Spin Master Corp. (SNMSF) Q4 2019 Results – Earnings Call Transcript

Spin Master Corp. (OTC:SNMSF) Q4 2019 Results Conference Call March 5, 2020 9:30 AM ET

Company Participants

Sophia Bisoukis – IR

Ronnen Harary – Co-CEO

Mark Segal – CFO

Conference Call Participants

Sabahat Khan – RBC Capital Markets

Adam Shine – National Bank Financial

Derek Dley – Canaccord Genuity

Brian Morrison – TD Securities

Gerrick Johnson – BMO Capital Markets

Steph Wissink – Jeffries

Linda Bolton Weiser – D.A. Davidson

Jamie Katz – Morningstar

David McFadgen – Cormark Securities

Kirill Kozyar – CIBC World Market


Good morning, afternoon, evening. My name is Cheryl, and I will be your conference operator today. At this time, I would like to welcome everyone to the Spin Master Fourth Quarter 2019 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker’s remarks, there will be a question-and-answer session. [Operator Instructions]

Sophia Bisoukis, you may begin your conference.

Sophia Bisoukis

Thank you, Cheryl. Good morning everybody, and welcome to Spin Masters financial results conference call for the fourth quarter and year-ended December 31, 2019. I am joined this morning by Ronnen Harary, Co-CEO; and Mark Segal, Spin Master’s Chief Financial Officer.

For your convenience, the press release, MD&A and audited consolidated financial statements for the fourth quarter and 2019 are available on the Investor Relations section of our website at spinmaster.com and on SEDAR.

Before we begin, please note that remarks on this conference call may contain forward-looking statements about Spin Master’s current and future plans, expectations, intentions, results, levels of activity, performance, goals or achievements or any other further 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 not to place undue reliance on these forward-looking statements, except as may be required by law, Spin Master has no obligation to update or revise any forward-looking statements, whether because of new information, future events or otherwise.

For additional information on these assumptions and risks, please consult the cautionary statements regarding forward-looking information contained in the Company’s earnings release dated March 4, 2020. Please note that Spin Master reports in U.S. dollars and all dollar amounts to be expressed today are in U.S. currency.

I would like to now the conference call over to Ronnen.

Ronnen Harary

Thank you, Sophia. Good morning and thanks for joining us on the call today. In 2019, we faced several challenges, as we continue to navigate and evolving retail and content consumption landscape. Our overall performance for the year was one of contrast. On the one hand, our diverse portfolio performed very well against the industry wise softness growing 16% excluding the decline in Hatchimals. Well on the other hand, our operational initiatives were not executed as planned, leading us to miss both our growth product sales and adjusted EBITDA margin targets for 2019.

To put this into perspective, while our growth product sales declined 1% in 2019, against an industry that declined 3% globally. Our margins fell far short of our goals in 2019. We are now heavily focused on cleaning up any structural issues and driving cost savings in areas where we have identified inefficiencies.

Mark will discuss with you in more detail our plan to address our operational challenges through 2020. However, I would like to address some significant senior leadership changes that occurred to position us for the next stage of our evolution, in an evolving Toy industry, content landscape and retail environment.

These changes will optimize Spin Master for growth with a renewed commitment to operational excellence, as we continue to execute against our long-term strategy. We’re moving quickly to adapt to the new realities, leveraging the underlying strength of our core business, our dedication to innovation and our financial stability.

As part of this operational excellence initiative, we have kicked-off a project called Excel, which is a top priority for us. It is critical to our long-term success that we evolve our processes, systems, structures and accountability to better match our business complexities and better serve our customers. Project Excel is designed to help us do that. We need to quickly clean up our structural issues and drive cost savings to get our operating margins back to where we want. We were not happy, neither one would be satisfied till this is accomplished.

Our long-term growth is driven by our ability to identify, develop, acquire new and innovative products and brands, create and license evergreen, entertained content and grow internationally, in partnership with inventors, broadcast production studios, distributors, and licensed source.

We can continue to go deeper in our categories through our internal innovations, strong partnerships and acquisitions constantly fueled by our discipline 36 month brand innovation pipeline.

We are ramping up our sourcing and procurement activities outside of China with new manufacturing capabilities in Vietnam, Mexico, and India, with other countries under consideration. This multidimensional global platform gives us a competitive advantage in terms of our ability to understand kids play patterns and serves as a foundation for future growth. I encourage you to think of us not only as a toy company, but as an integrated entertainment business with toys, entertainment, and digital toys and games.

Many of you have joined us at the New York Toy Fair last week, where we revealed our innovative 2020 portfolio of toys, games, entertainment franchises, and digital toys. We continue to be at the forefront of evolving trends, capturing the hearts and the minds of children around the world and maintaining our position as an industry leader. We’ve been innovating in toys for over 25 years and we understand the art form of creating toys and play patterns that resonate with kids globally.

At the same time, we produced entertainment for 12 years, over 1,000 episodes of content and counting. At the core Spin Masters, our ability to create engaging kids storytelling for multi-platform consumption. Through the acquisition of Sago Mini and Toca Boca, we entered the digital mobile business three and a half years ago. This acquisition provide us with a strong brand presence in the digital mobile space and allowed us to develop a leadership position in the kids mobile app and direct-to-consumer area.

We spent the last three and half years learning and understanding this dynamic new marketplace. Because children are increasingly accessing and consuming entertainment content on mobile devices, we have strategically invested and focused in all areas of content consumption, which includes our mobile digital presence. For years, we have been studying play patterns which have been converging between physical brands, entertainment franchises, and mobile digital platforms.

Today, Toca Boca and Sago Mini average over 200 million — 20 million. I wish it was 200 million, but it’s 20 million for now. Monthly active users on a combined base globally, giving us a strong base of users to expand both app sales and direct-to-consumer subscription-based products.

In 2020, we’ll be enhancing our offering from one to three subscription products. These will include Sago World, Sago School. Along with an innovative subscription offering of Sago Mini physical boxes, which just launched two weeks ago and which integrate with the digital world.

In 2020, we’re increasing our focus on expanding and deepening the focus we have — the businesses we acquired, such as Gund, Swimways and Cardinal, and the franchise, we believe have long-term growth potential such as Bakugan, Monster Jam, DC and PAW Patrol. Our goal is to do more with less.

I would like now to discuss our business segments with you in more detail. Activities, Games and Puzzles and Plush segments is a strong and stable platform for Spin Master. We are growing the business through brand building, focusing on expanding our existing brands as well as supporting new promotional activities. We’re targeting global channel expansion to increase our footprint and strategically enter adjacencies that complement our current products.

At the end of 2019, we completed the acquisition of the Orbeez brand. The acquisition further strengthens our activities business, providing opportunities for integration into our existing product lines, as well as further innovation. Kinetic Sand continues to grow into a global brand.

Hollywood hair from Cool Maker is the only do-it-yourself studio will let you create your own hair extensions. Games and Puzzles continues to drive steady and reoccurring volume.

