Spin Master Corp

TSX:TOY

Earnings Call Transcript 2022-Q2

[Operator]

Good day, and welcome to the Spin Master Corp. Second Quarter 2022 Earnings Call. Today’s conference is being recorded.

At this time, I’d like to turn the conference over to Sophia Bisoukis.

[Sophia Bisoukis, VP, IR]

Thank you. Good morning, and welcome to Spin Master’s financial results conference call for the second quarter ended June 30, 2022.

I am joined this morning by Max Rangel, Spin Master’s Global President and CEO; and Mark Segal, Spin Master’s Chief Financial Officer.

For your convenience, the press release, MD&A and unaudited consolidated interim financial statements are available on the Investor Relations section of our website and 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 are reasonable in the circumstances. However, there can be no assurance that such estimates and assumptions will prove to be correct. Many factors could cause actual results to differ materially from those expected or implied by the forward-looking statements. As a result, Spin Master cannot guarantee that any forward-looking statements will materialize, and you are cautioned not to place undue reliance on these forward-looking statements.

Except as may be required by law, Spin Master has no obligation to update or revise any forward-looking statements, whether because of new information, future events or otherwise. For additional information on these assumptions and risks, please consult our cautionary statements regarding forward-looking information in the company’s earnings release dated July 27, 2022.

Please note that Spin Master reports in U.S. dollars, and all dollar amounts to be expressed today are in U.S. currency, unless otherwise noted. I would now like to turn the conference call over to Max Rangel.

[Max Rangel, President and CEO]

Good morning, everyone, and thank you for joining us. As we announced yesterday, Spin Master had a very strong second quarter with revenue growth across all 3 creative centers amidst a rapidly shifting macroeconomic environment.

Our second quarter revenue increased by just under 30%, with Toy revenue growing more than 34%, proving once again the power of our diversified Toy portfolio, including breakthrough innovation, evergreen franchise brands and fan field licensing properties.

Digital games saw revenue gains of over 9% and entertainment grew 3.3%. Combined, this performance showcases the power that can be harnessed by leveraging our 3 creative centers to reimagine everyday play for children around the world.

In addition to growing our top line, we also maintained our focus on operational discipline, resulting in a year-over-year 39% increase in adjusted EBITDA in the second quarter. We were able to navigate through external pressures with supply chain system, raw material cost increases and inflation, while maintaining strong margins and profitability.

We are very pleased with our sustained growth across all creative centers, and I want to thank our more than 2,000 team members globally for their commitment to innovation, collaboration and operational excellence.

Our vision in Toys is to be a global leader by creating play experiences that spark creativity and imagination in kids and families around the world. It’s clear that our portfolio is resonating with children globally as evidenced by our POS performance in the second quarter and year-to-date. I want to share some highlights with you, all of which is sourced from NPD.

Our excellent performance in both North America and international helped us maintain our toy market share position as the fourth largest manufacturer in the quarter in the G9 countries for the third consecutive quarter per NPD. Speed Master continue to grow our POS ahead of the toy industry with a 10% increase in the second quarter compared to the industry at 7%.

In Q2, Spin Master had the second fastest growth rate of the top 5 global manufacturers and was number 4 globally year-to-date through June, up from 5 last year. Spin Master grew 7% year-on-year in the first half compared to the industry, which was up 1% for the first half of 2022 and now Spin Master had the fastest growth rate of the top 5 global manufacturers in the first half.

In North America, POS grew 12% in Q2 compared to the industry at 8%. Internationally, our POS in the second quarter was up 6% compared to the industry at 3%. On a year-to-date basis, we outperformed in North America, a market that grew 7% compared to the industry, which was up 2%. We grew 4% internationally year-to-date, while the market was down 2%.

From a brand perspective, we are very encouraged by our momentum at the retail level and are also pleased to see our POS sales grow in 6 of the 11 super categories that are measured by NPD.

PAW Patrol remains the number 1 preschool property globally. Global POS for PAW Patrol increased 3% in Q2, demonstrating PAW Patrol’s global popularity and reach. We recently launched an exclusive feature length special, Cat Back on Paramount+ together with the theme toy line. Following on the heels of Cat Back is a new PAW Patrol theme this fall, Big Truck Pups, which will air on Nickelodeon with an all-new toy lineup.

Gabby’s Dollhouse continues to be a standout license for Spin Master. Last quarter, we shared that the Gabby’s Dollhouse’s Perfect playset was the number 1 item in the playset Figures and Accessories class in the U.S. And I’m happy to share that the playset maintained its leadership position in the second quarter. Season 5 of Gabby’s Dollhouse featuring 8 new episodes dropped on Netflix just 3 days ago, and we expect continued demand for new toy launches for the line hitting shelves in August.

The final item I want to highlight within Preschool Dolls & Interactive is Purse Pets. It’s amazing to think we launched this collection of interactive fashion purses less than a year ago. It is a great example of Spin Master’s ability to innovate and understand what surprises and delights kids. Purse Pets made NPD’s list of the top 5 new properties in 2021, and continued that leadership as a number 4 new property globally in the second quarter and year-to-date.

In August, we are launching a new collection in collaboration with Sanrio’s Hello Kitty in France, which will continue to drive collectibility and attract a new audience.

In Activities, Kinetic Sand POS grew 7% in Q2, and remains the number 2 brand within the Arts & Crafts category. This fall, we are launching Swirl and Surprise, our most hands-on approach to Kinetic Sand art play, which will actually allow kids to create original sand art.

Our Games & Puzzles category experienced mixed results in Q2. While the pandemic saw the resurfacing of classic titles, consumers are now shifting to new game innovation. We saw softness in Cardinal games, but are encouraged by our POS performance of our core game IP, such as Head Bands, which grew 32%.

