Spin Master Corp

TSX:TOY

Earnings Call Transcript 2017-Q4

[Operator]

Good morning. My name is Michelle, and I will be your conference operator today. At this time, I would like to welcome everyone to the Spin Master Q4 2017 Financial Results Conference Call. [Operator Instructions] Thank you. Ms. Hunter, you may begin your conference.

[Karoline Hunter]

Thank you, Michelle. Good morning, everyone, and welcome to Spin Master's Financial Results Conference Call for the Fourth Quarter and Full Year Ended December 31, 2017. My name is Karoline Hunter, and I'm Spin Master's Senior Director of Investor Relations. I'm joined this morning by Ronnen Harary: Co-Chief Executive Officer; Ben Gadbois, Global President and Chief Operating Officer; and Mark Segal, Chief Financial Officer. Following our formal remarks, we will open the line for your questions. For your convenience, the press release, MD&A and audited consolidated financial statements for the fourth quarter and full year are available on the Investor Relations section of the company's website at www.spinmaster.com as well as on SEDAR. Before we start, 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 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 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 to not 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 statement, whether as a result of new information, future events or otherwise. For additional information on these assumptions and risks, please consult the cautionary statement regarding forward-looking information contained in the company's earnings release dated March 7, 2018. Please note that Spin Master reports in U.S. dollar, and all dollar amounts to be expressed today are in U.S. currency. I would now like to turn the conference over to Ronnen Harary.

[Ronnen Harary, Co]

Thank you, Karoline. Good morning, everyone, and thanks for your interest in Spin Master. Let me begin by saying that we are very pleased with Spin Master's financial and operating performance in 2017 as we had another year of significant growth. I'll share with you some strategic highlights for the quarter and year, and following my remarks, Mark will provide you with a detailed review of our financial results, including our outlook for 2018. Ben will then discuss our operational results, growth initiatives, the products and content we will be delivering in 2018. I would like to start with innovation. It is at the core of who we are. Our 2017 product line reflected our ability to tap into our global R&D network and collaborate with inventors. Hatchimals continues to be a great example of an innovation-led success and demonstrate the evolution of an idea into a product, then into a brand. This evolution is the model that we seek to follow into the future. We capitalized on excitement around the initial launch of Hatchimals and built a global brand that includes a successful low-price-point collectible line, the Hatchimals Colleggtibles, and innovative higher-price-point items. The brand awareness we have worked hard at creating has provided a platform for a direct global licensing and merchandising program. In 2017, we signed over 50 Hatchimal license agreements for products such as backpacks, apparel, bedding, books and more. We're managing the licensing and merchandising program internally, which delivers higher margins for us. Although we launched in late 2016, we really view 2018 as a Year 2 for the Hatchimals brand, and we'll be delivering even more interactivity and collectibles this year. 2017 was a solid year for Activities business. Activities is targeted at children aged 3 and up. We offer a wide range of innovative products, with global appeal based on classic play patterns that integrate fashion, trends and popular culture. In 2018, Activities is launching a new KumiKreator bracelet maker under the Cool Maker brand, an innovative way to play and instantly create braided bracelets. The popular Kinetic brand is growing with the addition of a new compound made from real beach sand and beach-themed playsets. We are driving innovation in the iconic Etch A Sketch product line for the launch of the [ Etch Revolution ]. It's a revolving screen that creates amazing graphic designs. The continued growth of our Games and Puzzles supercategory, which increased by over 3% in 2017 according to NPD, is very encouraging. We only entered the Games and Puzzles category in 2010 and are already the #2 manufacturer in the games segment of the market -- in the games segment in the U.S. according to NPD. It's remarkable to see how the segment of the market is growing in an age of so many digital distractions and advancements in technology. Underlying this growth is parents' desire to spend time with their kids in an unplugged family environment. Cardinal continues to grow as the Spin Master's game business. In 2017, we acquired Marbles and Perplexus. We intend to continue to aggressively develop and expand this area of our business. At the same time, parents are also looking for ways to limit their kids' screen time on mobile devices and television, and this has contributed to growth in the outdoor and super toys category, the largest category in dollar terms in the U.S. in 2017 according to NPD. The acquisition of Swimways in 2016 gave us a beachhead in the growing Outdoor and sports category and will be further built up in our Outdoor business segment with the acquisition of Aerobie this July -- as of this July 2017. We're very excited about this opportunity to bring innovation to the segment, and you'll be beginning to see some of this innovation emerge in 2019 and beyond. Entertainment continues to be a major driver of Spin Master's growth. Our Entertainment team has expanded in 2017, reflecting the success we've had and our commitment to creating exciting new content. We currently have 2 highly rated preschool properties on the air: PAW Patrol and Rusty Rivets. The Nielsen ratings for the full year 2017 ranked PAW Patrol in the #1 position in kids aged 2 to 5 years old, followed by Rusty Rivets at #4. PAW Patrol is evolving from a preschool brand to a mainstream pop culture brand. As highlighted by the Super Bowl segment with Justin Timberlake and Jimmy Fallon that featured a plush Chase and Jimmy Kimmel's reference to PAW Patrol in the opening segment of the 2018 Oscars. The fifth season of PAW Patrol began airing on Nickelodeon this February. We gave many of you guys a sneak peek -- and woman -- a sneak peek of the new content planned for 2018 and 2019 at the New York Toy Fair. The Mighty Pups 44-minute special airing on Nickelodeon this fall is just one of the new themes and formats we're introducing to the franchise in 2018. We're also launching the Ultimate Rescue theme for the show and a toy line later this year. Overall, the quality of content continues to be get better every season, and the toy line is equally exciting. We're managing PAW Patrol as an evergreen global franchise, and we are working hard to ensure the content resonates with audiences to maximize long-term growth. Abby Hatcher: Fuzzly Catcher is a new animated preschool show slated for late 2018 or early 2019. This adventure comedy series will resonate with all kids, especially with the key demographic of girls aged 2 to 5. The show introduces Abby Hatcher, a 7-year-old with a giant heart and obsession with her favorite creatures, the Fuzzlies. Her dreams come true when she moves into a hotel filled with the Fuzzlies. Abby loves playing with the Fuzzlies. So in each episode, when a Fuzzly accidentally lands in trouble, Abby heroically saves the day. At its core, Abby Hatcher: Fuzzly Catcher models the power of a little girl to bring a whole community together with her eternal optimism and her acceptance of everyone, no matter how different they are. In addition to Abby Hatcher, we will also be relaunching Bakugan in 2019. Together with this content, we will continue to build our licensing and merchandising program to support our entertainment franchises. We are producing entertainment content across multiple platforms as we see entertainment content connecting with larger audiences and increasing in reach and frequency. Our partners, such as Nickelodeon, offer both linear, broadcast and on-demand SVOD platforms. We are increasingly accessing YouTube as a medium to deliver our content. The Hatchimals YouTube channel includes Hatchimal short-form content that is generating millions of views, and we will continue to develop [ short-form content further ] for Hatchimals and other brands when it makes sense to do so. Our acquisition of Toca Boca and Sago Mini was an important step into making sure we are present in the app space as smart devices are being accessed by more and more kids at a young age. Our vision for Toca Boca and Sago Mini is to build fun and creative apps that encourage open-ended play. However, we also want to provide an end-to-end experience for kids that encompasses physical product, entertainment and digital mobile. Our entertainment team and the Toca Boca app development team in Stockholm are now collaborating, and we are enthusiastic about some of the ideas that they're generating. We're also excited with the acquisition of Gund that we announced on Monday. Gund is a heritage brand with 120-year-old roots in the plush business. And Gund produces products -- are highly emotional, trusted purchases, and many kids keep their Gund plush toys for decades. I will admit, my girlfriend, who's 32, still has her Gund. But I'm soon working on replacing that Gund. It represents a strong IP and quality product that we like to acquire. With the acquisition, we'll now bring together Gund's deep expertise in plush and Spin Master's ability to innovate and scale internationally, to expand further into infant and juvenile areas with Baby GUND as well as deeper into specialty gift categories. We're already experiencing synergies on the entertainment side with Gund, since Gund is able to now design and develop amazing plush. And Gund will also help us design and develop some incredible plush with the new Fuzzlies in Abby Hatcher. In 2018, we'll continue to focus on core growth strategies. We have a strong lineup for our new product coming this year that we're excited about, and which many of you saw in New York recently. We remain strategically focused on creating and building our own intellectual property, the resulting margin expansion, diversification of our revenue streams, which will create value for shareholders. My final point before I pass over to Mark, relates to one of the areas that we're most proud of, and that's the Spin Master team. We've built an exceptional team globally in all areas of our business, and the results we have generated over the past few years is a testament to the team's strength and the underlying basis for Spin Master's continued growth and value creation. I'll now hand over to Mark, our Chief Financial Officer, to review the financial results. Mark?