Regarding our Plush business, Gunds, we continue to scale the business through our ability to use our global sales and distribution infrastructure, and our ability to capitalize on strong licensing opportunities with key partners. This year we added two strong licensed partnerships to the Gund portfolio. Hilda, the award-winning animation series airing on Netflix, which we announced earlier this year and the new animated preschool series Gabby’s Dollhouse. Beginning in fall 2001, we’ll bring these characters from the show to life through new toy line that will include Playsets, Fuggler, Plush, Games and Puzzles.

We’re also very excited about our ability to mind the 100 year old Gund library of ideas and reimagine them. Crinkle Tinkle for Baby Gund is a great example of an old idea brought back to life. Baby Gund is an area that we will continue to focus on we believe it has strong potential to grow globally.

The boys action and construction category was our strongest performing business segment in both the fourth quarter and full year. With strong momentum solid contribution from three major launches this year, How to Train Your Dragon, Monster Jam, Bakugan all performed exceptionally well in 2019.

We saw strong Bakugan brand engagement internationally and solid performance in the U.S following the launch on Netflix. We’ve seen a good start in 2020 of Bakugan and expect the momentum to continue through the year. The second season of Bakugan Armored Alliance brings an exciting point of innovation to the franchise. And we launched our Cartoon Network on March 1 with the second half of season one also watching on Netflix this month.

The Monster Jam line performed extremely well at retail locations resulting in the largest year for Monster Jam retail toy sales in the brand’s history. In 2020, we will remain committed to continuous innovation offering an elevated play experience for Monster Jam fans and further expanding their presence in the wheels aisle around the world. This entrants the wheels category provides with a great opportunity for diversification and growth. At New York Toy fair, we introduced the Monster Jam Megaladon Storm and RCDA goal that you can drive on water and land.

In January, 2020 we kicked-off our DC entertainment boys action line, as a new license for action figures Playsets, Remote Control and Robotic Vehicles, Water Toys and Games and Puzzles. The line is off to a strong start we have innovated the line and the reaction at retail has been very positive. Those of you who visit our booth can feel the excitement of the 2020 DC lineup, which includes action oriented toys inspired by Batman’s 80 year legacy that celebrates him as the number one DC Super Hero.

The Preschools and Girls segments saw solid growth in fourth quarter driven by fresh teams and PAW Patrol and innovative new product lines such as Ready-to-race rescue TV special and new toy items that continue to bring the theme to life. PAW Patrol continues to be a top rater Preschool show globally and we can continue to deliver very high ratings on our shelves and our specials.

In fall of 2020, the Dino Rescue theme will be integrated into the PAW Patrol world staying true to the storylines and the characters while exploring new landscapes and rescues. We’ll be introducing the first ever motorized PAW Patrol vehicle, the PAW Patrol, Dino Patroller featuring large-scale wheels for expert rough terrain. Adding to our partnership and continuing to build the strength of PAW Patrol as a franchise. We’re excited to — pardon me — We are excited to launch the first ever full length animated PAW Patrol theatrical film in association with Nickelodeon and Paramount pictures.

Paramount will be distributing films starting August 21 and this has been a really exciting journey for us as a company and represents our first 4A into feature film. The film will feature an all new location, New pup, and will be animated in a high quality feature film animation. Our goal is for PAW Patrol to be the first of many feature films and we’ll set the foundation for other properties to follow onto the big screen.

We expect PAW Patrol to continue to be a strong contributor to our sales for many years based on new themes and innovative products. In Girls, we’re also excited about Luvabella, Mealtime Magic, which is technology-advanced baby doll that delivers a premium play experience and innovation to a tried and true play pattern. The universe is an out of this world brand of collectible unicorns that allows kids to explore and immerse themselves in a never ending world of make believe.

We’ve had some great innovation in 2019 the remote control and interactive character segments. We launched, Juno, our animated baby elephant and Owleez an interactive flying pet. Juno and Owleez are both a testament to our team’s ability to continue to innovate in this high-tech space and merged technology with great play. We were very happy with the performance of our Monster Jam Remote-controlled trucks, which performed very well.

In 2019, we launched Hatchimals Pixies, which has allowed us to break into the small doll category. Pixies is a cross between a collectible doll house in an egg. For 2020, we’re excited to introduce Hatchimals Pixies crystal fliers. Hatchimals Pixies that really fly. The Pixies can air dance and you can glide her in flight with an IR sensor in her feet. We also seek to leverage innovation across product lines. For example, we developed the hatching technology that made hatch most a groundbreaking success into our How to Train Your Dragon line. This will be followed by our new present paths interactive property in 2020, which some of you saw in New York and which we are keeping under wraps until later this year. We have more innovation for 2021 and beyond.

I want to take a moment to update you on the impact of the COVID-19 situation to our business. The situation is very fluid and is driven by factory startup dates, labor return rates, capacity available for Spin Master, tooling availability and raw material and component availability. Many of our key factories are open, but most are not yet operating at full capacity. Travel restrictions remain in place and we are doing as much on video conference as we can. We’re shifting some production to Mexico and other countries where possible. As Mark, we’ll go over in a minute, we do not expect to see an impact, we do. We do expect to see an impact in 2020.

I can tell you that we are acting very entrepreneurially and using every tool available to us and mitigate the impact of the virus as much as possible. We have an excellent team in China who are constantly working on mitigation strategies. For example, in the second half of the year fall season, we are compressing our schedules to stay as closely on track as we can and we’re working very closely with our retailers.

Paradoxically, our elevated inventory levels at the end of 2019 will help us mitigate some production gaps. To conclude our outlook for gross product sales in 2020 reflects the pressures of businesses currently experiencing, including further declines in a Hatchimal product line combined with the shifting toy industry landscape the challenging global growth outlook that is causing heightened uncertainty and the potential impacts of COVID-19.

All this has led us to look at our 2020 growth projections conservatively. Our 36 month brand pipeline is designed to achieve long-term growth. 2019 was healthy with the business growing 16% excluding the decline of Hatchimals. Although, we are not projecting growth for 2020. Our pipeline remains healthy and we will continue to grow again.

Our brands, partnerships, products, entertainments and mobile digital franchises are resonating strongly with children. We are confident in the success of our strategic direction and we are proud of our global teams for their commitment to delivering our success. Looking forward to 2021, we continue to be excited about offering and a normalized run rates on growth and profitability.

I will now turn the call over to Mark.

Mark Segal

Thank you, Ronnen. On January 21, we released preliminary gross product sales and adjusted EBITDA results for the fourth quarter and full year ended 2019. At that time, we discussed in detail the challenges that affected both gross products sales and profitability for the full year.

On today’s call, I will briefly summarize our final Q4 and full year performance. In addition, I will discuss our 2020 outlook and provide further detail on our operational excellence journey. I’ll begin with a brief summary of performance.

Despite the operational challenges we faced during the fourth quarter, revenue of $473.5 million was up 14.3% from the same period last year, or 14.7% on a constant currency basis. We grew gross product sales in the quarter by 18.3% with an unfavorable foreign exchange impact of $2.6 million. On a constant currency basis, gross product sales grew 18.9%.