Last quarter, I mentioned that we were focusing heavily on Rubik’s and are putting a lot of marketing innovation and global scale behind this popular puzzle. Rubik’s Cube saw strong double-digit POS growth in Q2 and we are launching an innovative line this fall, including Rubik’s Phantom, featuring innovative thermochroic technology that temporarily reveals the tile colors when the cube is touched.

After highlighting Gabby’s Dollhouse, I now want to spend some time on the rest of our license portfolio, which has been performing extremely well. According to NPD, our license portfolio POS was up 46% in Q2. And on a year-to-date basis, Spin’s license portfolio POS was up 44%. We continue to be the number 2 manufacturer for the Wizarding World franchise in the quarter, supported by the latest movie, Fantastic Beast: The Secrets of Dumbledore. We are introducing new dolls and playsets within the line this coming fall, and we will enable loyal fans to expand their collections and imaginative play experiences.

Within Wheels & Action, we have a robust assortment of licensed toy properties, including Batman and DC Universe. According to NPD, global POS for Spin Master’s line of Warner Bros. DC Universe increased 12% in the quarter. The next major theatrical release for the DC Universe is Black Adam, hitting theaters this October, with toys launching early fall.

Monster Jam remains the number 2 property in vehicles per NPD, and the success of this action backline is helping to fuel POS within vehicles, which increased 20% in Q2. We have demonstrated a solid track record for delivering innovation, growth and global distribution capability for licensors. It is this reputation that helped us recently win 2 new major licenses.

The first is an all-new preschool animated series license from Disney called Fire Bots, with Spin Master as the North American toy licensee. Fire Bots will air on Disney Junior in 2023, and the toy line is anticipated to launch in summer 2023. The line will include figures, playsets, vehicles and more. Fire Bots is set in a fantastical world where talking vehicles live, work and play with the humans who drive them. The whole team is very excited to bring the inspirational characters from the show to playrooms next year.

We’ve seen a trend within the toy industry regarding the growth of the category, and is an area that’s been master has historically been underrepresented. Given the opportunity to grow penetration within this consumer, we have been developing toys and collectibles that transcend into the video gaming and Esports worlds. We started with the launch of League of Legends, and we just announced a new multiyear license with Sony Interactive Entertainment as the global master toy licensee for the PlayStation brand, including titles such as God of War, Horizon Zero Dawn, The Last Of Us and others. We will develop product across a wide range of categories, including action figures, collectibles, playsets, role play, vehicles, games and puzzles, all of which will bring the interactive storytelling of Sony’s immerging games to life.

I will now take a moment to discuss our key marketing initiatives. We are applying the same principles of innovation to marketing as we do with our toys, entertainment and digital games creative centers. This starts with a focused approach to our priority brands and franchises where we’re basically investing over 80% of our global marketing dollars. We have built an agile, innovative in-house team that has allowed us to test and adjust at scale as the market changes quickly around us. This flexibility has helped us grow reach more efficiently, predict performance and improve our sell-through sequentially for the last couple of years.

We will continue to apply this playbook in the second half of ‘22, leveraging both commercial focus and marketing innovation to our priority brands to maintain and build our momentum, supporting our innovation and positioning us for a clean inventory sell-through. We are investing early in the season to establish strong baselines for our innovation and combining marketing and promotional pricing strategically to grow share.

We continue to see our promotional efficiency grow, and we’ll invest in this area this fall as consumer behavior shift in reaction to the macroeconomic environment. We continue to activate with shoppers fluidly across channels, both online and in-store. Our spend is increasingly digital-first, helping us to grow ROI and market share.

In 2022, digital is approaching 50% of our global spend, with major growth in Europe and nearly 2/3 of our spend in digital here in the U.S. and Canada. Despite e-commerce becoming a significant larger portion of the overall industry POS, when compared to just a few years ago, we are seeing moderation of growth.

With sales shifting back to bricks and mortar, we believe we have opportunities to elevate our in-store displays in partnership with our retail customers. We are taking a balanced approach to pricing, promotions and investing where it makes sense to remain competitive, but also preserving our profitability.

Now I’m going to turn to Entertainment, and in this creative center, our team is focused on creating content that will serve as a catalyst for toys and digital games. We’re building diversified content squarely focused on children across many age segments, with a multi-platform approach. Fans of our Entertainment are engaging across channels from traditional linear to streaming and to digital platforms like YouTube, and Spin Master entertainment is strengthening our execution across all dimensions to capture our share of viewing minutes.

This past quarter, we made a few exciting announcements regarding our Entertainment content pipeline. We announced the upcoming launch of an all-new animated series, Vida the Vet. Season 1 will debut on premier children’s entertainment broadcasters like BBCs in the U.K. and TreeHouse in Canada this coming fall 2023. The team is working on securing more international broadcasting partners to expand the reach of the show.

We are excited to invite fans on yet another epic adventure on the big screen with our second movie in the PAW Patrol franchise, PAW Patrol: The Mighty movie, and it’s coming to theaters in October of 2023.

Traction is progressing well, and our new PAW Patrol derived spin-off Roblin Crew will debut in ‘23, and specials to celebrate PAW’s tenth anniversary are also in the works.

Turning now to the Digital Games creative center, we have experienced explosive growth over the last 2 years. Kids have evolved to digital playgrounds as a key form of engagement with their friends. This trend was further compounded by the pandemic where kids were largely out of school, restricted to their own homes and forced to engage with friends online. The industry is now seeing a shift in the macroeconomic environment with kids spending more time in school and extracurricular activities unencumbered by pandemic restrictions.

In addition, families have been able to travel for vacations more than they were able to in 2020 and 2021, leading to a shift in how leisure time is being spent. We continue to see engagement with our properties remain very high. However, in line with trends with the global digital gaming industry, we have seen a reduction in in-app purchases and a slower growth within our entertainment-focused apps from Sago Mini and Originator.