[Mark L. Segal]

Thanks, Ronnen. I'll start by reviewing our fourth quarter results followed by the full year, then a review of our business segments for both periods and conclude with our outlook for 2018. Overall, our fourth quarter revenue increased 30.3% from 2016, driven by Hatchimals, Hatchimals Colleggtibles and our games portfolio. Foreign exchange tailwinds increased overall revenue by $9.1 million. In constant currency terms, revenue increased by 27.6% relative to last year. Gross product sales increased [ 28.6% ] in the fourth quarter. Our international growth was strong in Q4 compared to the same quarter last year, with gross product sales rising 34% in Europe and 94% in the rest of the world. Overall, international gross product sales comprise nearly 41% of sales in the fourth quarter. North American gross product sales rose just under 17% in the fourth quarter. So we are doing well in our domestic markets too. Sales allowances for the quarter as a percentage of gross product sales increased 1.8% to 15.1% from 13.3% last year. We aggressively managed promotional and markdown allowances in Q4 to ensure that we ended 2017 well positioned for 2018, with very clean inventory levels at retail. Ben will discuss this more later. Other revenue, which primarily reflects merchandising royalty and television distribution income from products marketed by third parties using Spin Master's intellectual property and app revenue from Toca Boca and Sago Mini, rose 144%. Please note that part of this growth is due to an accounting change. Under GAAP, we are now required to reflect app revenue, which forms part of other revenue on a gross basis and reflect Apple and Google's commission as part of COGS. Previously, app revenue was shown on a net basis. Accounting for app revenue on a net basis, other revenue increased approximately 100% in Q4 compared to last year. Our gross margin for Q4 represented 51.9% of revenue compared to 50.8% last year, an increase of 1.1 percentage points. If the accounting change for app revenue is adjusted to a net basis as reported in prior periods, gross margin in Q4 would have increased further to 52.6% compared to 51.9% as reported. The increase in gross margin was driven by an increase in other revenue and a favorable impact from foreign exchange, offset partially by air freight costs for certain high-demand products, such as Hatchimals, Cardinal and Moonlite, and increased sales allowances. Total SG&A, excluding share-based compensation arising from the equity participation awards at the time of the IPO, increased by $40 million. This increase was driven by investments and marketing initiatives in the quarter and increased warehousing costs, primarily as a result of our growth outside of North America and an increase in our domestic North American business. However, SG&A, excluding share-based compensation as a percentage of revenue, declined 1.7% to 44.9% from 46.6%. The decline was driven by lower marketing and product development costs, offset by higher warehousing and distribution. We reported net income of $20 million or $0.21 per share in the fourth quarter compared to $2.7 million or $0.03 per share last year. Adjusted net income was $25.5 million or $0.25 per share compared to $9.3 million or $0.09 per share last year. Adjusted EBITDA in the quarter more than doubled to $47.3 million from $22.9 million last year. Adjusted EBITDA margin rose to 10.7% compared to 6.8% in Q4 '16, reflecting the increase in gross margin and lower SG&A. As a reminder, when we talk about Q4 from a profitability perspective, a significant portion of our annual marketing expenses are incurred in Q4 in order to maximize the impact on consumer purchases and our return on investment. This typically causes a misalignment of sales and marketing spend between Q4 and Q3, resulting in adjusted EBITDA margins in Q4 significantly below those in Q3. Finally, we had free cash flow of $18.4 million in the quarter compared to negative $3.9 million last year. The increase is primarily attributable to an increase in cash from operating activities, a decrease in cash flows used in investing and a decrease in cash used for licensed brand and business acquisitions. Turning now to the full year 2017. Revenue was up 34.4% in '17 compared to last year. Foreign exchange tailwinds increased overall revenue by $8.1 million. In constant currency terms, revenue increased by 33.7% relative to last year. Gross product sales rose 32.1% last year, significantly above industry growth rates, which were in the low single digits. Over the last 10 years, we have grown gross product sales at a CAGR of 13%, nearly 3x the average global industry growth rate. International gross product sales for 2017 was 34.7% to total gross product sales compared to 32.5% in '16, moving us closer to our goal of generating 35% to 40% of annual gross product sales internationally. We're starting to enjoy some significant economies of scale in the international market. Ben will have more to say about this later in the call. Sales allowances as a percentage of gross product sales were 11.6% for the year, down 20 basis points from 11.8% last year. Sales allowances are affected by product mix, geographic mix and our promotional activity, particularly in Q4. And we are pleased with the year-over-year decline despite the strong revenue growth we achieved. Managing sales allowances is a key focus of management's efforts. We continue to see sales allowances in the 11% to 12% range going forward, but we will be working hard to continue to reduce this further. Other revenue in 2017 was up nearly 79% from last year. The increase was driven by increased licensing and merchandising income and higher app revenue from Toca Boca and Sago Mini. On a net avenue -- revenue basis, other revenue increased 68% for the year. Gross margin for the year was 51.6% of revenue compared with 51.7% last year. The slight decrease in gross margin was primarily due to the inclusion of lower-margin Swimways products for the full year in 2017, partially offset by favorable impact from foreign exchange and increased other revenue. If the accounting change for app revenue is adjusted to a net basis as discussed, gross margin in 2017 would have been 51.8% compared to the 51.6% as currently reported. We continue to focus on cost management and generating operating leverage. SG&A, excluding stock-based compensation, was 36.4% of revenue, 30 basis points lower than the 36% -- 36.7% we reported last year. Looking at the key components of SG&A, marketing expenses represented 8.3% compared to 9.7% last year. We generated significant leverage on our marketing spend for key brands, such as PAW Patrol and Hatchimals. We did, however increase spending on strategic PR initiatives. The highly successful North American PAW Patrol Road Tour as well as our Macy's Thanksgiving Day parade PAW Patrol sponsorship were key elements