This growth continued to be led by the boys action and construction segment followed by 11.6% growth in the activities, games and puzzles and plus segments, and 9.6% growth in the Preschool and Girls segment. On a geographic basis, Europe grew 27.2% followed by North America at 18.8% and 1.6% for the rest of the world.

International gross product sales represented 43.9% of the total. Globally Q4 POS, including Hatchimals was flat. With respect to the U.S, we perform better than the industry with our Q4 POS excluding Hatchimals up 12% year-over-year in comparisons to an industry that showed weakness.

We continued to see positive POS momentum internationally in Q4 in many key markets. In Europe, we saw positive POS growth overall, driven by strong performance in key countries such as Germany and the U.K, where despite the turbulence of the market due to Brexit. We saw POS growth of 4% for the year compared to a mid-single digit decline in the U.K toy market overall.

Our overall POS performance for the year was solid relative to industry. With POS growth of 1% globally, despite the decline of Hatchimals and compared to a global industry that declined 3% and the U.S. industry that declined 4%. Global POS excluding Hatchimals was up 14% year-over-year. POS continues to be the leading preschool brand globally. We saw poor POS growth in Europe through 2019 and strong POS growth in Germany, Russia, Poland, Hungary, and Slovakia in particular.

In Asia, the Q2 launch in Japan continued to gain momentum in Q4. In the U.S. POS for PAW Patrol declined for both the quarter and the year. As we mentioned in Q3, we saw an impact on poor POS, due to the launch of Toy Story 4, which targets the same consumer. Our main TV driver in Q4, The Jet, also did not perform as expected and it was not nearly strong as the TV driver in 2018. PAW is seeing the normal ebbs and flows of a global brand, but remains very solid, and we will continue to manage the brand for the long-term closely monitoring retail inventories.

Kinetic Sand continuously grew throughout the year. In Q4, POS was up 49% compared to last year. Current POS year-to-date is also very encouraging. Globally, our POS is up 5% and up 16% excluding Hatchimals. Cardinal, Monster Jam, Bakugan , Gund, Kinetic Sand and Swimways all showing very strong POS growth. In the U.S., POS is up low single-digits and up low double-digits excluding Hatchimals driven by the same brands globally. PAW Patrol POS is up low-single digits globally. PAW Patrol is slightly down in the U.S. currently, but trending up very strongly as our marketing kicks in ahead of Easter.

Turning back to the P&L. Sales allowances increased to 19.8% of gross product sales, compared to 18.1% in Q4 ’18. This increase was related to higher markdowns, as well as the noncompliance charges from customers given our supply chain issues. As well as proportionate the highest sales in Europe and Russia, which have both higher pricing and the highest sales allowance rate.

Other revenue which primarily reflects licensing and merchandising royalties, television distribution revenue and app revenue declined by 3.9% during Q4. Gross profit for the quarter was $226.1 million, or 47.8% of revenue compared to $199 million, or 48% of revenue in Q4 ’18. This 20 basis point of decline in gross was principally related to higher sales allowances and higher fright expenses related to the distribution issues we faced in H2, 2019.

Selling, general and administrative expenses increased 21.3% compared to Q4 18. As a percentage of revenue, SG&A was 48.9% in Q4, up 280 basis points from 46.1%. The increase was primarily related to higher distribution costs arising from the establishment of our third party DC on the East coast and the consolidation of the standard on guidance from ways in Cardinal warehouses into this new facility.

High inventory storage and transportation expenses contributed to the increase, as we carried more domestic inventory and anticipation of higher tariffs in the U.S. China trade war and a shift towards domestic sales over FOB.

I do not want to call out the elevated levels of warehousing and distribution expenses in 2019 as one-time that would be disingenuous. However, I do want to point out that the level of spend we saw in this area in Q4 is highly inflated at 9.8% compared to historical spend levels of about half of that. We’re doing everything we can to get this expense line back down to historical spend levels.

In Q4, we recorded an adjusted net loss of $7.8 million, or $0.08 per share compared with adjusted net income was $6.2 million, or $0.06 per share in Q4 of 2019. Adjusted EBITDA was $6.7 million in the quarter compared to $35.2 million in the prior year. EBITDA margin was 1.4% down 710 basis points from 8.5% last year.

Turning now to the full year. Revenue decreased by 3.1% to $1.58 billion, in constant currency terms revenue is down 2.1% compared to ’18. Although, we started the fourth quarter with positive momentum based on the progress we have made in October, with both orders and shipments after a strong start. Order level shipments, and in particular, our operational performance in November and December were considerably below our expectations. As a result, we reported global growth product sales of just under $1.7 billion down 1% from 2018. Outperforming the [G13] countries which were down 3% is measured by NPD.

Gross product sales were flat on a constant currency basis, excluding the plan decline in Hatchimals, we generated the 16% increase in gross product sales as Ronnen just mentioned. The decrease was primarily a result of a decline in remote control and interactive segments, principally related to Hatchimals, which declined just over $230 million year-over-year. This headwind was partially offset by solid gains in the boys action and construction segment, led by Bakugan and Monster Jam, DreamWorks Dragons and the positive influence of initial shipments of DC licensed products.

From a geographic perspective, Europe grew 14.4% driven by strong performances in Russia in Germany, Austria and Switzerland. North America decreased by 5.4% and the rest of the world declined 4.9%. On a full year basis, international gross product sales grew to 39.3% of the total gross product sales compared to 36.5% in 2018 and 34.7% in 2017.

In 2015, our goal was to reach 40% of sales — 40% of sales generated from international markets. We’ve now increased that goal to 45%. As a reference, 70% of global industry toy sales occur outside of North America. We haven’t long runway for growth and we making the necessary investments to do so.

Sales allowances as a percentage of gross product sales was 13.5%, which is well above our typical historical range of 10% to 12%. The increase was primarily driven behind markdowns and increasing noncompliance charges from customers attributable to our operational performance issues, and continued expansion in Europe and Russia, which have both higher selling prices and a higher rates of sales allowances.

In 2020, we are targeting to get this rate down to approximately 12.5% as our operational performance improves. Other revenue declined by just over 3% for the year, due to lower licensing and merchandising revenue offset by higher TV distribution revenue and app sales. We expect other revenue to be flat for 2020 compared to 2019.

Gross profit in 2019 represents a 49.6% of revenue compared to 50.2% of revenue in 2018. SG&A increased by $33 million, or 5.4% for the full year. The decrease in gross margin and the increase in SG&A during the year were primarily driven by the factors I mentioned in my description of Q4. Adjusted net income for 2019 was $92.8 million, adjusted EBITDA for the year was $219 million a decrease of $85 million.

Adjusted EBITDA margin was 13.8% compared to 18.6% in 2018. The decline in profitability was caused by our previously discuss supply chain challenges, lower sales and increased sales allowances. We were pressured through the back half of 2019, as we continue to do everything to service our customers using inefficient warehousing and transportation processes.