Monthly active users, a key performance indicator of franchise health, remains very strong. In the second quarter, the entire Toca Boca ecosystem had over 75 million monthly active users, up 32% compared to the same quarter in the prior year. We know that the open-ended creative play that Toca Life: World provides is relevant and engaging for kids around the world.

In addition to being named the Apple Store’s app of the year in 2021, Toca Boca was just awarded Best Original Game app by Kidscreen just last week.

Active Sago subscribers also increased 4% over the prior year, and we expect that the launch of the new Sago Mini Friends series in Apple TV+ this fall will increase brand awareness for Sago Mini World and drive increased engagement with our play-to-learn apps. Our Originator studio is hard at work on 2 major initiatives, including a PAW Patrol digital game called PAW and Friends and a STEM-based learning app.

We remain focused on expanding our digital game ecosystem to leverage our trove of IP to reach and leverage new users. Noid, our newest digital game studio in Stockholm, is well down the path of developing a Rubik’s digital game, which will launch in 2023. We have several other digital games initiatives in development, leveraging Spin Master’s toy and entertainment IP. We have also expressed our desire to grow our digital games presence through acquisition. We now have an experienced team to help us find potential acquisitions within this rapidly evolving and growing space.

Before I turn it over to Mark, I wanted to comment briefly on the macroeconomic environment. We recognize that the consumer spend in some regions is slowing, with concerns regarding inflation and the impact that this may have on discretionary spending. As we’ve said in the past, the toy category trends tends to be less affected by recessionary environments, partly due to parent’s choice to ensure their children will always receive the toy they’ve been dreaming of for the holiday season or for their birthday party, but also because toys are an efficient local form of entertainment during tougher times, as we saw in previous economic downturns.

We’ve heard reports of high inventory levels at retail due to delays in shipping from the tail end of ‘21, combined with slowing spending. We have learned many lessons from the operational challenges we experienced in late 2019 and have embedded proactive, rigorous planning practices to ensure we manage inventory levels very tightly.

We remain in a very strong position financially and are maintaining our outlook for 2022. We believe Spin Master is well-positioned to manage through external market pressures to deliver profitable growth and long-term shareholder value as demonstrated by our plan to return capital to shareholders while continuing to invest in growth initiatives.

Looking to the balance of the year, we are confident in our ability to execute against our strategy of reimagining everyday play, powered by our deep expertise across toys, entertainment and digital games.

I will now hand over to Mark, who will share more details on our performance.

[Mark Segal, CFO]

Thank you, Max, and good morning, everyone. The second quarter of 2022 was another exceptional quarter for Spin Master. We maintained revenue growth momentum and delivered margin expansion and profitability, achieving a very strong first half.

We generated just over $506 million in revenue for Q2, a 29.6% increase over last year. Revenue was $514.7 million in constant currency, up from $390.8 million, an increase of 31.7%. Revenue growth drove strong profitability growth with adjusted EBITDA of $113.7 million, up 39% over Q2 of 2021.

Our performance this quarter was driven by the continued strength of our innovative and diversified portfolio, growth across all 3 creative centers, improvements in gross margin, proactive management of our supply chain and cost discipline.

Let me now briefly review Q2 Creative Center performance. Toy gross product sales were $484.4 million, an increase of $125.4 million or 34.9%. On a constant currency basis, gross product sales were up 36.6%. As we mentioned on our Q1 call where we signaled 40% H1 seasonality, retailers brought in goods earlier this year to avoid potential supply chain disruptions to their full planogram set. As a result, gross product sales in the first half of 2022 represent a larger proportion of our expected 2022 full year gross product sales compared to prior years.

On a category basis, Preschool and Dolls & Interactive grew by $79.2 million or 32.9%, driven by Gabby’s Dollhouse, Wizarding World, PAW Patrol and Purse Pets. Activities, Games & Puzzles and Plush grew 26.1%, led by Rubik’s Gun and the introduction of Pixel Bits. Wheels & Action grew $38.1 million or 49%, led by DC Comics, Monster Jam, Tech Deck and Bakugan. Outdoor declined by $17.5 million. Recall that over half of this decline was related to brands that we divested in Q1 of this year.

Geographically, we delivered strong gross product sales growth across all markets led by Europe, which was up nearly 41%. North America grew just under 35%, and the rest of the world was up 28%. International gross product sales were nearly 30% of total gross product sales, consistent with last year.

Q2 sales allowances increased to 9.7% from 9.1% as a percentage of gross product sales, driven by geographic mix from the growth in Europe, which has a higher overall sales allowance rate than the global average, offset by lower markdowns.

On a year-to-date basis, sales allowances were 10.6% compared to 11%. Historically, we have operated in the 10% to 12% range, and we expect sales allowances to be towards the upper end of that range for 2022.

Toy revenue or gross product sales, net of sales allowances increased by 34.1% to $437.6 million from $326.4 million. Adjusted EBITDA for Toys grew to $83.2 million at a 19% adjusted EBITDA margin compared to $47.3 million or 14.5%. Adjusted EBITDA margin improved due to higher gross margins from favorable changes in product mix, price increases and operating leverage, partially offset by product cost and ocean freight inflation.

Entertainment revenue increased slightly to $28.4 million compared to $27.5 million. Adjusted operating margin was 63.4% compared to 45.8%. This improvement was a result of lower entertainment content deliveries in Q2, which drove lower amortization. As a reminder, when we discuss entertainment profitability performance on a stand-alone basis, we focus on adjusted operating margin as this is after content amortization.