of our increased PR spend. We are finding that this experiential marketing spend connects consumers with our brands more closely than traditional marketing channels and generates a strong ROI. Product development expenses represented 1.5% of revenue compared to 1.9% last year. The decline was due to the initial heavy development spend we invested in Hatchimals in 2016. In general, our product development expenses range between 1.5% to 2% of our annual revenue. Selling expenses, at 6.9% of revenue, were consistent with last year. Distribution expenses represented 3.5% of revenue compared to 2.8% last year. The increase was primarily associated with investments to support our European growth, which is mainly domestic. We also had onetime investment in warehousing capacity, including a transportation management system that drove up costs. However, these investments position us for future growth in both North America and Europe. Admin expenses decreased to 16.9% of revenue in 2017 from 17.4% last year. Excluding the impact of share-based compensation arising from equity participation agreements, admin expenses represented 16.2% of revenue compared to 15.6% last year. The increase of 0.6% was driven primarily by the TRU bad debt expense of $5.4 million. Excluding both TRU and share-based compensation, admin expenses were 15.9% of revenue. We reported net income for the full year of $161.1 million or $1.58 per share, an increase of over 60% compared to $99.5 million or $0.99 per share last year. Adjusted net income rose approximately 44% year-over-year to $173 million or $1.70 per share compared to $120.1 million or $1.19 per share. Adjusted EBITDA was $292.2 million in 2017, up 42.2% from $205.5 million last year and well above our sales growth rate. Adjusted EBITDA margin increased by 100 basis points to 18.8% in 2017 from 17.8% last year. Our balance sheet at December 31 continues to show strength and gives us financial flexibility. We ended 2017 in a plus cash position, driven by strong profitability and tight working capital management. Our net working capital as a percentage of sales was just over 5% compared to over 10% at the end of 2016. We lead the industry in this critical metric. Overall, we generated $193.4 million of free cash flow in 2017, 62.9% higher than the $118.7 million we reported last year. Free cash flow represented 66% of adjusted EBITDA in 2017 compared to 58% last year. Looking at our business segments for both Q4 and 2017. Gross product sales in Activities, Games, Puzzles and Fun Furniture in the quarter were up 20% from last year. For 2017, gross product sales rose 8.2%. The Cool Maker-branded product in our games portfolio, including Cardinal, Spin Master-branded games and Marbles games were the strongest contributors. In the Remote Control and Interactive Characters segment, Q4 gross product sales rose 114.7%. For 2017, sales were up over 100% from last year. The quarter and the year were primarily driven by Hatchimals and Hatchimals Colleggtibles. Gross product sales in the Pre-School and Girls segment were up 7.1% compared to 2016. However, Q4 was down 18.2% from the same quarter last year. The decrease in the fourth quarter was driven by a decline in Brightlings, Powerpuff Girls, Chubby Puppies and partially from PAW Patrol. I want to comment on PAW Patrol in particular. The decline was primarily due to timing factors. In Q4 2016 as compared to '17, we shifted disproportionately higher percentage PAW Patrol on a domestic basis to manage the promotional activity we had set up for Q4 '16 and early Q1 2017. In Q4 2017, however, we set up most of our 2017 PAW promotional activity earlier, which allowed us to ship more PAW Patrol on an FOB basis in Q3. Also, our 2018 spring promotional activity for PAW Patrol related to Season 5 will be shipped early in Q1 and not in Q4 2017. This allowed us to end the year in 2017 with much lower inventory at retail. In 2017 as a whole, PAW Patrol grew solidly, and POS remains healthy, both in 2017 and 2018. Ben will discuss this further in a few minutes. Moving on to Boys Action and High-Tech Construction. Gross product sales were up 5.6% in Q4. However they were down 27.4% for 2017. BB-8 Star Wars-licensed products boosted sales in the fourth quarter, as did growth in Tech Deck. However for the year, the segment declined, driven by Meccano High-Tech, and the licensed products for Pirates of the Caribbean did not perform as we had hoped. We anticipate the demand carefully in advance and managed our selling tightly in the segment. We ended the year with low inventory at retail, and limited markdowns were required in Q4. We generated gross product sales of $93.1 million in '17 from our Outdoor business segment compared to a partial year in 2016. Q4 will generally be Swimways' smallest quarter due to the seasonality of the business, which is weighted 70% in the first half of the year. From an acquisition perspective, we acquired Perplexus in Q4 for approximately $10 million. Perplexus had no meaningful impact on margins in the quarter or the year. On March 5, 2018, we acquired certain assets relating to the Gund line of business from Enesco for just over $79 million. The purchase price we financed from internally generated resources and our credit facility. Gund's gross sales in 2017 were approximately $65 million and are weighted 40% H1 and 60% H2. EBITDA margins are in the mid-teens. Gund will be included in the Activities, Games & Puzzles and Fun Furniture business segments. We expect to close the Gund acquisition on April 1, 2018. Looking ahead, as we have indicated, our long-term goal is to grow organic gross product sales by mid- to high single digits every year. There will be some years of high growth as we've seen in the past few years, and there will be years of more modest growth. For 2018, we expect our organic gross product sales growth rate to be in the mid- to high single-digit range compared to 2017. From a seasonality perspective, we expect gross product sales in the first half of '18 to be in the range of 32% to 35% of full year gross product sales compared to approximately 30% in the past. The shifting seasonality to H1 relative to prior years is, for the most part, driven by the demand for Hatchimals Colleggtibles in H1 2018. This line was only introduced in May 2017. Our adjusted EBITDA margin for 2018 is expected to be consistent with 2017. For clarity, the outlook I just mentioned excludes Gund. We will update guidance in May with our Q1 results as we always do and break out organic and inorganic growth at that time, as we did with Swimways in 2017. Finally, from a capital allocation perspective, we will continue focusing our investments in the area of innovation, international expansion, entertainment, talent and strategic M&A. In the near term, our focus is on value creation through capital growth. I'd now like to turn it over to Ben Gadbois. Ben?