Total net working capital as a percentage of revenue was 17.5% compared to 10.8% last year. Core working capital for 2019 increased to 21.5% of revenue compared to 13.3%. This was primarily driven by an increase in trade receivables due to a shift in shipments to later in the quarter and a byproduct of the shift from FOB to domestic as well as high inventory levels.

Overall, our cash conversion cycle increased by 35 days. Free cash flow for the year was $84.6 million compared to $129.5 million in 2018. The decrease in free cash flow is attributable to lower cash flows from operating activities, partially offset by less cash used in investing activities. Our balance sheet remains very strong. We ended the year with $115 million in cash. We are well positioned to take advantage of acquisition opportunities. I want to outline the steps we are taking to address the operational issues we faced in 2019. As Ronnen mentioned, we’ve kicked-off project Excel at initiative aim that evolving our processes, system structure and accountability.

We are focusing on three primary areas. Our first focus is supply chain optimization. We would address issues with our DC structure to ensure we are both to address changing demands in our industry. We want to improve on time delivery and our full rates and our scheduled attainment. We will aim to improve our customer service. We still have strong relationships with customers. However, these were challenged in 2019. We’re going to be focused very heavily on key metrics and our domestic and FOB mixed. There is no right answer as to what are domestic and FOB mix should be. It varies by region, by customer and by product.

North America is more FOB centric. Europe is more domestic orientated. Historically our mix has been oriented more towards FOB, which is more efficient for us from a supply chain perspective. Even though our FOB margins are lower than domestic, these sales don’t touch our warehouse system.

Secondly, we will focus on process simplification, automation. Increasing our levels of automation and simplifying our business processes will increase efficiencies and drive cost improvements. We want to be focused more on data driven insights and we aim to refine our systems to increase productivity.

From a people perspective, our third area of strategic focus in 2020, we want to make sure that we allocate resources to the most important areas of the business to set goals that match our strategy to improve accountability through tighter some measurements of performance, and we want to make sure that we improve coordination between teams globally.

A few weeks ago, we announced the promotion of Tara Deakin, the Chief People Officer, a new positioned at Spin Master. Spin Master is committed to attracting and retaining the best talent and a strong leadership team is one of the most integral components to realizing our strategic plan and the long-term success of our company. We’ll continue to assess and strengthen our leadership team to ensure we have best in class leaders with deep expertise to propel our organization forward.

Our team is fully aligned on these initiatives, and we will keep you updated on our progress throughout the year. We continue to believe in our long-term financial framework and that at its core, this business can consistently grow organic gross product sales in the mid-to-high single digits. There’ll be years when we have very strong growth but they’ll also be years with growth product sales growth is more modest or potentially down.

In general, we are adopting a more conservative time for our outlook. This is consistent with our philosophy every March as it is too early, but especially given the year we are coming off and the unknowns the is regarding COVID-19.

For 2020, we expect gross product sales to decline mid-single digits, excluding any impact on our supply chain from COVID-19. However, we do expect to show low-single digit growth excluding the expected decline in Hatchimals year-over-year.

I want you to give you a little more color on our organic 2020 top line outlook. Hatchimals is still strong as a top three collectible, but we expect a further 50% volume decline compared to 2019. Dragons was very big for us in 2019 and there is no movie this year, so we expect it to soften. Bakugan is strong and doing well, as Ronnen mentioned, but we are not guiding to any significant increase in 2020. We are very happy with that DC comics launch. The reaction from retail has been strong. However, 2020 is a non-movie year and we’ve been modest in our expectations. Overall for these reasons, we were expecting a mid-single digits decline in organic GPS year-over-year.

With respect to COVID – 19, we’ll monitoring the environment very closely and are continually assessing the impact to Spin Master as information becomes available. We anticipate that the evolving situation will have an impact on our global operations as approximately 60% of our manufacturing base remains in China.

Currently all of our suppliers have resume production. All of our tool makers have resume production. 71% of workers have reported back in all of our factories. The delayed production is estimated to be between one and four weeks. We expect to be back in full production at the end of March. As a result of these factors, given the delay so far this year and based on our current assumptions, we’re expecting a further reduction in organic growth product sales, which will affect Q2 shipments in particular. This will result in an organic gross product sales that decline towards the high-end of the mid-single digit range.

We have initiated a broad range of actions to mitigate any supply chain disruptions and we will try to reduce the above impact as much as possible through inventory substitution, and schedule management with our supplier’s logistics providers and customers. From a profitability perspective, we expect 2020 adjusted EBITDA margin to be in line with 2019. Margin pressure is likely continue through — to continue through 2020, as we focus on improving our supply chain and delivering operational excellence through process simplification and automation.

We are not where we want to be, and we are taking actions to address that. We are committed to discipline cost management, operational efficiency, and productivity gains, as we transitioned through 2020 and set the foundation for a return to solid midterm growth and margin improvement.

Beyond 2020, we expect to continue trending towards our 18% adjusted EBITDA margin target. To assist you with your 2020 models, we want to provide you with a few other details. In terms of revenue phasing, we expect the split between H1 and H2 revenue as a percentage of full year revenues to be 30% to 32% in H1 and 68% to 70% in H2. We expect Q3 and Q4 to be closer to each other in size going forward as each commerce grows as a proportion of our business and reset a switch to a higher portion of domestic performance.

I would expect us to carry high inventory levels at the end of Q3 to manage this. By way of background, when TRU was in business, their model focus more on FOB, which drove more of our revenue into Q3. We expect depreciation and amortization to be up approximately $13 million compared to 2019 of that $10 million results from more deliveries of entertainment content. We expect interest expense to remain in line with last year and our effective tax rate to be between 26.5% and 27.5%. We expect capital expenditures of approximately 5% to 6% of revenue.

To conclude, we remain committed to our long-term financial framework, which targets organic gross product sales growth of mid-to-high single digits. Our formula for innovation and growth is still valid and our strategy is to continue with what has worked. We are extremely focused on cost management and productivity initiatives in order to return to our targeted margin structure.

That concludes our call. Ronnen and I will now be pleased to take questions. Operator, please open the line.

Question-and-Answer Session


[Operator Instructions] Our first question comes from Sabahat Khan from RBC Capital Markets. Your line is open.

Sabahat Khan

Just on the top line guide, I guess how much of it would you say is maybe demand driven versus the supply chain issues preventing you from a meeting? Some of the demand that’s out there.

Mark Segal

As our guidance indicates, we think we’re going to be mid-single digit down organically. The supply chain impacts, we’ve got it separately to that. The guidance that we’ve given you really is driven by some of the commentary that I just went through in my script around the Hatchimals decline and Dragons down and other products that I just went through now. It is important to note Sabahat that if you exclude the decline in Hatchimals, which will probably be around a $100 million year-over-year, we expect organic gross product sales to grow around 2%. So that is a still an indication of a brand innovation pipeline working in our innovation machine still driving growth.

Sabahat Khan

Okay. And then on the East DC side, I guess this may be a two part question there. I think, if I understood correctly, the issue there would that DC was just a over concentration of product. In that facility, am I thinking about that right in terms of the headwind? And then secondly, are you able to share how much are your overall kind of GPS moves through that facility at all?

