------- Yes. So 2020 was an unusual year because we ended 2019 with exceptionally high inventory and also the receivables were higher than normal. And so we spend a tremendous amount of time as a management team focused on net working capital. The sales and the operations and the finance teams all work together really closely to bring inventory levels down from $185 million to just over $100 million at the end of 2020. And in terms of our overall core net working capital percentage, we landed up at 13.1%. We also brought accounts receivable down nearly $80 million year-over-year. So in all aspects, we focused very clearly on generating free cash flow, which was a very significant underperforming area in 2019, and I think we did a stellar job as a company in achieving our goals. Going forward for 2021, I think you should be modeling around the same levels. I think it would be unrealistic to assume we could generate anywhere close to the kind of improvements that we saw last year going forward. So I would say to you, around the 13%, 13.5% core working capital as a percentage of sales would be a reasonable metric to look at. -------------------------------------------------------------------------------- George Doumet, Scotiabank Global Banking and Markets, Research Division - Analyst [44] -------------------------------------------------------------------------------- Okay. And maybe one last one for Ronnen. The appetite for a larger acquisition in the digital gaming space, is that a potential we can see -- something you can see this year as mainly like smaller and kind of nurtured philosophy that we saw with Toca? -------------------------------------------------------------------------------- Ronnen Harary, Spin Master Corp. - Co-Founder, Co-CEO & Director [45] -------------------------------------------------------------------------------- Yes. I -- we're open to different things, but I think that our strategy and approach is going to be focused on smaller studios that are out in the marketplace and smaller products that they have that can be brought into the fold. We're looking for great products with amazing studios with really good talent. And there's a lot of them out there and talent studios that can benefit from our large network. And also our expertise now that we're starting to build -- we're not starting, but we're getting deeper into, which is acquiring users and being able to acquire users for a low cost. So I think that focusing on smaller acquisitions and doing more of them is probably a better approach for us than buying larger, bigger studios that come with a lot of complexity to them. So I think that we're slow and steady, but very focused on the area. -------------------------------------------------------------------------------- Operator [46] -------------------------------------------------------------------------------- Our next question comes from Gerrick Johnson with BMO Capital Markets. -------------------------------------------------------------------------------- Gerrick Luke Johnson, BMO Capital Markets Equity Research - Senior Toys and Leisure Analyst [47] -------------------------------------------------------------------------------- Great. Mark, I think, you're very detailed in your outlook for 2021, so I appreciate that. One line I didn't hear, I mean, I may have missed it, was your forecast for sales allowances. What would that be? -------------------------------------------------------------------------------- Mark L. Segal, Spin Master Corp. - CFO & Executive VP [48] -------------------------------------------------------------------------------- Thanks, Gerrick. Typically, Gerrick, we've historically operated in the 10% to 12% range. I think for 2021, we'll be towards the upper end of that range, but below 12%, is our goal. -------------------------------------------------------------------------------- Gerrick Luke Johnson, BMO Capital Markets Equity Research - Senior Toys and Leisure Analyst [49] -------------------------------------------------------------------------------- Great. That's very helpful. And then, I have a couple more here. Selling, marketing, distribution and product development, that was probably the biggest surprise -- positive surprise relative to our model. You did discuss distribution. But I was curious about product development with a lot of the projects that you have going on. How did that trend? And how are you looking at that in 2021 on the product development side? -------------------------------------------------------------------------------- Mark L. Segal, Spin Master Corp. - CFO & Executive VP [50] -------------------------------------------------------------------------------- Maybe, Ronnen, I'll go first numerically, and then you can jump in with any context. Gerrick, typically, our product development costs are around 2% of sales. Keep in mind, though, that's not our full R&D spend. It's important to understand that because part of our product development spend is variabilized through our inventor royalties, which actually sit in our selling expenses. But in terms of the straight numbers that you see on the P&L, around 2% is the range that we will continue to operate in. I mean, we are continually looking at areas to expand into and think about. But Ronnen, maybe you could comment on that. -------------------------------------------------------------------------------- Ronnen Harary, Spin Master Corp. - Co-Founder, Co-CEO & Director [51] -------------------------------------------------------------------------------- Sure. Gerrick, I just want to make sure I understand your question. You're saying from a qualitative perspective, how is the product development going, or just if you can clarify? -------------------------------------------------------------------------------- Gerrick