[Benoit J. Gadbois]

Thank you, Mark, and good morning, everyone. The business continues to perform well, and we had another year of significant revenue and profitability growth. The global toy industry, particularly in the U.S., is experiencing some fundamental changes. The convergence of content and physical toys, the shift towards online e-commerce and the disruption caused by Toys"R"Us bankruptcy are all factors in this changing landscape. While some of these changes have had been positive for us, creating new opportunities to innovate and drive growth, others have presented obstacles for us to overcome. The industry growth rate in many major market declined in Q4. For the year, toy sales globally and in the U.S. both grew by 1%. This, however, was lower than original industry estimate and also lower than the industry growth over the past several years. Despite overall industry weakness, we had 3 items in the top 10 best-selling toys in the U.S. in Q4 and the top item for 2017 in the plush and infant toddler preschool toy supercategories, as measured by NPD. We continue to outpace the industry overall, delivering double-digit growth across most of our markets. In 2017, according to NPD, Spin Master was the #4 toy manufacturer in the U.S. We were also #2 in the games subsegment. In 2017, we achieved the #1 manufacturer spot and the top growth manufacturer in the plush supercategory, driven primarily by Hatchimals. Hatchimals was the #1 in top growth plush property in the U.S. for 2017 according to NPD. Our key brands are clearly resonating with consumers, with both PAW Patrol and Hatchimal ranking #1 in the Infant/Toddler/Preschool Toys and Plush supercategories, respectively. The TRU bankruptcy filing in Q3 2017 caused some uncertainty and deceleration in the industry during the fourth quarter. This had a disruptive effect on our orders in Q4. As we mentioned in Q3, we did see a shift of about $8 million to $10 million in orders from Q3 to Q4. However, at the time of bankruptcy, we proactively planned to manage orders and shipment from Toys"R"Us to the end of the year, with clean inventory at retail and with lower credit risk exposure. No one yet knows how the Toys"R"Us situation will play out. There are significant shifts going on at retail, and it would be unreasonable to think that the bankruptcy of Toys "R" Us will have no impact. We expect demand to shift to other channel, including both bricks and mortar and online, should TRU continue to lose share. We are monitoring the situation very closely to be prepared for any channel disruption that may arise from further store closure in the next 2 to 3 quarter. We also expect any disruption to be over by the end of 2018. From a channel perspective, we are continuing to see a shift to online sales. This has been a growing trend over the past few years, and we don't see any sign of online sales growth slowing down for 2018. In 2017, approximately 23% of our POS was made through online channel, which is consistent with the industry. As we see more of our consumers shopping online, we are responding by allocating a greater portion of our marketing spend in internal talent toward digital and social and less toward traditional TV. We have invested in deeper management in the marketing group by a focus on our TV, digital, social and PR investment in order to maximize these -- this critical area. We want to make sure we generate as much operating leverage as possible with our marketing spend. We saw the positive impact of this focus in 2017. We're also seeing an increase in alternative channels, such as bookstore, grocery, drugstore and trend clothing stores. These retailers are looking to drive incremental volume and revenue in toys to complement their existing product lines. They do not carry a wide range of toys, but they look to carry the most popular brands. Our brands, such as PAW Patrol and Hatchimals, are driving growth in these channels. This shift to alternative channel will likely grow in 2018, exacerbated by Toys"R"Us store closures. Throughout the year, we closely monitor beginning inventory level, shipment in, POS and ending inventory level to ensure we have clean sell-through at the end of December. This level of discipline is very important for financial reasons, but also for our strategic focus of building evergreen brands. Overall, we are very pleased with the way we have managed our retail inventory during Q4. We ended the year with our best inventory retail position since we went public, despite a 30% growth in revenue. This puts us in a strong position going into 2018. We also received Walmart's U.S. vendor of the quarter award for Q4 and vendor of the year award for 2017 in the toy category. Walmart uses POS growth and inventory management as the key metric in selecting the winner, and we are pleased to have been recognized for our management in these areas. We will continue to monitor POS and inventory, looking for further alignment going forward. We are continuing to deliver on all 4 of our growth strategies. As a reminder, our 4 growth strategies are to continue to innovate our core portfolio; two, build our global entertainment properties; three, grow international sales; and four, make strategic acquisitions. Our pipeline was full of innovative products in 2017, and we recently launched our 2018 line at the New York Toy Fair in February. Let me run through a few highlights of 2017 and the upcoming 2018 product lineup. In Activities, Games, Puzzle and Fun Furniture segment, we are getting very strong contribution from our game portfolio, including Cardinal. Cardinal continues to grow domestically and internationally as we leverage our global sale and distribution infrastructure. In 2017, we expanded our portfolio of games and puzzle through our acquisition of Marbles and Perplexus. We launched Soggy Doggy, and it won Game of the Year at this year's Toy of the Year Award. Soggy Doggy was also the top growth property in the preschool games subclass in the U.S. for '17 according to NPD. We feel Spin Master is well positioned to capitalize on the strength of the Games and Puzzles supercategory. In activities, we will be launching the innovative KumiKreator bracelet maker under the Cool Maker umbrella as well as an up and active preschool game called Croc 'n' Roll. In Remote Control and Interactive Characters, the Hatchimals brand grew significantly in 2017 with all products, including the original Hatchimals, Hatchimals Surprise and Hatchimals Colleggtibles, which have all performed exceptionally well. Hatchimals was the #1 dollar growth property in the U.S. for 2017 and also was the top property in the Plush supercategory with 6 of the top-15 items according to NPD. Specifically, the high-price-point Hatchimal had very strong sell-through, and we finished 2017 where we wanted to be from an inventory perspective for the brand leading into 2018. The popularity of collectible is still very high. In 2017, Hatchimals was the second-largest growth property in collectible, with 2 of the top 10 items according to NPD. In 2018, we will be expanding the brand with Hatchimals Mystery, 4 new and unique Hatchimals. Who you hatch will be a mystery. Our third annual global Hatchimals Day will take place on October 5 with an exciting new Hatchimals launch. Hatchimals Colleggtibles Season 3 and 4 are being released in 2018. The summer-time series will feature over 100 new characters, and there will also be 80 new Hatch Bright characters that shine when the lights go out to collect. Our investment in innovation was exemplified with the launch of Luvabella and Moonlite in 2017. For 2018, we will be delivering increased sophistication and advanced technology to Luvabella. The more you play, the more she learns and responds. Moonlite turns a mobile phone into a children storybook projector and brings innovation to story