Ronnen Harary

The East Coast Warehouse structurally was not architecturally set up correctly. It was a size right. And it wasn’t outfitted correctly. And so now we’re actually redoing it and making all the changes necessary to make sure that there won’t be any issues set up during peak season. I would personally down there in the warehouse myself last week and meeting with the founders and going through everything with our team and putting a plan in place to actually re-architect of what was done in the past. So, it’s all getting reconfigured peak season.

Mark Segal

Yes. In terms of the second part of your question. Sabahat, I don’t want to break out the specifics of how much revenue moves through a particular DC. In 2019, the problem was that we tried to move too much through that. It was, as Ronnen described, it wasn’t structured correctly for the amount of volume we try to move through that facility. And one of the big challenges we have now is to simplify that to structurally change it and to actually get the balance right so that we can get that to our normal warehousing rights. If you look at the P&L in 2019, you will see that we actually spent around $98 million in warehousing, which is nearly $37 million more than we did in 2018. The right was around 6.4% compared to our historical average of less than four. So, we are very focused on getting our numbers back down to our historical warehousing and distribution levels in order to get our margin back up. And so the whole structural simplification program in ’20 is designed to help us do that.

Sabahat Khan

Okay. And then, the additional headwind that you’re building and from COVID-19 as a few percentage point. Is that driven by the inability to maybe get some products here that you need or is that consumers just not get into the store and buying toys, there’s like kind of supply or demand?

Ronnen Harary

No. That was based on supply chain, because if you understand what was happening and these happening in China right now, there have been delays in starting up manufacturing. We’re not at full capacity. And so we are not able to get the goods into our customers in particularly Q2 because of that disruption to our supply chain.

Sabahat Khan

Okay. And then on the comment around the Q3 and Q4 being of equal size. I guess you mean on a revenue or EBITDA basis or both for this year?

Ronnen Harary

No. I was referring to top-line. And I don’t think I said exactly equal, I think, they will be more equal if you go back in previous years Q3 was significantly bigger than Q4 top-line, around 45% versus 25%. So we see that balancing out more. But in terms of EBITDA, Q3 will always be significantly more profitable than Q4, and the reason for that is because most of our marketing spends happens in Q4, when we’re actually marketing closer to when the customers are in the actual retail stores. So you’re always going to see a significantly higher profitability in Q3 versus Q4, and if you go back historically that’s always been the case. Okay.

Sabahat Khan

And then if I could squeeze in one last one, I guess on the flat year-over-year margin guide, is your sort of baked in assumption that some of the supply chain issues kind of continue through the Q3 and then year-over-year you have somewhat better performance in Q4 because that’s when most of the issues were. Is that the way it would’ve kind of think about the — sort of the unwind of that supply chain headwind through the year?

Ronnen Harary

Yes. Look, it’s going to take us some time to get the warehousing structures set up. But what we are very focused on doing is get as much getting as much as we can done, as we enter the second half of the year. And then as we actually exit 2020, we want to be in a situation where our run rate is getting us back to our historical margin structure. Just keep in mind though that, the P&L impact in 2019 was not on the warehousing, it was also sales allowances. So we’re very heavily focused on sales allowances as well. And the two issues are actually interrelated because if your warehousing is not performing well, then you’re subject to fines, noncompliance charges, penalties and so on, which hit us hard in 2019. So we want to get that all straightened out so that the $35 million hit that we took in 2019 for warehousing and the $25 million hit in 2019 that we took for sales allowances, which are really the primary components of our margin compression in 2019, or out of the way so that when we get back to 2021, we back on the normal track.


Thank you. Our next question comes from Adam Shine from National Bank Financial. Your line is open.

Adam Shine

Alright. Thanks a lot. So if we think about the Q4 implication and sort of what initially would — I think implicitly described as sort of 50 million forfeited TPS in 2019, you would’ve thought that that would’ve made for a fairly easy comparable into 2020 then you also add whatever’s, what a guests at DC comics, regardless of whether it’s a movie, you’re not that’s incremental. So, what would you think that Hatchimals would have been able or any decline in Hatchimals would have been able to sure partly mitigate some of that bounce back and incremental revenues to come from DC comics. There’s got to be a bit more at price. So maybe, Ronnen, can you speak to, first off, how do we go from achieving a degree of stability? The back half of last year, when Hatchimals to sort of 50% decline.

And what else is going on in 2020 beyond just conservative outlook being articulated. Are you, clearly losing market share and shelf space in regards to a penalty from the misfiring in Q4? I mean, there seems to be a few missing pieces to the puzzle here.

Ronnen Harary

Yes, hey, Adam. I actually, our portfolios is super diversified, is probably the most diversified it’s ever been. And from a POS perspective coming into — coming out of 2019 and rolling into 2020, the POS is actually doing very well and not only doing a well in — it’s doing well across the portfolio and it’s doing well across geographies. So from that perspective, we’re very pleased. We’re dealing with this what I call a self-inflicted wound or a bump in the road that has really interrupted our supply chain. I don’t think that we are seeing any shelf space losses from retailers or anything like that. We have a longstanding relationship with all these retailers. They understand that this was a bump in the road and they know our vigilance and tenacity to go in and to fix problems when they arise. And that’s what we’re currently doing. We just don’t like missing our numbers. We’re embarrassed when we miss our numbers, and so we’re taking a conservative tone.

We’re very focused on growing the top line above what we guided you guys to this year. We can’t make those promises, but the teams out there and they’re out there selling a very focused and actually going out to get even more shelf space, and more promotions and more ads and everything like that to grow the top line. And we’re also trying to mitigate the EBITDA percentage because that’s not acceptable. But stuff is going to take some time for us to work way up and we’re just taking a conservative outlook and we’re looking for — we’re looking for the long-term here company’s been around for 26 years and we continue to be around for long periods of time for much longer.

So we just wanted to take conservative outlook, but I can tell you that the portfolio is very diversified, more diversified than it’s ever been. We are taking a refocus in companies that we bought like Gund, which are showing a lot of promise, putting a lot of energy back in Swimways Cardinal is doing in games doing exceptionally well. And we don’t talk about it very much on our calls, but it’s an incredible business. And everybody’s very focused on fixing the year and trying to make the year as strong as possible. And then rolling into 2021 is market rest, back to the levels that we current that we’d been at historically. We just don’t want to over promise going into 2020.


Thank you. Our next question comes from Derek Dley from Canaccord Genuity. Your line is now open.

Derek Dley

Just want to confirm what you said just on Bakugan. Did I hear right that you’re not expecting any growth out of Bakugan this year? Just wondering why that would be the case?

Mark Segal

I mean we are expecting growth, but we are taking a conservative view of that growth.

Derek Dley

Did you guys say that you were not expecting growth but you are expecting growth? I’m a little confused here.

Mark Segal

So Derek, we don’t guide to individual products and individual, we talk about our business overall from the guidance perspective. I try to give you a little bit of color on Bakugan in the sense that we are guiding to growth Bakugan. We do expect it to grow, but we’re taking an overall conservative view of growth in general.