Luke Johnson, BMO Capital Markets Equity Research - Senior Toys and Leisure Analyst [52] -------------------------------------------------------------------------------- Well, the change in that line was $135 million from $165 million, right? And distribution was down $24 million. So I'm kind of asking, what was product development and how is that trend year-over-year in the fourth quarter? And then what we should anticipate that line trending in 2021? And Mark said it's usually 2%. And I'd assume that's partly period expenses and partly D&A coming through. But anyway, what should we expect for the product development in 2021? -------------------------------------------------------------------------------- Ronnen Harary, Spin Master Corp. - Co-Founder, Co-CEO & Director [53] -------------------------------------------------------------------------------- Gerrick, I can tell you that the team is -- first of all, they're working overtime during COVID to bring the products out, and it's actually a tough environment for them to work in from a creative perspective, but the team is doing an exceptional job. And the team is keeping the pipeline for all the core categories that we're in, and they're keeping them very full and very robust. And I would say, pushing the envelope in terms of freshness, newness, innovation. And I think you guys will enjoy the presentation on next week. So you'll be able to get a glimpse into all the new products that the team has been working on. And I think that will give you a better understanding of everything once you see all the products. -------------------------------------------------------------------------------- Gerrick Luke Johnson, BMO Capital Markets Equity Research - Senior Toys and Leisure Analyst [54] -------------------------------------------------------------------------------- All right. Maybe I'll move on to something a little bit more qualitative and quantitative here. Mighty Express, kind of curious about the performance there. What your expectations are for toy line? And then all 3, a softball, Wizarding World. What are the upcoming planned events that Warner has that will support that, help you guys drive toy sales? -------------------------------------------------------------------------------- Ronnen Harary, Spin Master Corp. - Co-Founder, Co-CEO & Director [55] -------------------------------------------------------------------------------- Gerrick, you can throw us a hardball. You can constantly throw us hardballs. We are used to hard balls. -------------------------------------------------------------------------------- Gerrick Luke Johnson, BMO Capital Markets Equity Research - Senior Toys and Leisure Analyst [56] -------------------------------------------------------------------------------- I usually do. -------------------------------------------------------------------------------- Ronnen Harary, Spin Master Corp. - Co-Founder, Co-CEO & Director [57] -------------------------------------------------------------------------------- I think that Wizarding World is -- the response has been amazing from retail, especially in Europe. They are really, really excited about the product line. So I think this side is really very, very exciting. I think we can share more details with you on March 9 in terms of some of the stuff that Warner Bros. is going to do to support that. But so far, very good from that front. That's really good. And in terms of Mighty Express, Mighty Express is doing well. And it is -- I would definitely say that when you're starting with SVOD, it's a slower build. And we are going to take in a combo approach to this, whereby you have the SVOD and then in certain other markets when Linear comes online, go to Linear. And so you really need to be able to have SVOD, Linear, YouTube, all the channels working together to get you the most amount of exposure before you put the product line into the marketplace. And so we're constantly looking at awareness levels and to make sure that the awareness levels are neat or -- the awareness levels are at a point when it's appropriate and there's enough awareness to put the product into the marketplace. And so that's the key thing that we're focused on is building up awareness and then putting the product into the marketplace, and not doing things based on old ways of thinking because everything has changed so much. So we're being very particular and measured when we actually go out and put the toys into the marketplace plus our other license and merchandising partners. But I'd say the show has been well received, and we continue to drop new seasons into Netflix and the awareness is building. But we're taking -- I would say like this is a -- it's going to take longer than your traditional preschool approach just because of the dislocation between the Linear and SVOD in 2021 in this current state of the market. -------------------------------------------------------------------------------- Gerrick Luke Johnson, BMO Capital Markets Equity Research - Senior Toys and Leisure Analyst [58] -------------------------------------------------------------------------------- Yes. Yes. Okay. And then sorry, I do have one more quantitative question for Mark. Input costs, how they're going to affect you this year? Because Mattel called out 200 basis points of gross margin hit from input costs, and they're the only ones. No other toy company has brought that up, even a little Jakks specific of saying they're not seeing anything. So what are you seeing on input costs? Because from Mattel seeing 200 basis points, I think there's got to be something out there. So what's your comment on that? -------------------------------------------------------------------------------- Mark L. Segal, Spin