Digital Games revenue increased 9.2% to $40.3 million compared to $36.9 million due to higher in-app purchases in Toca Life: World. In constant currency, digital games revenue increased 16.5%. Adjusted operating margin was 24.8%, down from 37.1% due to higher product development and personnel costs as digital games invested in future products and higher marketing costs, partially offset by margins from higher in-app purchases in Toca Life: World.

From a consolidated P&L perspective, gross margins were 56% compared to 53.7%. The 230 basis point improvement was largely driven by favorable changes in toy product mix and price increases, offset partially by inflation. In addition, lower content deliveries within the Entertainment Creative Center resulted in lower amortization, which positively impacted overall gross margin.

SG&A was $190.4 million, representing 37.6% of consolidated revenue, down from 38.2%. Marketing expenses increased by $7.6 million or 27.9% to $34.8 million, but declined slightly as a percentage of consolidated revenue to 6.9% from 7%. For 2022, we expect marketing spend to be between 9% and 10% of revenue. We will invest in marketing strategically to support sell-through, share growth, brand momentum and channel and mix goals.

Administrative expenses grew 27.7% due to higher personnel-related costs and incentive compensation accruals, but declined slightly as a percentage of revenue to 19.6% from 19.8%. Selling expenses grew to $35.3 million or 8.1% of Toy revenue from 7.5% due to higher sales of partner licensed products.

In Q2, we recorded net income of $88.1 million or $0.83 per diluted share compared to net income of $33.5 million or $0.32 per diluted share last year. Adjusted net income in Q2 was $72.4 million or $0.68 per diluted share compared to $41.6 million or $0.40 per diluted share. Adjusted EBITDA was up 39% to $113.7 million compared to $81.8 million. Adjusted EBITDA margin was 22.5%, up from 20.9%. The increase in adjusted EBITDA was driven by increased gross profit, partially offset by higher administrative, selling and marketing expenses.

Turning to the balance sheet. Inventory at the end of Q2 was $184 million, up $48 million from $136 million at Q2 ‘21. At the end of Q2, we had approximately $44 million of in-transit inventory, representing 24% of total inventory compared to $33 million or 24%.

While our inventory levels are up year-over-year, we are well positioned with high-quality inventory to meet expected consumer demand through the second half, and we continue to use safety stock, prebuys and pre-builds to help mitigate any potential supply chain disruptions and maintain customer service levels.

Free cash flow in Q2 was $84.1 million compared to $69 million, driven primarily by higher net income. Free cash flow for the 6 months ended June 30 was $4.7 million compared to $62.5 million, primarily due to lower cash flows provided by operating activities, driven by higher net working capital. We ended the quarter with $558 million in cash. We continue to be in extremely strong liquidity position with available liquidity of over $1 million.

Given our strong financial position, we are pleased to announce our first-ever quarterly dividend of $0.06 per share. The first dividend will be paid in mid-October to shareholders of record on 30 September. We continue to remain focused on increasing opportunities to leverage our diverse and global platform by making accretive acquisitions across all 3 of our creative centers as a priority. Our decision to also initiate the dividend reflects our confidence in our operating performance and cash flow generation ability, while maintaining a strong balance sheet to support future growth.

Looking forward, our outlook for the full year 2022 remains unchanged. We remain mindful of the fluid macro environment and we feel we have taken an appropriately measured and balanced perspective with our 2022 guidance. If we were to achieve our 2022 guidance, this would represent very solid year-over-year performance.

From a guidance metric perspective, we continue to expect gross product sales to grow low double digits compared to 2021 in constant currency. As discussed in May, retailers have brought in goods earlier this year to avoid potential supply chain disruptions. And as a result, first half 2022 gross product sales will represent a larger proportion of full year gross product sales compared to prior years. We continue to expect the third quarter to remain our largest quarter from a top line perspective, and expect the fourth quarter to have a more challenging comparative.

As a reminder, in the fourth quarter of 2021, we had initial shipments for the launch of the Batman movie in Spring ‘22, strong sales for PAW related to the movie and very robust Gabby’s Dollhouse sales on its initial launch.

We continue to expect total revenue to grow low double digits compared to 2021 in constant currency, excluding the PAW Patrol movie distribution revenue of $26 million. You will note that we have added a constant currency clarification to our gross product sales and total revenue outlook. We have done this to remove the effect of exchange rate volatility on growth rates, primarily from the euro and British pound. Please note that with respect to foreign exchange, we have a natural U.S. dollar hedge as we buy and sell mostly in U.S. dollars. We have non-U.S. dollar-denominated sales in both euro and pounds, thus when those currencies weaken against the U.S. dollar, it impacts gross product sales negatively. However, we also have a significant short position in Canadian dollars as a large part of our cost base is in Canadian dollars. Therefore, a weak Canadian dollar results in lower U.S. dollar costs and has a positive impact on profitability. On a net bottom line basis for 2022, we expect the impact of foreign exchange movements in our major currency pairings will be much lower than the impact to the top line alone.

In addition to our revenue guidance, we are also maintaining 2022 adjusted EBITDA margin expectations, which remain in line with 2021 adjusted EBITDA margins, excluding the PAW Patrol movie distribution revenue of $26 million.

As a result of rising interest rates and inflation, along with the potential for further supply chain disruptions, we have implemented cost containment and productivity programs to offset increases as much as possible, and where necessary, we have raised prices for our full 2022 line. However, given the macro volatility we are experiencing, we believe it is prudent to maintain previous margin guidance at this time.

To conclude, we continue to demonstrate our ability to produce compelling entertainment and digital games content, magical toy experiences and be a great licensing partner. We have built a strong and focused global platform and are incredibly proud of the effort and results that our employees have delivered. We remain committed to growth with disciplined cost management, operational efficiency and productivity. We continue to believe in our long-term financial framework and that at its core, our formula for innovation and growth across toys, entertainment and digital games is stronger than ever.