Derek Dley

Okay, that’s more clear. Thank you for that. In terms of your inventory position up quite a bit here and in Q4. How comfortable are you carrying that inventory into 2020? Should we — are you likely going to do some markdowns to try and clear and get it more current?

Mark Segal

So, inventory was up from around $110 million in ’18 to over 180, at the end of 2019, which is a big increase. We did what we could in Q4, either through markdowns we’ll promotional activity or we’ll close out. So whatever we could to get rid of inventory we didn’t want to carry into 2020. We comfortable that the vast majority of that inventory will actually sell through it reasonably normal margin levels. So we don’t believe we have any major exposure in that area. And paradoxically, with COVID it’s actually helping us now because we are able to substitute some shortages in new products with existing inventory, particularly where it’s in lines that don’t change very much like Kinetic Sand or Gund or a few other areas where there isn’t a very big shift in the product line. So we’re comfortable overall with inventory and we expect it to be back down to close to normal levels by the end of 2020.

Derek Dley

Okay, that makes sense. And then just a little last one for me on the CapEx. Just want to confirm the number. So you said 5% to 6% of sales. Is that gross sales or sales after rebates?

Mark Segal

No, no. That’s net sales revenue. And that’s a splits around two-thirds of CapEx will go towards entertainment and around one-third will be for tooling.


Our next question comes from Brian Morrison, TD Securities. Your line is open.

Brian Morrison

I want to go back to the guidance on margins if I could. Just the 500 basis points last year was really largely due to the DC, whether it be volume or allowance distribution costs. So you mentioned there and identified the issues, the automation or process simplification I realize it’s not a fixed overnight, but I’m not sure I understand why there’s no margin recovery this year? Will the East Coast DC not be ready for the busy season and are essentially you’re saying market will be flat and then you’re going to get a hockey stick back to 19% in 2021? Is that the message?

Mark Segal

Well, let me just peel that question down into a few different components here. Firstly, we’re not guiding to 2021 margins today. So I say to you in terms of the trend that’s our target, and we’ve historically operate it at around 18% or even more that’s our goal and that’s where we want to get back to as soon as we possibly can.

If you look at what happened in 2019, there were three major things that hurt our margins and one was our sales allowances, second was the warehousing, and then there was also the impact of selling expenses, which is really a variable cost and that is not something that we actually get an offset through marketing and so I’m not really focused too much on that. It’s the sales allowances and it’s the warehousing. And my estimation is that around $35 million of that was from warehousing and distribution, around $25 million was from the sales allowances.

And then there was also the impact on lost sales because we actually could have probably generated another $50 million of sales and got the margin on that. So we are very focused on cleaning that up in 2020, the warehousing and distribution side of it does have a direct impact on sales allowances, as we clean that up, we’ll be suffering less noncompliance charges, fines, penalties and so on.

But what we’re doing, Brian, is that we’re taking a conservative view of that for 2020, because until we get traction, we’re only in March. And this addresses a question that Adam Shine had as well. We’re only in March it’s early and until we get traction, we want to make sure that we are actually guiding conservatively and we’ll update you as things go along in May, in August and as we normally do we update our guidance through our quarters.

So at this point we taking a cautious tone. We’re not happy where we’re at. We want to beat flat or in line and we are doing everything we can to get there. We’re just not committed to it today.

Brian Morrison

I understand that. But I would have to think that some of those material costs were incurred last year. I mean $35 million in warehousing, like would we not be in a position where that would be addressed by the busy season? It just, I find it a little bit maybe overly cautious if that’s the message?

Mark Segal

Well, look. Let’s get the traction. Let’s prove we can do it and then we’ll guide.

Ronnen Harary

I can say that is definitely our goal to be set up correctly with the most optimized warehousing structure, 80-20, by the peak season. That is our goal. I think it would be a gravity, okay, to have a repeat of last year in 2020. We’re just taking more conservative view of everything. But, Brian, I can just tell you that it’s all hands on deck and we actually are very fortunate, we brought in a really seasoned head of supply chain problem and I encourage you guys to look up his bio.

He’s working out only being on the — in the job three weeks. I’ve spent a lot of time with him. I’m very pleased. He brought in some more people in operational finance, which we’re very pleased about. And so the team is getting rounded out, and everybody here, we’re rallying the organization to mitigate this issue.

So I’m with you, it’s not where we want to be, but as Mark says, we’ll update you guys in six weeks time. We’ll give you guys some more insight on what’s happening and we’ll keep you very current on everything.

Brian Morrison

In terms of gross product sales, Mark, can you just maybe discuss your exposure to the Asian market place? I believe that was a growth engine sort of on a going forward basis. Maybe you can just the exposure there toward product sales?

Mark Segal

Yes, it’s actually, it’s really small, Brian. I mean, we do have some sales in China, which will be impacted as a result of what’s happening with the virus currently we have some distribution in other Asian countries, but overall it’s really quite a material for us in the general scheme of things. PAW Patrol continues to do well in Japan and that’s really about it, but it’s overall a relatively limited impacted and it wasn’t a major factor when we considered our guidance for 2020.

Brian Morrison

Okay. And then lastly, your balance sheet? Nice to be in that position at this time. But in terms of M&A are you seeing greater opportunities and with such surplus capital, would there be potential to maybe shift to a certain extent. For opportunistic opportunities to return capital to shareholders?

Mark Segal

So I would say to you, we continuing to look at acquisition opportunities all the time. I think right now just given what we’re focused on for 2020 as Ronnen and I just described, I think any large M&A would probably be off the table, but tuck-in acquisitions we continue to look at and we’ll continue to do them throughout the year because it’s a key part of our innovation pipeline and it’s a key part of how we intend to grow the business.

Ronnen Harary

Yes, just to add there, I mean, I think as we mentioned at toy fair, we’re focusing even more heavily on the digital mobile space, the game space, and we’re seeing some exciting opportunities in that area. So I think that returning capital back is not in line with our being a growth company. So we’d rather allocate the capital to make some strategic acquisitions to continue to grow and set ourselves up for the future. And that is one area where we’re starting to see a lot of opportunities come our way.

Brian Morrison

I had one last one too. Thank you. Is Mark or Ronnen. What is your expectation for industry growth this year?

Mark Segal

Well, we haven’t actually said anything on that, Brian. We don’t really have a view right now. Nothing’s been published formally by the public traditional forecasters. So we’ll have to get back to you when something more formal is published. I think overall, the general theme is that globally, the industry is continuing to grow in the historical ranges of around 4% to 5%. The U.S is definitely more challenge and is growing at a lower rate than that. So I would say there’s a bifurcation between the U.S and other countries around the world. But we haven’t actually published a formal view on that.


Our next question comes from Gerrick Johnson from BMO Capital Markets. Your line is open.

Gerrick Johnson

Mark, hopefully you find your business without having a view on the industry performance for 2020?

Mark Segal

Well, Gerrick, you know, we don’t plan our business with a macroeconomic view of the world. I mean, the toy industry has grown very differently to economic cycles. We had our best years ever in the toy industry in 2008 and 2009 and the reality is that, we are focused on innovation, we focused on our product lines, we focused on taking share and it’s not driven directly by correlation to industry growth rates.