time by projecting vibrant image onto the ceiling or wall. It is an innovative link between toys and publishing. In midyear 2017, we made a calculated decision to be cautious with higher-price-point Air Hogs, Meccano and Zoomer item to ensure higher profitability, reducing markdown risk heading into 2018. We managed this very well and ended 2017 with appropriate levels of inventory both in our warehouse and at retail. In the Zoomer brand, the Playful Pup and Hungry Bunny will be added in 2018 as well as lower-price-point Zoomer Zupps tiny unicorns. Zoomer is entering in its sixth year as a brand. We are continuing to introduce new play patterns that interact -- in interactivity at both high and lower price points. In Pre-School and Girls, PAW Patrol continue to grow globally. According to NPD, PAW Patrol is the #1 property in the Infant/Toddler/Preschool Toys supercategory in the U.S. for 2017. As Mark discussed earlier, the decline in PAW Patrol shipment in Q4 2017 was isolated to that quarter. Overall, PAW Patrol shipment were up in 2017 and so was the POS. Consumer engagement remain very high, and we won Vehicle of the Year and Preschool Toy of the Year at this year's Toy of the Year Award for the Sea Patroller and My Size Lookout Tower. PAW Patrol generated very strong sell-through and has set us well for the front half of 2018. 2018 we will be launching Twisty Petz, a cute line of collectible that transform from adorable animals into bracelets with a simple twist. We also have another exciting girls product line coming into 2018, but we are keeping that one under wraps for now. In Boy Action and High-Tech Construction, Meccano sales were down in 2017 relative to 2016. As I mentioned earlier, we took a cautious approach. For 2018, we are focusing on the core and the licensed car featuring licenses such as Ferrari and Lamborghini. Tech Deck will be launching more boards; BMX bikes; and Tech Deck Dudes, a miniature lines of collectible figures in 2018. Star Wars showed some year-over-year improvement but off of a low base, and it was not meaningful for us in dollar terms. We do not see Star Wars as a long-term growth driver for us, but we'll continue to selectively launch items that fit our portfolio and profitability thresholds. In 2018, we are excited about several boys item, including Boxer, a robot controlled by remote control and through gesture, sound and touch; Flush Force, our new boy collectible line; and Fuggler, a unique line of funny, ugly monster plush. In our Outdoor segment, we have initiative in place to grow Swimways internationally. We are beginning to innovate in the water sports and toy area. You will see more of that innovation in 2019 and beyond.In terms of entertainment, our second growth strategy, our goal is to launch at least one new entertainment property per year. Building strong entertainment franchises underpins the growth of our brand. Season 5 of PAW Patrol is currently on air in the U.S. and Canada, and we are in production and development of Season 6 and 7. Most markets around the world are a season or 2 behind North America. We continue to be excited about PAW Patrol's long-term growth potential.In 2017, Rusty Rivet was ranked #3 in the preschool boy on Nickelodeon. The second season began airing this January and highlights 6 build-related themes, including the mobile, Rivet Lab, Tigerbot, and Botarilla. These build themes tie in with the toy line being launched broadly in August that will offer an easy-to-use, hands-on set that lets preschooler build authentic replica of their favorite characters from the show. We are hard at work on other creative properties for the boys and girls in 2018 and '19, including the relaunch of Bakugan as previously mentioned. Our third growth strategy is to grow our international sales. International sales continue to grow faster than North America, and we are pleased with our progress. In our direct market, we saw strong growth, particularly in Germany, Mexico and the U.K. These are markets where retail relationship and consistencies are key, and we are now regarded as a critical supplier, especially as some of our competitors in these markets have reduced their footprint. Our credibility is driving higher retail engagement and we will continue to capitalize on this opportunity. 2017 was the first full year of direct sales in Australia and Central Eastern Europe. We exceeded our internal projection for these geographies in our first year of operations. We are seeing the benefit of improved retail engagement by having a direct presence in these markets. We were also very pleased with our growth in China following our July launch. Although it has not yet been a full year, we have achieved strong momentum with a dedicated storefront on Tmall Alibaba and in distributors' windows, brick and mortar sales. We were recently awarded the new e-commerce power brand award for toys from Tmall in China. While still small, we are confident we are on track to see solid growth in China over the next several years. We remain underrepresented internationally compared to our major competitors. In 2015, we said our goal was to have international sales represent 35% to 40% of our total sales in the medium term. We have already achieved the lower end of this range. We are now focused on 40% as the next milestone. We will continue to expand our business in existing markets, open new markets, strategically convert some of our distributors to our own sales office and grow business with third-party distributors where we do not have offices. Our four growth strategies continue to make strategic acquisitions. Since our IPO in 2015, we have completed 8 acquisitions, 3 in 2017. We are continuing to focus on the underlying thesis for each of these acquisitions and ensuring we are leveraging our strength and the intellectual property we acquired to achieve the maximum growth potential. We are continuing to see strategic, accretive, favorably priced acquisition that improve our growth profile. As we have discussed, there is a great deal of fragmentation in the industry beyond the top-10 toy manufacturers, who comprise roughly $10 billion of the overall U.S. market. This represents roughly half in dollars of the total U.S. toy industry. We see a lot of opportunity to acquire some of the smaller player. The potential disruption that we are seeing as a result of the Toys"R"Us bankruptcy may present opportunities for us to acquire dislocated companies. We have the balance sheet and financial flexibility to do so, and we are actively seeking opportunities with the right strategic fit. We are very excited about our recent acquisition of Gund. Gund is located in Edison, New Jersey and has distribution throughout the United States, Canada, Europe, Japan, Australia and South America. Gund is a great fit for us, delivering on several key business strategies, including allowing us to build a stable platform for expansion into the infant toy and specialty gift categories. We also see the potential to further grow the business internationally. We are moving forward with the currently issued team in place and are focused on executing the established growth strategies. To conclude, we had a very successful 2017, and we are excited about 2018. Our differentiated brand presence, high retail engagement and strong consumer demand gives us the opportunity to continue to grow. Our entire management team is focused and hard at work on many drivers of growth for the company, including our capital allocation and developing our internal talent. By strategically executing against our 4 growth strategies, we are striving to deliver profitable growth and shareholder value creation in 2018 and beyond. That concludes our formal remark. At this time, Ronnen, Mark and I will now be pleased to answer your questions. Operator, please begin the question period.