That concludes our prepared remarks. We will now take questions. Operator, please open the line.

[Operator]

[Operator Instructions] Our first question comes from Brian Morrison with TD Securities.

[Brian Morrison, TD Securities]

Mark, first question is the guidance. It appears that ex-PAW Patrol, your revenue forecast in the second half of the year is going to be flat year-over-year, but it does imply some margin degradation. I just wonder if you can clarify, is there some digital or entertainment spend, some mix shift, a degree of conservatism in there? Just trying to reconcile, realizing it is a tough comp you’re going up against.

[Mark Segal, CFO]

Yes. Look, we are, as I said to you just a few minutes ago, maintaining a prudent guidance tone. We did see some pull forward of margin from H2 into H1, and we got some operating leverage as a result of that because of the gross product sales, primarily from North America FOB that shifted a little bit into H1. So that definitely is an impact for the full year margin guidance.

But just remember also, Brian, that we have some disproportionate marketing and promotion costs in the second half of the year that we don’t have in the first half, as well as sales allowances. So you saw that our sales allowances are running at around 10% for the year. We expect that to be closer to 12% for the full year, and most of that will come through in Q4.

Also, we’ll see some entertainment deliveries that will dilute margins in Q4 as well. So that’s really the reason why we’ve actually maintained our margin guidance for the full year.

[Brian Morrison, TD Securities]

Okay. So just to be clear, there’s some additional content spend, which makes sense, and then potentially, you’re taking some caution due to foreign exchange and also due to the uncertain economic outlook. Is that fair?

[Mark Segal, CFO]

Yes, that’s also fair. But again, just the main economic drivers is the pull forward from Q2 -- sorry, from Q3 into Q2, and also the marketing and promotion costs and sales allowances that hit us in Q4.

[Brian Morrison, TD Securities]

And is that different from last year, though?

[Mark Segal, CFO]

It’s roughly consistent with last year.

[Brian Morrison, TD Securities]

Okay. And then I guess on the Digital Games business, sorry if I missed this. But it is a bit soft in the second quarter even though it’s a very good quarter. But I’m just wondering if you can elaborate on that, and then the outlook for the second half to snap back. And I guess, with Noid coming down the pipeline in early 2020, ‘23, are you still targeting a doubling of Digital Game revenue? And maybe you can give us the ballpark time frame for that.

[Max Rangel, President and CEO]

So the digital game market in Q2 did moderate. And obviously, in the prepared remarks, you would have heard that there basically are other entertainment choices for children right now with leisure. However, we still beat the market quite handily. And so we grew over 9%. And in constant currency, that number would have been high double digit. Having said that, we have basically a second half that has a lot of content late in September and a really strong Q4 with Toca Life: World, which is really one of our big engines. Separately, we have the Sago Mini Friends TV show as well, which we expect would bring a lot of new users to our franchise. So we see a tremendous back half, particularly from September onward.

Let me pivot to the future, which is really what you’re asking. And so we just met with our Board and have a strategic plan. And over the midterm, we see a very strong and very optimistic outlook for digital games. Why? Today, we play in roughly about 2% of the marketplace, which is really kids and family. As you well point out, Noid comes on board and basically brings the Rubik’s game and gets us into puzzle. We see our basically addressable market increasing quite dramatically over the next few years. So in the midterm, 3 to 5 years, you can expect that we remain very committed to continue to advance towards that 20% that we’ve actually declared. So that’s the outlook for us in digital games.

[Brian Morrison, TD Securities]

Okay. And just in terms of M&A, which will be a contributor to this, is this taking longer than you thought? Or multiples not declining with the market? Or do you feel you’re tracking the plan?

[Max Rangel, President and CEO]

No. I believe we have a very active deal flow in the space. We have a new team that’s basically very active in basically managing targets. And so we are very encouraged with things that we may be able to pull the trigger. So without being able to tell you a lot more, that’s where we are.

[Brian Morrison, TD Securities]

Okay. I appreciate the color, and I certainly like the dividend initiation.

[Mark Segal, CFO]

Thanks, Brian.

[Operator]

And our next question will come from Martin Landry with Stifel.

[Martin Landry, Stifel]

You touched about the shift in consumer confidence. And I was wondering if you’re seeing some of that impact your turnover of maybe higher-priced items. Wondering if you can give us some idea about the proportion of your sales that are generated above $50 and if those items are turning slower than others.

[Max Rangel, President and CEO]

Yes, Martin, we are seeing quite a bit of success with Gabby’s Dollhouse, for example, or even the DC Universe launch in the first half. And most of those items would have been between $29 and $79. And so we’ve seen really great success over $50. We do know as well, Martin, that households, particularly in the U.S., over $100,000 have been driving quite a bit of the purchase. And we have fared quite well. And therefore, that’s driven our mix and our performance in POS. So we have succeeded in that space.

When you cross the $100 price point, we have seen some moderation in consumers choosing those items. But as well as we have seen moderation in consumer choosing items that are less than $10. So you have the 2 ends of the spectrum that are declining more rapidly than basically the big happy middle.

[Martin Landry, Stifel]

Okay. That’s helpful. And you mentioned or you announced last week a license agreement with the Sony PlayStation. It’s targeted to the collectors market, and it’s going to be after games like God of War and others. And I was wondering, how do you intend to transform gamers into collectors? How can you convert that passion of gaming into collectibles? And can you give us some color of how did you fare with your license for League of Legends?

[Max Rangel, President and CEO]

Absolutely. So it is incredibly important that you recognize these people are amazing fans and what our job is to do is to bring their characters and their passions to life physically. And we’ve been able to do that, and this segment has been really a key growth driver for the entire market. So the kid in every adult is actually driving this behavior and is not insignificant.