Gerrick Johnson

Understood. But those are tailwinds and headwinds. So, we will move on. You said 71% of your workers are back to factories in China? When I was at Toy Fair a week and half ago, that range is about 20% to 30% from the public, sorry, the private toy companies I spoke. You guys have not mentioned the time, but what the rate was. So, is this a better ramp up than you originally planning?

Mark Segal

So, when we were at Toy Fair, we didn’t published a specific number at that time that in our factories a couple of weeks ago, it was around 54%. So it’s gone from 54 to 71 in a couple of weeks. And so I think it’s going in at a positive rights rate.

Ronnen Harary

Yes. We gave you guys the latest, we’ve got that information last night at our weekly COVID meeting. And I will say, I’m versus some of the other companies out there. I mean, I’m exceptionally proud of our Asian operations and our team there in both in China and Hong Kong. The discipline that they’ve applied to this situation, the accuracy they’ve applied to the situation, the ability to work through it, I mean, it was staggering to see, our video conferencing, everybody on the other side wearing masks, but showing up to work policies and procedures that are in place in our China office to not spread the virus in Hong Kong office and the fact that can’t travel.

The fact people are working at that capacity is breathtaking, and I’m super proud. I mean, we have a lot of factories in the region and the team is working super hard to get our share. And, I would also say is that, the relationships we’ve had with factories are longstanding and these are great factories. So, I applaud the factories for doing what they need to do to get this back in place. So I would say this, I was surprised at the jump last night myself, but also very pleased at the same time to see that things almost getting back to normal.

Gerrick Johnson

Okay, great. And I think Brian nailed it with his question. He got to the crux of the matter here. We’re looking at your guidance for your EBITDA margin for 2020. I would also add that, you also had a threat of off again tariffs slashed your that you had to deal with that probably caused some extra costs and disruption. So, I think, that question that I just want to make a statement there on that and that’s what we’re all looking at right now. But one thing that may relate to it, what is the cost that’s going to be associated with this project Excel?

Mark Segal

So Gerrick, that’s part of kind of our conservativism around the adjusted EBITDA margin guidance, there will be a cost to simplify and change. We’re working to actually minimize that as much as we can. We are working with partners. We are working with vendors and we’re doing everything we can to that project and the changes we have to make as efficient as possible. We’re not going to call out a specific cost in terms of what the impact is going to be, but we will update you throughout the year as that project, Excel continues to evolve and as we make progress and hopefully you’ll see it actually flow through our P&L.

Gerrick Johnson

Okay. We’ll see it flow through, but are you going to pull it out as one-time items in adjusted EBITDA, adjusted EPS?

Mark Segal

To the extent that they all cost that meet that criteria, we’ll do that.

Ronnen Harary

I’d like to just comment on that if I may. There isn’t the majority of the work is being done internally with their own teams with a few people from the outside coming in to help but the majority is done internal.

Gerrick Johnson

Okay. And as everyone else asked the questions, I will too. Gross margin was done only 20 basis points but for several answers were up 170 bps, freight was higher there must have been some fairly solid positive offset. So what were those?

Mark Segal

So we did actually have some offsets from product mix on the stuff that we did sell. We saw some increased app sales we saw some increased TV distribution, although even though we did see a declining in licensing and merchandising, there were some things going in the right direction. Product mix was the most significant factor that went in our favor.


Our next question comes from Steph Wissink from Jeffries.

Ashley Helgans

Hi, this is Ashley Helganson for Steph. Most of my questions have been answered. So I’ll keep it really quick. Can you please quantify Hatchimals total volume in 2019?

Mark Segal

Yes. So we actually not, we don’t break that out specifically Ashley, but what we’re doing is quantifying the delta between the years. And so what we called out in 2019 was the year-over-year decline of around $230 million. And ’19 versus ’18. And what we’re saying again in ’20 is that there will be around a 50% decline in ’20 versus ’19. So part of the guide down in terms of the industry decline is due to the reduction in Hatchimals sales.

Ashley Helgans

Okay. It’s like $115 million in 2020?

Mark Segal

To around $100 million.


Our next question comes from Linda Bolton Weiser from D.A. Davidson.

Linda Bolton Weiser

I just wanted to double check on something you said about free cash flow. I thought you said $50 million or $80 million or something but I just wanted to double check your operating cash flow is $98 million and your CapEx total was $94 million in 2019. Is that correct?

Ronnen Harary

I don’t have the numbers off the top of my head. I think our free cash flows was $84.6 million was what I actually read out. I can get back to with a specific numbers after the call or Sophia


Linda Bolton Weiser

Okay. And then secondly, one thing that hit me at Toy Fair was that you have a lot of innovation in your product lines, but that I felt a little bit like it was just a proliferation of product lines and products going on. Do you think it might be helpful to sort of frame your business around core brands and then express that to analysts and investors? Is that the way you think about how you run your business? And I know you mentioned four things Bakugan, Monster Jam, PAW Patrol and DC Comics. Is that what you view to be your four biggest core brands? Maybe you can just come in and how you think about it and how you run your business?

Mark Segal

Well, the way we’ve been running our business and reporting to you guys is in the segment that we talked about before. But I do think you bring up a good point. I mean, we have some opportunities to, as I mentioned in my earlier remarks, to do more with less. We do have some very large segments of business, especially our Games business, both with our Spin Master Games and with the acquisition of Cardinal. Gund has a lot of potential. And then our franchise of like PAW Patrol and Bakugan and our partnership franchise like DC and Monster Jam and Kinetic Sand is becoming a real growth engine in the whole activities area of our business.

So I think you bring up a good point. I mean the way we organize ourselves at Toy Fair is it is a lot about the products because that is the DNA of our business. We love showing the innovation and the excitement and going product-by-product. But I can hear what you’re saying and maybe may be a little bit hard for you guys to parcels through, especially in a short amount of time and an hour and there’s a lot of people there and stuff like that. So we’ll take that feedback. And with some good feedback in terms of how to give you more color to go deeper in the various different segments and with what’s going on. So thank you.

Ronnen Harary

Linda. One of the things we did do and we are doing is we’re actually getting analysts and investors into our facilities more so the day after Toy Fair, we actually took some investors and analysts through our Spin Masters east office and we went deep in outdoor and Gund and Cardinal. And we want to do that more just to help you understand the business better and we’ll continue to do that.


Thank you. Our next question comes from Jamie Katz from Morningstar. Your line is now open.

Jamie Katz

Hi, good morning and thank you for taking my questions. At Toy Fair last week I think you guys said you were going to try to do everything you could to grow your margins back up again in 2020 and obviously, now you guys are calling for flat EBITDA margin. So I’m curious if anything has changed outside of COVID-19, between then and now? And then second, as you guys continue to push towards international expansion, should we continue to expect a sales allowances to rise this year has generally, I think those have around a little bit higher abroad than domestically? Thanks.