Master Corp. - CFO & Executive VP [59] -------------------------------------------------------------------------------- Gerrick, we are seeing some emerging signs of some input cost increases in Asia. As I've spoke to the shipping cost element earlier, which I'm not going to repeat. The other element that we're seeing is plastic resin, some inflation in that area. But the point is that, at this point, we don't know if it's sustainable for the full part of the year. And our suppliers have purchased fairly significant quantities in advance based on the order that we've given them. So there might be some impact later in the year and into 2022. I don't think we can quantify it like some of our competitors might have. But there's definitely something there, and we're watching it very closely and looking at ways to mitigate any input cost impact in our margins this year. That's why I also want to be more measured in terms of our margin improvement because there is some elements of inflation that might come in that we cannot contain. So we just have to take a measured approach, and it is early in the year at this point. I think we're going to have time for maybe 2 more questions at most. We want to try and wrap up by 11. Thank you for sticking with us for a longer period of time. -------------------------------------------------------------------------------- Operator [60] -------------------------------------------------------------------------------- Our next question comes from Steph Wissink with Jefferies. -------------------------------------------------------------------------------- Stephanie Marie Schiller Wissink, Jefferies LLC, Research Division - Equity Analyst and MD [61] -------------------------------------------------------------------------------- Most of our questions have been asked, but two, just to tidy up. The first is on games. It was a category that was a point of emphasis a couple of years ago and even last year when we were together at Toy Fair. So if you could just talk about that category, what you're seeing the most recent acquisition of Rubik's? What your plans are for expansion of the games business? And then, secondarily, a number of your key retail accounts, particularly in the U.S., but also in Europe, are really driving omnichannel businesses now with click-and-collect and e-commerce. Can you talk a little bit about how you're supporting those initiatives? How that might change? How you market and merchandise? And what you're doing with some of your big brands can create online stores and really leverage some of those platforms? -------------------------------------------------------------------------------- Mark L. Segal, Spin Master Corp. - CFO & Executive VP [62] -------------------------------------------------------------------------------- Steph, thanks. I'll take the first part of the question, and then Ronnen, maybe you can take the second part. In terms of games, your question on games, Steph, there really are 4 categories to our games business. And the first one is family board and action games, which is actually the largest category. We have a pretty solid market share and our growth outpaced the industry in 2020. So we feel pretty good about that. Then you have family standard games, which is where most of the classics sit. And again, we saw strong sales in 2020 on that category. The third category is adult puzzles. We're 1 of the top 4 manufacturers in that space, but we are the fastest growing. And again, we grew our share in 2020 over 2019. The final category is children's games and preschool games. In that category, we were actually down versus the industry. You saw our overall games in Q4 was not as much as many of you might have expected. So we were actually down against the industry, and that was mainly driven by the softening in licenses that we had. Licenses like Baby Shark, LOL and Toy Story were down. Some of them are more -- tend towards more in-store traffic and impulse purchases. But with new theatrical in 2020 around 0, that was definitely a factor. And we do see growth in 2021 in this area as theatrical licenses expand again. So hopefully, that gives you some color on the Games & Puzzles area. Ronnen, would you like to talk about the omnichannel and marketing? -------------------------------------------------------------------------------- Ronnen Harary, Spin Master Corp. - Co-Founder, Co-CEO & Director [63] -------------------------------------------------------------------------------- Yes, sure. Steph, it's unbelievable because you must be listening in to our board meeting yesterday because half the Board meeting was on this topic. It's unbelievable what's happened in the marketplace. That's -- COVID has definitely accelerated everything. And it's amazing to see each retailer, especially the large ones like Target, Walmart, each react in their own nuanced way. And I can just tell you that our teams are really focused on this change in the way the consumer is shopping and making sure that we're going to market effectively and looking even internally how we're actually organized structurally with our teams and the competencies and capabilities that you really need to be able to win and really connect with the consumer in this digital shopping space. And it's interesting because for us, I mean, the omnichannel is just -- it just means it's everything. It's digital, it's retail, it's foot traffic. And so we're very focused on it. We're very focused on it. We're very focused with each large retailer to bring our unique programs and everything from like looking everything like data leakage to the search and making sure that we're relevant, and we're very focused on it. I think that on March 9, we can actually -- when Laura presents, she can give you a