And so we are putting our innovation against those wishes from this segment, and that is basically what is driving our League of Legends and what will drive further our innovation behind the Sony properties.

[Martin Landry, Stifel]

So are you -- is League of Legends meeting your expectations? Because I saw that some of your products were discounted heavily on the web.

[Max Rangel, President and CEO]

Yes, it is meeting our expectation. I mean, I want to couch you. This is not -- it’s a small segment for us, but it’s doing well. And we actually plan to do the same with and more with the PlayStation properties that we are getting our hands on to help them basically bring those fans some more physical toys to them in collectibles.

[Martin Landry, Stifel]

Great. And then last question, your license with Disney on Firebirds -- Fire Bots, sorry. It seems that it’s been a while since you’ve announced a license with Disney. I was wondering could this open the door for additional licenses. And then what was the trigger for Disney to choose Spin Master?

[Max Rangel, President and CEO]

Well, over the last couple of years, we’ve had a great result behind some of the licenses that we have brought to the company. And I think people are taking note that we are actually taking licenses and growing them sometimes 10x, Martin, even beyond that. Our footprint has expanded, and our capabilities have expanded as well. And this has given, obviously, licensors quite a bit of confidence in what we can do.

What hasn’t changed is our desire to innovate. And what is not changed that normally change is that we’re putting resources against these properties that bring basically fandoms that are basically well-established. And so the combination of all this is giving people quite a bit of confidence to work with us, and we’re putting an entire team to bring this to life. So we’re excited about Disney’s Fire Bots, and we don’t believe this will be the last thing that we’ll try to basically work with them on.

[Operator]

And moving on to Steph Wissink with Jefferies.

[Steph Wissink, Jefferies]

We have 2 questions. The first is on trade inventory levels. Maybe, Mark, you can help us just think through with the pull ahead, what would you need to see in POS in the back half to end the year clean in the channel in terms of inventory? And then maybe just help us connect that to the guidance you’ve given us for higher marketing and promotional spend in the back half. Is that what’s required by your retailers to sell through? Or is that something that you’re doing proactively to position yourself from a market share perspective?

[Mark Segal, CFO]

Steph, I’ll take the second part of your question first, and then I’ll pass over to Max on POS. Steph, so we’re not seeing any unusual requests or behavior coming through from retailers in terms of our promotional spend or our markdown accruals. Obviously, there’s a seasonal element to that where most of that actually comes through in the latter part of the year. But certainly, as we’ve guided you to on our marketing spend and on our sales allowances, we see that within normal bounds. But obviously, this year is slightly unusual just given the volatility that we’re experiencing from a macro perspective. So we are being a little cautious about that, and that was part of what we fed into our guidance. But at this point, I can’t call anything unusual out to you on those particular areas. And then on the POS side, Max, do you want to...

[Max Rangel, President and CEO]

Sure. So we have basically planned the second half exactly as you would expect to marry up with what inventories are key retailers with them. And so there’s 2 things happening just for perspective. I’m going to address more the mechanics of basically between now and, call it, end of September as you read, and it’s true, retailers are basically drawing down inventories to get ready for that holiday new items. And so we’re actively working with them. We are in a really good position.

We’re not necessarily way over our skis on that. So we start with a really good position with them. Nonetheless, we’re cleaning out along with them and getting ready for the fall. And in the fall, we have a bi-week forecast. First, with our innovation so we can basically get those out the door quickly and with great performance and making sure they sell clean and sell-throughs are high. And we have 2 Super Saturdays this next holiday season. So we’re planning also the seasonality difference between year-on-year. So we feel very confident.

From a marketing spend perspective, we have really strong marketing dollars allocated, not just for the innovation, but also for base brands, and basically, respective of channels. So we’re in a good place there as well.

[Steph Wissink, Jefferies]

That’s very helpful. And my follow-up question is on digital games. And I think this was asked a bit earlier, but I’m going to ask it in a slightly different way. I think you referenced higher cap in your release. Can you just talk a little bit about the competitive dynamics? And if you’re seeing, is it truly just share of time that’s working against you? Or do you find that the kids market is becoming more competitive and so your acquisition costs have gone up?

[Max Rangel, President and CEO]

No. So I think on the acquisition piece, I’ll just clarify, if I -- I don’t think I referenced any competitive item on digital games, but if I can follow up with you separately. As kids had other leisure choices, your assumption is correct, they’re spending less time. But they’re still in the ecosystem. Our monthly active users are still, by and large, the same number. So we’re keeping our ecosystem quite well, but they’re spending less time, and because they’re spending less time, they’re actually also are not spending as much money on it. So that’s basically what we’re seeing so far.

[Operator]

And our next question comes from George Doumet with Scotiabank.

[George Doumet, Scotiabank]

Can you maybe quantify or give us a little bit of color maybe the weakness in in-app purchases, maybe something you can quantify? And how would you see the recovery in the digital games margin over the coming quarters?

[Mark Segal, CFO]

Yes. So George, we don’t break out the individual components of our digital games revenue at this point. I mean, at some point going forward, we may choose to add in some additional color, but we’re not breaking that out right now. Sorry, what was the second part of your question?

[George Doumet, Scotiabank]

Well, I’m just trying to get a sense of -- obviously, there’s some investments that were made for future growth. So I’m just trying to get a sense of how you see the evolution of the margin of Digital Games over the next couple of quarters.

[Mark Segal, CFO]

Yes. So if you think about our Digital Games business, what we’re driving towards in the second half of 2022 and into ‘23 is we have a lot of new games launches. So you’re seeing higher product development and personnel costs as we actually build those games. We’re launching PAW and Friends, as Max mentioned, we’ve got the Rubik’s game coming down the line and we’ve got some other initiatives that we have lined up for ‘23 and beyond.