Mark Segal

Yes. So in connection with your first question, I think we’ve covered the EBITDA margin piece a lot of detail on the call. What I will just reiterate is that we are guiding conservatively on our EBITDA margins until we get traction, we’re not happy with it or, and we’re going to do everything we can to get them back up and we’ll give you more guidance throughout the year as we get traction. So there’s nothing that, nothing has changed between this week today. And when we actually spoke to a Toy Fair, nothing has changed in that respect.

In connection with sales allowances mix is a small element of the sales allowance increase because in Europe in particular, the Europe countries and the way the retail structure works there is higher price, higher allowance model. The net price is actually relatively similar to the U.S, but if you look at the sales allowance line in isolation, as we grow Europe, it does push ourselves allowances just mathematically.

We’re going to look at pricing everywhere, but, that in particular, we want to make sure there isn’t any dilution on that front, but that explains the mix element of the sales allowance increase. The vast majority of the issue in sales allowances is not makes, it is simply our ability to control markdowns, call off spending, noncompliance charges and f that. And that’s where we really going to be focusing on in 2020.


Thank you. Our next question comes from David McFadgen from Cormark Securities. Your line is open.

David McFadgen

A couple of questions. So first of all, just on the sales allowance, so obviously ticked up in 2019. I was just wondering what your view is for 2020? Where do you think that might come out?

Mark Segal

Yes, so David, as I just answered previously on Jamie’s question, the three components of sales announces that we’re going to be heavily focused on is markdowns. It’s going to be on noncompliance, and obviously any promotional spending that we actually have to undertake that hits the sales announced line. Warehousing and our ability to service our customers effectively has a direct impact on our noncompliance charges. So to the extent that we drive efficiencies through our warehousing system, we will be able to reduce sales allowances as a result of that.

And then on the mark downside, you obviously the strength of our line has a direct impact on that. Our ability to deliver, our ability to sell through has an impact on that. So we’re going to be very focused on that. I did say in my remarks that we would like to get down to around 12.5% compared to where we were in ’19, which is 13.5%. And that would still put us above the historical range of 10% to 12%. In 2018, we were at 11.6%. So I still see our numbers being higher for 2020, but we are pushing very hard to get them back down to our historical ranges.

David McFadgen

Okay. And then just a question on the mid-single digit decline and excluding any impact from the coronavirus. I was just wondering, you obviously you flagged Hatchimals is going to be down again. Can you give us any color on your expectations for PAW Patrol? I mean you did say earlier that PAW Patrol is so far this year and the U.S. is down a bit. So I was just kind of wondering what your — what do you think that product would do in 2020? What’s baked into your guidance there?

Ronnen Harary

Yes. So we’re not going to give specific guidance on PAW Patrol data, but I can tell you that it’s a very solid line. It continues to resonate with kids around the world. And so it’s going to be a very solid contributor in 2020 just like it was in ’19 and in ’18. In the early.

David McFadgen

Sorry. Can you give us an idea like how much it’s down so far this year in the U.S.? Any color there?

Mark Segal

No. We’ll give you color when we report our Q1 results in May.

Ronnen Harary

Just want to share with you the POS and PAW Patrol globally is up.

David McFadgen

Okay. That’s how you said POS was down in the U.S. so far in 2020?

Mark Segal

Globally. POS is up currently, it’s around in the U.S. but that’s because we actually haven’t done any of our marketing and what we’re doing now is we’re actually getting our marketing in and it’s picking up very strongly. So the trend is actually very strongly up ahead of Easter.

David McFadgen

Okay. And then just on the distribution expenses as a percentage of sales, as you shift more of your production out of China into other geographies, wouldn’t that sort of limit the ability to get distribution expenses down as a percentage of sales?

Mark Segal

Well, distribution expenses on that P&L is made up of a number of factors. Just keep in mind though, when we actually move goods from different countries in the world, that freight cost actually its COGS. It doesn’t go through our warehousing and distribution. So understand that element is sitting in our cost of goods sold. But when you look at our warehousing and distribution line, you’re looking at our third-party distribution costs in North America and in Europe primarily. And you’re also looking at the transportation costs to the extent that we pay those to our customers, right? Not all of our costs. Some are collect, some are prepaid.

So really, what drives our warehousing and distribution costs is the amount of goods that go through what we call domestic or DOM as opposed to FOB. Because FOB doesn’t go through our warehousing at all, it goes directly to the customer. So our ability to manage our 3PLs in North American and Europe drives the warehousing distribution cost line that you see in SG&A.

And that’s where we heavily focused on improving it and getting it back to less than 4%.

Historically, we’ve operated between 3.5% and 4% of sales and we now peaked over 6% in 2019. And that delta is — the delta that Ronnen and Paul Blom and everyone else and myself all heavily focused on reducing and getting back to our historically levels.


And our last question today comes from Kirill Kozyar from CIBC World Market. Your line is open.

Kirill Kozyar

Just provide more color about the difference between guided GPS and the industry growth besides the nonorganic impact you have mentioned and the lower industrial expected growth in North America? Thanks.

Mark Segal

Sorry. Could you just repeat that question? Are you asking for the impact that’s nonorganic as in the COVID-19 impact? Is that what you’re saying?

Kirill Kozyar

Yes, that’s correct.

Mark Segal

So basically the COVID-19 impact is really as a result of supply chain disruptions as because of our factories getting back to work at full production much later than they originally would. Usually after Chinese New Year in early February, the factories have back and it’s full steam, but really now they’re going to be back in full production only by the end of March. And so as a result of that production loss and supply chain deficits, Q2 is going to suffer from bad impact. And that’s why we gave additional guidance in addition to our organic mid-single digit guidance. Does that answer your question? I’m not sure I’ve got it quite correctly there.

Kirill Kozyar

Yes, thanks, that’s helpful. I have another follow-up. Do you have any solid timelines? So when they’re challenges, do you see a little bit behind or are you going to update us in six weeks from now or with Q1 call?

Mark Segal

I think we’re going to continue to update you guys on — in six weeks and we’ll update you guys again in the summer on all our calls we’ll update you guys.

Kirill Kozyar

And the last quick one. Just remind us about Hatchimals increase from 2018 over 2017?

Ronnen Harary

We’ll have to get back to you on that one. I can’t remember that number off the top of my head, but obviously 2017 and ’18 were the years where Hatchimals was really very large and growing very rapidly. And so that really was the peak of when the Hatchimals phenomenon was actually, we were experiencing that phenomenon, which is why the ’19 and ’20 comps are that much more difficult as Hatchimal decline as we planned it, but it’s obviously making the comps year-over-year quite challenging.

Kirill Kozyar

Thank you. That’s it for me

Ronnen Harary

Okay. I think that was the last one?


And I’ll turn the call back to management for closing remarks.

Ronnen Harary

Okay. Well listen, thank you everyone. That was a long hold, but we wanted to give you the additional color and we look forward to talking to you again in early may with our Q1 results. Thank you very much.


Thank you. Ladies and gentlemen, this concludes today’s conference call. We appreciate you participating and you may now disconnect.

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