closer look at what we're doing from a marketing perspective on some of our larger brands, to answer your question on that. But we can give you a deeper dive on how we're doing it, if that's okay. -------------------------------------------------------------------------------- Stephanie Marie Schiller Wissink, Jefferies LLC, Research Division - Equity Analyst and MD [64] -------------------------------------------------------------------------------- It is. Looking forward to next week. -------------------------------------------------------------------------------- Ronnen Harary, Spin Master Corp. - Co-Founder, Co-CEO & Director [65] -------------------------------------------------------------------------------- Yes. Looking forward to seeing you too. -------------------------------------------------------------------------------- Mark L. Segal, Spin Master Corp. - CFO & Executive VP [66] -------------------------------------------------------------------------------- Let's make this last question, operator, please. -------------------------------------------------------------------------------- Operator [67] -------------------------------------------------------------------------------- Our last question comes from Martin Landry with Stifel. -------------------------------------------------------------------------------- Martin Landry, Stifel Nicolaus Canada Inc., Research Division - MD of Equity Research [68] -------------------------------------------------------------------------------- Just a quick follow-up on the acquisition front. You have a rising cash balance that gives you increased flexibility. And Ronnen, it seems that it will be a focus view and Anton in 2021 and onwards. So just wondering, if you could talk a little bit about what would be the sweet spot in terms of size for you for acquisitions? -------------------------------------------------------------------------------- Ronnen Harary, Spin Master Corp. - Co-Founder, Co-CEO & Director [69] -------------------------------------------------------------------------------- I'm reticent to comment exactly what the sweet spot is because we're more focused on looking for quality companies with amazing management and focused on that. And the size is -- obviously, we're not -- we have an approach of -- we like to do measured small to medium-sized acquisitions, and we think that's a more of a strategic approach for us. So it's hard for me to comment on the size. And I also think it's -- it differs by create a center. It could be different in games. It could be different entertainment. It could be different in toys. So I wouldn't want to pigeonhole us in any dollar amount. And -- but what I can tell you is that we are very focused on it, and we're spending more time in the area, we're casting the net wider, we're going deeper into each vertical of each creative center, looking at new media, looking at games, obviously toys, traditional toys, looking for tuck-in acquisitions, certain assets like the Rubik's, expand our games business, other things for the activity as part of our business. Is there anything in the entertainment area that sort of new media? So we're going to be casting the net wide. But again, everything is grounded on. We really want amazing teams, amazing individuals. We don't want to be micromanaging companies that we buy. We want to bring in amazing talent. And I think, the incredible thing today is that there is a lot of talented people out there, there's a lot of talented companies. And I think there's a lot of people that want to join Spin Master and join the journey of what we're doing. And we're on the lookout for those talented individuals that have started companies that want to continue staying with their companies. But for -- but want to monetize or feel that it's better to expand and grow with us and want to be around our talent pool and are very passionate about what they do. And I think, that's really the essence of our M&A strategy, which is a very micro version of it, is really looking for the talent out there. And I think the days of -- you bring in companies and you like integrate the companies and all that type of stuff. It's -- yes, it's the place for it, but really the amazing thing that we're seeing in the marketplace is talented individuals that want to join Spin Master that have incredible products and incredible teams that can actually take us into new spaces. So when you look at Toca Boca and Sago Mini, that was -- that is really one of the classic acquisitions model that we'd like to actually emulate with amazing teams in creative new spaces. So it's a -- I gave you a different type of answer, but I hope you're satisfied. -------------------------------------------------------------------------------- Operator [70] -------------------------------------------------------------------------------- And this concludes our question-and-answer session for today. I'll now turn the call over to Mark Segal for closing comments. -------------------------------------------------------------------------------- Mark L. Segal, Spin Master Corp. - CFO & Executive VP [71] -------------------------------------------------------------------------------- Well, thank you, everybody, particularly for staying us -- staying with us for so long. As always, Sophia and I are available to answer any follow-up questions. And we look forward to talking to you on the 9th for our Investor and Analyst Day, and talking more about our product lines and our strategy. So thank you all, and have a great day. Bye. -------------------------------------------------------------------------------- Operator [72] -------------------------------------------------------------------------------- This concludes today's conference call. You may now disconnect.