Our goal in digital games is to be at 35% EBITDA margins -- EBIT margins rather. We were below that for this quarter, but I encourage you to take kind of a long-term view of this because as we build these games and as we deliver these games and margins are going to be slightly diluted until we get scale, and so that’s what you might see for the next while. But certainly, from a long-term perspective, the Digital Games business is highly margin accretive, and we expect to be in that 35% EBIT margin range.

[George Doumet, Scotiabank]

Okay. And my second one -- my second question is on the dividend side. I’m just wondering what the thinking behind the current level is and how would we -- how should we expect that to kind of scale up all the time? And maybe just in general, how do you guys view share buybacks?

[Mark Segal, CFO]

Yes. So, look, our first priority, George, and remains our first priority, is accretive M&A. That’s really where we are driving and where we are focused across all 3 of our creative centers is to continue to do that. But we did feel that given our balance sheet, given our cash position, given our overall liquidity position and our free cash flow generation ability, we felt that a dividend at this time was appropriate and the right thing to do from a total return perspective for shareholders.

I don’t want to comment on where the dividend is going to go in size. But certainly, it is something that the Board is going to consider every quarter. And we’re just happy at this point to initiate the dividend and to get a total return mindset from a shareholder perspective.

[Operator]

And our next question will come from Luke Hannan with Canaccord Genuity.

[Luke Hannan, Canaccord Genuity]

Max, I think you commented in the past that you kind of look at your inventory 3 different buckets, one being what you ship for the holiday period, one being those year round goods that you can replenish on sort of a daily basis. And then also, if I remember correctly, it’s the inventory that you’re planning to ship for the spring season.

So I’m curious to know if you can share the state of the inventory across those 3 buckets for not just what’s on your books today, but also what’s sort of currently -- what the levels are like at the retail level, if there’s anything to call out where one category may be over or under indexed versus the others?

[Max Rangel, President and CEO]

Happy to. It actually is really good news for us, and you’ll be happy to hear. When you think about inventory pull forward and you think about our business, about 50% of the inventory, in your mind, has to be things that were not there a year ago. So remember, we started Gabby’s in the fall. So anything that happened in the first half would be things that basically would have not been there from a year ago. Rubik’s we took over in the U.S. from Hasbro this past January 1. So all that inventory would be absolutely new.

So about 50% is things that were not in our base a year ago. That’s really good, number 1, number 2. About 17% of that is just basically inflation. So 2/3 of the inventory are basically captured by things that would have not been there before in a year ago base and/or inflation. So the remaining is the things that we’re dealing with at an individual level. And some of those things are not necessarily spring leftovers are actually good inventory as well. So we’ve broken down inventory very, very precisely so that we can actually action our dollars to make sure we are productive.

So going forward into the second half, that gives us a better opportunity to get those new items that people are looking for, for the holiday season. And that’s basically the play that we’re in and why we have so much confidence in what we have to do going forward. I hope that helps.

[Luke Hannan, Canaccord Genuity]

That does. That’s very helpful. My second question is, I guess, just on some product inputs and also just the supply chain in general. We are seeing freight rates, although they’re still definitely elevated compared to 2019, they are lower versus last year. So I guess the first question is when might that roll through your P&L? And then the second question, I think the biggest area of concern, again, correct me if I’m wrong, from a product input perspective, has been on resins and chips. I’m curious to know how the situation there has improved, if at all.

[Mark Segal, CFO]

Yes. So, Luke, we are actually seeing, at this point, a moderation on ocean freight. It is coming down a little bit, but it’s still at very high levels compared to prior years, as you said. So we do see some moderation. We’re not quite sure how that’s going to play out for the remaining part of the year. But we’ve certainly taken that into account in our pricing, and we hope to offset that as we’ve done.

In the case of resins, again, still at high levels, and still some potential for risk on that front there. So we’re maintaining a very cautious tone on that. It is still quite a bit higher than it was in prior years as a result of oil prices.

[Luke Hannan, Canaccord Genuity]

Okay. Last question for me, and then I’ll pass the line. On the decision to introduce a dividend, Mark, what was the, I guess, the liberation between whether to do return of capital in the form of a dividend rather than a share buyback?

[Mark Segal, CFO]

Yes. So that was actually a question that Luke answered as well -- or George, sorry, asked me as well. So I’m just going to deal with both of you. From the perspective of a dividend versus share buyback, Luke, as you know, we have a relatively small floats where the founders own 70% of the stock and public floats around 30%. So while we understand the benefits of a share buyback, there’s multiple benefits. We really are focused on enhancing our float liquidity over time. And so we felt that a dividend from a return of capital perspective was a more preferable route for us to follow.

The other advantage of a dividend, and this is for George as well, was that you know the Canadian market very well in terms of a lot of asset managers out there with dividend-only mandates. And that gives us -- by declaring a dividend, gives us the ability to go after and have investors who have dividend-only mandates.

[Operator]

And the next question will come from Adam Shine with National Bank Financial.

[Adam Shine, National Bank Financial]

Maybe Mark, first for you, and then I’ll hit Max with a couple of questions. In terms of any shift in sort of GPS from Q3 into Q2, I mean, the easy math looking at, let’s call it, 22% of the year GPS compared to, let’s call it, average 18% over the last couple of years would point to $100 million, which seems a pretty big number given the fact that you are also seeing some pretty strong demand for your products. So I don’t know, Mark, if you can help us a little bit in terms of the level of SKU from Q3 to Q2? And then I’ll follow up with some questions to Max.

[Mark Segal, CFO]

Yes, so look, we’re not going to quote a specific number in terms of the pull forward. I think your number was too high, though, Adam. I think, just in general, that was too much. But if you actually think about typical H1, H2 seasonality, we’ve historically been in the 33%, 35% range for H1. And as we had indicated in May, we see around 40%. So you can actually do the math on that.