[Operator]

[Operator Instructions] Your first question comes from Sabahat Khan from RBC Capital Markets.

[Sabahat Khan, Analyst]

On the other revenue line, I guess given the accounting change, how should we think about just the outlook for that line item for the course of 2018 versus 2017?

[Mark L. Segal]

So Saba, firstly, thanks for the question. I think other revenue, really, from an outlook perspective, should be modeled roughly flat with 2017. I don't think taking Q4 and -- as a run rate and applying that would give you the correct estimate for your -- so obviously, there is some seasonality associated with that as well. That's linked to our toy business, [ the end to end ]. The licensing and merchandising piece of that is linked to the underlying seasonality of toys. And then you have the app revenue business that is not seasonal, and which we hope will continue to grow.

[Sabahat Khan, Analyst]

All right. And then as you think about PAW Patrol, can you comment on what proportion of your total gross product sales you're expecting that to be in 2019? And I may have missed this, but are you able to share the magnitude or how much in sales shifted to Q1 from Q4?

[Mark L. Segal]

Okay, so I think you meant to say '18, Saba, but -- so we're not going to give specific guidance on a product line in terms of 2018. What I can tell you is that our PAW Patrol sales in 2017 were roughly the same as 2016, in the 20% to 25% zone. And in terms of the shift that we talked about earlier, if you look at that decline in Pre-School and Girls, there were other products as well that actually declined as well. Around 50% of that decline related to PAW Patrol. So it was about $10 million to $11 million. Ben, you want to answer?

[Benoit J. Gadbois]

Yes, just to add to what you asked, Saba, how much of Q4 shift to Q1, we actually don't look at it that way or measure it that way. One of our -- one of the key discipline we have in the company is to make sure that we always end the year with clean inventory, and we don't want to carry excess. And I know different companies have different philosophies. But for us, every year, we really, really try to raise the bar and really match the retail inventory with POS. So with that said, we're seeing -- if you actually look at NPD, we're seeing some nice POS already on PAW Patrol in Q1, not only North America but globally. So it's a philosophical question more than how much of the sales shifted to Q1.

[Sabahat Khan, Analyst]

All right. And then just one last one, a clarification. Now the comment earlier on the Nielsen rating, the #1 and #4 for PAW Patrol and Rusty Rivets, was that a global or was that a U.S. metric?

[Ronnen Harary, Co]

It was a U.S. metric.

[Operator]

Your next question comes from Steph Wissink from Jefferies.

[Stephanie Marie Schiller Wissink, Equity Analyst]

I have a few quick questions, if I can. I think, Mark, you mentioned, at least in the press release regarding the Gund announcement, that there was some alternative distribution opportunities. I'm wondering if you can extrapolate a little bit on what that might include. And maybe how some of your our product lines might be able to channel through some of those new distribution endpoints?

[Mark L. Segal]

Okay, so from a distribution perspective, a big chunk of their business, Steph, is actually in the specialty toy area, which is not an area that we are particularly active in. Also, Gund has around 20% of their sales internationally at this point. And we're nearly double that. So we see an opportunity to scale internationally. But in terms of the actual synergies and products, I'll pass it over to you guys to...

[Benoit J. Gadbois]

Yes, let me just, Stephanie, just to add to what Mark said. I think the opportunities is that Gund is a premium brand, and they have great distribution in specialty and the gift channels, where it's not necessarily where Spin Master has historically been strong. So we do see opportunity for element of our portfolio to actually leverage the Gund distribution network. But also internationally, Gund has some presence, but not as significant as we like. So there will be opportunities as well internationally.

[Stephanie Marie Schiller Wissink, Equity Analyst]

Okay. That's great. And then just a follow-up on the online comment. I think, Ben, you might've mentioned that it was 23% of your full year sales. I'm just curious if you'd be willing to talk about the holiday season versus the balance of the year. Does the online disproportionately skew in that fourth quarter? Or are you seeing some behavioral indicators around balance that are different in that holiday period versus the rest of the year?