I think it’s hard to tell precisely which order shifted from Q3 to Q2. But certainly, it wasn’t as much as the number that you indicated there.

[Adam Shine, National Bank Financial]

No, I suspect it was probably half of that. But okay. Max, if we go back to one of the questions earlier, I think Martin was asking around price levels and you talked about the big happy middle around $29 and $79. I don’t know if you can give us a bit more color just whether it’s within the context of $29 and $59 or $29, $79 the percentage of toy sales that are actually happening within that range, just for context and the reality check where I think average global household spend for kiddies is $59 or thereabouts, I think, a data point from NPD a year ago. And then one last question for you.

[Max Rangel, President and CEO]

Yes, sure. So I’ll make sure you get the specifics, so I want to be more accurate, and I’ll send that with Sophia after the call. But we are well represented by price point depending on the actual category in which we play. So that’s basically one of the things that you should take into account, which is our balanced portfolio gives us basically a very nice percent of play within the $20 to $29, then $29 to $39, and onwards to the even $79. So I think that’s the first piece that you have to take into account. So we are well covered.

And even within a franchise, we will be covered across different price points. So on PAW, we have vehicles that actually would meet the $20 to $29, but actually, we will extend ourselves to the other price points. I want to make sure that you get a lot more specificity than just a very ambiguous answer for me. So I’ll follow up with you separately. But Suffice it to say, we are well positioned to actually capture share in key price points that are growing.

[Mark Segal, CFO]

And we’ll get back to you afterwards with a breakdown on the price points. We have a chart that we can share with you.

[Adam Shine, National Bank Financial]

Fantastic. I appreciate that. So one last one just for Max. Not much was talked about in terms of maybe a degree of differentiation in terms of any trends you’re seeing Europe versus North America. I’m not sure if you can share a little bit with us in terms of looking backwards perhaps into the Q2 and then ultimately looking forward initially into the H2.

[Max Rangel, President and CEO]

We have seen the European markets in toys, specifically basically grow a couple of points below North American market. So that’s basically point of interest number one. We do have that right now in North America, our share position has been very strong. In Europe, it’s actually a bit stronger. And so that’s actually another data point for you.

And basically, it’s going to vary between the big 3 markets, Germany, France, U.K. The U.K. has been the softer of the 3 markets. And basically, that’s just the fact they’ve had a lot more microeconomic, if you know, headwinds earlier. And so that’s basically the piece that is different. Where in the North America market, we have a lot more -- it’s more homogeneous. And if you throw Mexico into the equation, Mexico is doing incredibly well, and the market is more salient, and we’re doing incredibly well in Mexico. So those are some of the compare and contrast from a category perspective, very, very homogeneous between the 2 regions.

[Mark Segal, CFO]

I think in terms of time, we’re going to have to make this one last question. I apologize if there are any questions that we’re not able to get to on the call. Now we can take them afterwards, but we’re going to make this one last question.

[Operator]

Our next question then will come from John Zamparo with CIBC.

[John Zamparo, CIBC]

Apologies if I missed it earlier. We’ve all seen the announcement though from Toys "R" Us and Macy’s. Obviously, it’s a positive development for the industry. But I wonder if you can talk about how this impacts your business specifically. Is there any incremental business included in the ‘22 guide.

[Mark Segal, CFO]

John, yes, Macy’s and Toys "R" Us have actually been working together for over a year already. There were some trials on the East Coast, which have gone well. And now they’re going to do a more national rollout. It’s great to see, obviously, the Toys "R" Us brand back within the Macy’s store-in-store concept. I can tell you, we’ve built that in. We’ve been dealing with them for a while now. It’s part of our guidance. It’s part of our expectations. It’s overall not that material at this point. We hope in the future years that it does become more material, but it’s not that material for us right now. But we, as I said, hope it does grow.

[John Zamparo, CIBC]

Okay. That’s helpful. And then my follow-up is on the slowing macroeconomic environment that Max referenced. Can you talk a bit more about this? Can you quantify it at all in terms of what you’re seeing in Q3, either from the perspective of shipments or point of sale? Just any additional color you can add on that.

[Mark Segal, CFO]

Yes. I don’t think we can be much more specific than what we already have been, John. I think, as Max described, and as we said before, the toy industry is relatively recession-proof. I think we’re in good shape. We are actually maintaining a kind of a cautious tone just given the overall environment, but I think we’re well positioned, and the toy industry overall is well positioned.

[Max Rangel, President and CEO]

Yes. We’ll send some more. But just so that I don’t leave it without something to hang on to because I don’t like that feeling either, trust me. When we talk about the bookends, right, and you think about the less than $10, it’s basically down about -- it’s down about 12%. It’s the last number I’ve seen, and I think it’s pretty recent, trust me. And then when you think of you across $100, you’re basically also declining, not even high single-digit declines. Everything in the middle, right, from like $11 to the $99, and particularly $79 is really more growing even double digit, and we’re actually growing ahead of that.

So when you think about the slowdown, I mean, it’s really more where people are spending. So less about impulse purchases and big items. And so I want you to think of it that way. But from our shipments and everything else, basically, we’re tracking along. So I hope that at least satiates you for now, but we’ll see more details along with Sophia.

[Operator]

And that does conclude the question-and-answer session. I’ll now turn the conference back over to you.

[Mark Segal, CFO]

Okay. Well, thank you, everyone. We look forward to talking to you in November at our Q3 call. And if there are any analysts that didn’t get to ask questions, we’ll follow up with you afterwards. Please give Sophia or myself a call. Thank you very much, and talk to you again.

[Operator]

Well, thank you. And that does conclude today’s conference. We do thank you for your participation. Have an excellent day.