[Benoit J. Gadbois]

Yes, so a couple of quick comments, Stephanie, is that we continue to be very focused on e-commerce. Just a couple of years ago, we were approximately half of the industry average. We're now at par with industry average. So it means that we spend a lot of our time and talent and effort on growing our -- the e-commerce side of the business. And we see more growth, and we believe it's a trend that's here to stay, and e-commerce will continue to grow. Now in relation to the second part of your question, in Q4, the data that we have internally show that it's -- e-commerce grew to approximately 28%, 29% of the industry sales. So Q4, we see that there is definitely a spike that takes place in the marketplace.

[Stephanie Marie Schiller Wissink, Equity Analyst]

Okay, that's great. And then last question is just on the seasonality, just given the guidance for the year, it looks like some of the initiatives around collectibles and certainly the Outdoor and active category with Swimways, is going to help to rebalance or create some proportionality in the front half. Should we think about that as a continuation strategically into '19 and '20 as you build out brands, like Gund and others, that maybe have a bit more of an annual business versus a back-half seasonal business?

[Mark L. Segal]

Well, Steph, if you look at our historical seasonality, it's typically been around 30-70, H1, 30%. As I said to you, the primary driver of the increase for this year related to collectibles, where we're not comping the first half of 2017. And so I don't think there is a structural shift because Swimways was in for the full year in '17 and will be obviously in for the full year in '18. As that grows, you might see a slight shift. And then Gund seasonality is about 40% H1. So again, you might see a slight shift. But it's not dramatic, and I don't want to be too specific at this point in relation to '19 and '20.

[Operator]

Your next question comes from Gerrick Johnson from BMO Capital Markets.

[Gerrick Luke Johnson, Senior Toys and Leisure Analyst]

So if you normalize PAW Patrol shipments, you're adjusting for the FOB versus domestic shift in 3Q, 4Q. And then the 1Q spring shipments are pushed forward out of 4Q. You adjust all that, would PAW Patrol shipments have been up?

[Mark L. Segal]

Yes, yes, PAW Patrol was still up for the year, Gerrick and -- but on a shipments basis and a POS basis.

[Benoit J. Gadbois]

Yes, Gerrick, just PAW Patrol, overall, if you average it all out and you normalize all of it, it would still be up in North America as well as internationally.

[Gerrick Luke Johnson, Senior Toys and Leisure Analyst]

Okay. For that -- to be clear, for that holiday period, I wasn't talking about the year, but for the that holiday period, if you include 3Q, first quarter, 4Q, all that together.

[Benoit J. Gadbois]

No, the -- no, correct. That is correct, Gerrick. The POS is up on all the metrics any way you look at it.

[Gerrick Luke Johnson, Senior Toys and Leisure Analyst]

Okay, great. And then on the other revenue, even adjusting for the app accounting change, revenues still grew about 100%. Can you kind of unpack that? And specifically, how much of that was incremental licensing revenue from Hatchimal?

[Mark L. Segal]

Yes. So Gerrick, we don't actually break down other revenue into all its components. There are 3 primary components. I'll try and give you some color on them. The first one is distribution revenue, the second is licensing and merchandising, and the third is app revenue from Toca Boca and Sago Mini. So the licensing and merchandising was impacted, to some extent, by Hatchimals. We are seeing a nice growth from that program, not very material. Also, PAW Patrol and other properties that we are licensing merchandising income from. And then we are seeing growth in the app revenue area. So I think it's really actually across the board that we're seeing some growth.

[Gerrick Luke Johnson, Senior Toys and Leisure Analyst]

Okay. And then finally, your inventory grew 50% on top of 63% last year. So can you explain what's going on with your own inventory?

[Mark L. Segal]

So inventory increase was -- firstly, let me say before I answer inventory that our overall net working capital, as I said to you, was more than halved, from 10.7% to 5.6% this year as a percentage of sales. So I think we did exceptionally well. And obviously, that has had a positive impact on free cash flow. Inventory actually did increase, and that was driven by 2 factors: One was our increase in our European business, which is mainly domestic; and the other was the increase in our North American inventory, primarily Hatchimals Colleggtibles in expectation of growth in the first half of 2018.

[Operator]

Next question comes from David McFadgen from Cormark Securities.

[David John McFadgen, Director of Institutional Equity Research]

A couple of questions. Mark, can you confirm what the largest revenue line is now? Is it Hatchimals or is it PAW Patrol?

[Mark L. Segal]

David, we don't break down the revenue, as you know. We usually only give the top line item. But in this particular case, I will tell you that both PAW Patrol and Hatchimals are both around the same, in the 20% to 25% zone. They're almost identical in that perspective.

[David John McFadgen, Director of Institutional Equity Research]

Okay. So just a couple of questions on the outlook for 2018. What kind of growth are you expecting for PAW Patrol in 2018?

[Mark L. Segal]

So David, at this point, we're not going to give specific product guidance. It's too early in the year. We've kind of given you our best view at this point in time of where we think the year's going to shape up. As we go through the year in Q1 in May and Q2 in August, we'll give you more granular guidance. But we're not going to comment specifically on PAW Patrol right now.

[David John McFadgen, Director of Institutional Equity Research]

So you can't even just confirm whether you think PAW Patrol will be up or down for 2018 versus 2017?

[Mark L. Segal]

Well, as Ben said earlier, David, both POS and shipments are continuing to be very strong.

[David John McFadgen, Director of Institutional Equity Research]

Okay. And then just on Luvabella, I was just wondering, are you forecasting fairly -- I know you're not going to give us the actual number. But are you forecasting fairly large growth in 2018 for that product line? Or is it just too early right now to say?

[Mark L. Segal]

Again, it's too early, and I just want to just reiterate that we don't give specific product line guidance in terms of our outlook.

[David John McFadgen, Director of Institutional Equity Research]

Yes. Okay. And then just on the working capital, so this year, 2017, you actually had a working capital inflow. In the past, you've typically had working capital outflows, so that was a really good metric to see. Do you think that's sustainable in 2018? Or will we see a reverse back, and there'll be working capital outflow in 2018?

[Mark L. Segal]

I think we had very good performance on net working capital in 2017, as you mentioned. It is a critical part of how we, as a management team, operate the business. Both DSO, DPO and DIO are all critical metrics, as is cash conversion. So it's going to be a continued focus on how we operate. And it's also, by the way, a key part of our incentive compensation plan. So it's something that the business as a whole is extremely focused on. I can't give you a prediction at this point. We will continue to see inventory, I think, increase a little bit as we grow our European business and as we shift some of our FOB business to domestic to better service the market here. But I think it's a little bit early to be too granular on our net working capital for the year.

[David John McFadgen, Director of Institutional Equity Research]

Okay. And then just lastly, I noticed you took a small impairment charge for intangible assets in the quarter. I was just -- and then obviously, for the year, it's a bigger number. I was just wondering if you could tell us what product that related to.

[Mark L. Segal]

In the fourth quarter, we took a small charge for our Spy Gear product. Not material.

[Operator]

[Operator Instructions] Your next question comes from Brian Morrison from TD Securities.

[Brian Morrison, Research Analyst]

Mark, just -- can you tell me about the puts and takes of a flat margin guide for 2018? On a positive, I assume there's more licensing deal and sales of owned IP. On a negative, I assume you've got acquisition contributions and more international costs as your sales increase. Maybe just walk through the puts and takes and whether there's potential upside through economies of scale as well.

[Mark L. Segal]

Thanks, Brian. So as you noticed, we guided flat on our adjusted EBITDA margins. We'll continue to focus on growing our margins. But as you know, it's early in the year, and we don't want to be too granular on that. The reality is though, that we will continue to focus on operating leverage. We'll continue to focus on reducing our cost. We do see some areas where we will have to invest in international, particularly in growing some of our people around the world to sustain the growth. So for that reason, we did not actually guide for an increase in adjusted EBITDA margin at this point in the year. Plus there will be some integration costs associated with Gund.

[Brian Morrison, Research Analyst]

Okay. And then maybe just Ronnen on Bakugan, can you just provide some details on the relaunch in 2019? I believe Corus will be involved in the production again. But when it hits the market, is this a global relaunch? Or will it be aimed at a specific geographic region before going global? Just how do you think about a relaunch of a historically successful story or franchise?

[Ronnen Harary, Co]

Yes. Well, thanks, Brian. I appreciate getting a question. I felt a little left out. But the first and foremost is to wait 7 years for a fresh generation of kids, okay, to come into the property. And I think that the discipline that we've employed by having the patience to wait is first and foremost. Second is staying very true to what makes Bakugan very special, but at the same time, to bring something new and different to the actual Bakugan toys themselves. And I think when we show that to you guys in the spring, you guys will really appreciate the advanced innovation we brought forth to the actual toy itself. And from a story and show perspective, again, trying to follow the same tips -- formula that we employed on the first 4 seasons. But again, making it a little bit more current and relevant to what's happening in the marketplace. So for example, the show is actually -- instead of being 22 minutes in length, it's two 11s to fit what's happening now with movement in terms of kids and how they're viewing content in partnership with our broadcaster, which we'll be sharing with you guys shortly. And in terms of it being a global launch, it will be a global launch around the world. We're very focused on that. We're very excited about the ability to launch globally through a lot more direct offices this time around, rather than distributors. And that would be -- gives us the ability to control the marketing and control the shipments in and the overall brand. So I think that we're very focused on the global aspect of it this time around than last time around. And yes, it's going to be everything from the toy, to the television, to online, to the marketing, to the in-store. The company's very, very focused on making this a global franchise and also working on other things like we talked about before, which is potentially trying to get a movie out in the next few years. And there is also a very concerted effort to focus on the Asian market with Bakugan also.

[Brian Morrison, Research Analyst]

Right. Mark, just on international sales. You're now at that low end of the 35% to 40% range. This was a midterm target. But now that you're there, is there any updated targets, more long term? Is 50-50 something -- with your international aspirations now?

[Mark L. Segal]

I think our new target at this point, Brian, is the 40%, which is -- represents the top end of the previous range. We kind of hit the bottom end, and now we're focused on the 40% as the next goal. I think 50-50 is probably a little bit aggressive at this point in the next few years. It's taken Mattel and Hasbro 20, 30 years longer than we have been around to actually get there. Ben, do you want to add to that?

[Benoit J. Gadbois]

Yes. No, I think, Brian, the next milestone for us is 40%. We still have a lot of room for growth where we already are with opening more doors and just keep leveraging our portfolio. And there's also new markets for us to enter. So you will -- we're very focused on our international growth. But 40% is the next milestone.

[Brian Morrison, Research Analyst]

Okay, and then just last question. I just want to clarify, going back to PAW Patrol, and I don't want to get too detailed here. But if I want to make sure, because it's important that I understand Ben's comments correctly [ in the text ]. So it sounds like the message here is continued growth outlook as we move through 2018. And then including all the adjustments in Q4, it would've been up in all geographies. Is that correct?

[Mark L. Segal]

Yes, I think that's fair to say, Brian. I mean, the overall message we're trying to get across here with PAW Patrol in Q4 is, it's not a major factor. It's not something to get concerned about. POS is up for the year. Shipments were up for the year. It's strong. And this is why, actually, we like giving guidance in terms of halves and not in quarters because you can have a few shifts here or there and it really doesn't create -- I don't want you to overanalyze it. And so I think -- yes, Ben, you want to add?

[Benoit J. Gadbois]

Yes. The key thing is, for us, not just how we manage PAW Patrol but how we manage all of our other properties is we have an internal formula that we're very disciplined around. And it's the looking at the beginning inventory at the retail level, looking at what we're shipping, what the POS is and what the ending inventory is. And we always, always strive to keep the ending inventory very, very tight so that it actually reduces potential for mix issues, allocation issue in the marketplace. So it gives us more flexibility as a company. So -- and it also helps driving our working capital tremendously. So we're very focused on this formula. And this is why sometimes, the POS for example, has been very strong on PAW Patrol. And the shipment, again, there was a timing issue because of that formula.

[Operator]

I have no further questions at this time. I turn the call back over to the presenters for closing remarks.

[Karoline Hunter]

That concludes our call. Thank you for participating, and we look forward to speaking with you again following our Q1 reporting in May. Thank you.

[Benoit J. Gadbois]

Thank you.

[Operator]

Thank you, everyone. This will conclude today's conference call. You may now disconnect.