Hasbro, Inc. (HAS) Q1 2018 Earnings Report, Transcript and Summary

Good morning, and welcome to the Hasbro First Quarter 2018 Earnings Conference Call. [Operator Instructions]. Today's conference is being recorded. If you have any objections, you may disconnect at this time. At this time, I'd like to turn the call over to Ms. Debbie Hancock, Vice President of Investor Relations. Please go ahead.

Thank you, and good morning, everyone. Joining me this morning are Brian Goldner, Hasbro's Chairman and Chief Executive Officer; and Deb Thomas, Hasbro's Chief Financial Officer. Today, we will begin with Brian and Deb providing commentary on the company's performance, and then we will take your questions. Our earnings release was issued this morning and is available on our website. Additionally, presentation slides containing information covered in today's earnings release and call are also available on our site. The press release and presentation include information regarding non-GAAP adjustments and non-GAAP financial measures. Our call today will discuss certain adjusted measures, which include these non-GAAP adjustments. A reconciliation of GAAP to non-GAAP measures is included in the release and presentation. Please note that whenever we discuss earnings per share, or EPS, we are referring to earnings per diluted share. Before we begin, I would like to remind you that during this call and the question-and-answer session that follows, members of Hasbro management may make forward-looking statements concerning management's expectations, goals, objectives and similar matters. There are many factors that could cause actual results or events to differ materially from the anticipated results or other expectations expressed in these forward-looking statements. Some of those factors are set forth in our Annual Report on Form 10-K, our most recent 10-Q, in today's press release and in our other public disclosures. We undertake no obligation to update any forward-looking statements made today to reflect events or circumstances occurring after the date of this call. I would now like to introduce Brian Goldner. Brian?

Thank you, Debbie. Good morning, everyone, and thank you for joining us today. The Hasbro teams around the world are doing an excellent job navigating a challenging and dynamic industry environment. We remain focused on executing our Brand Blueprint to profitably grow for the long term. Our strong financial position enables us to continue investing in our brands, in consumer insights, in innovation, in storytelling and in our teams while making strategic long-term decisions to accelerate our efforts and to advance our business. The global retail environment is rapidly evolving. How consumers discover brands, engage with brands and ultimately purchase products within brands are converging. Consumers' shopping and buying actions are moving in all directions, from brick-and-mortar to omni-channel, while adding mobile. Hasbro continues to onboard new skills and talents needed to thrive as a global play and entertainment company in a converged retail world. In the first quarter, we took steps to accelerate our commercial organization's transformation. Much of this impact will be in Europe, where we have new leadership, and we are working to clear the excess inventory we discussed with you at year end. This transformation is already evident in the U.S. And over the past 3 years, we have grown our retail distribution by more than 21,000 doors net of recent store closures at traditional retailers. And we have developed our digital and content to commerce capabilities. The liquidation of Toys"R"Us in the U.S. and in the U.K., along with ongoing uncertainty around its other operations, has created near-term disruption in our business. The liquidation began in the first quarter and will continue with increasingly lower liquidation pricing in the second quarter. We anticipate the revenue impact will be most pronounced in the first half of the year with a lesser impact in the third and fourth quarters, including the important holiday season. We expect the U.S. liquidation will conclude at the end of the second quarter, and we still don't have resolution on the International markets plans. Our expectation continues to be that it will take about a year to work through this disruption, and we will drive growth in 2019 and beyond. In addition to the Toys"R"Us impact, we entered the year with work to do to clear through carryforward inventory, in particular, in Europe. We also planned our business to phase revenue later in the year. The quarter's reported financials reflect these factors on shipments across brands and categories. However, consumer takeaway demonstrates the strength of our brands and initiatives. Hasbro brands and Partner Brands are selling well. Our marketing efforts and product innovations are driving high demand across retailers. Franchise Brands, Partner Brands and Hasbro Gaming takeaway is up sizably. Online point of sale continues to grow significantly faster than total point of sale, and revenues grew in each product category. In the U.S., even when you remove Toys"R"Us from the analysis, consumer takeaway is significantly up across our franchise, partner and gaming categories. Our global retailers view this as an opportunity to gain share in a key consumer category, and they are partnering with us to develop growth plans for our brands going forward. We managed our new initiatives, shipping in the quarter and beyond, to avoid being caught up in the liquidation process. Our new Quick Strike products, which we previewed with you at Toy Fair and tap into consumer trends, are coming later this year. We're working aggressively around the world to put the impact of Toys"R"Us behind us. Importantly, this is not something happening to our company. We're taking control of the situation, making strategic decisions in how we approach the market, how we grow and the steps we are taking to build our capabilities and transform our organization. We have great confidence in the outlook for our brands and the ability of Hasbro to become even stronger in a rapidly developing converged retail environment. Franchise Brand point of sale grew across the brands in this portfolio. With significant innovation, combined with multi-screen storytelling, we have confidence in the underlying demand for our brands. TRANSFORMERS: Bumblebee, our first film under our new Paramount production and distribution agreement, hits theaters this December and marks an important evolution in Hasbro's role as storytellers. MAGIC: THE GATHERING began this year as planned, with revenues down in the first quarter. While point-of-sale data for MAGIC: THE GATHERING is not captured by NPD, in March, we saw positive fan reaction to the spring set, Dominaria, which fans celebrated at pre-release events this past weekend, and it goes on sale next weekend. Magic: The Gathering Arena, our new digital platform, is moving to the next stage of the beta process and is now being streamed and shared with more players ahead of its launch later in 2018. Feedback continues to be positive, and we're making continual enhancements during this period prior to launch. Within Hasbro Gaming, consumer demand remains strong. New launches, such as Hearing Things and Don't Step In It performed well and tapped into social gaming trends. In addition, DUNGEONS & DRAGONS and JENGA grew revenues. We continue to see immense interest in gaming from consumers of all ages, and Hasbro is investing to further leverage our advantage and reach in this area. Partner Brand point of sale increased behind the MARVEL lineup and BEYBLADE, which is off to a very strong start in its second year. We couldn't be more excited about the success of Black Panther. And early on, we agreed with MARVEL that this property had strong potential. As a result, the Black Panther product line is the broadest line we have ever created for a Marvel Studios origin film, including Iron Man; Captain America; Thor; and even the ensemble film, Guardians of the Galaxy. Point of sale of Hasbro items from Black Panther are performing well, ahead of everyone's expectations. We're working to satisfy demand and deliver new products throughout the year to capitalize on the May home entertainment release and the key holiday season. We also began shipping Avengers: Infinity War product in the first quarter. We expect both properties to contribute throughout 2018. STAR WARS remained the #1 property in the G9 markets according to NPD, and we continue to see improvement in the year-over-year point-of-sale comparisons. Solo: A Star Wars Story product, is now available ahead of the film's release on May 25. During the quarter, we launched our Has Lab crowdsourcing campaign. Our first initiative is the largest STAR WARS vehicle ever from Hasbro, Jabba's Sail Barge. The campaign exceeded our expectations with over 8,000 backers for this $499 product. This showcased not only amazing innovation from our team, but the power of digital consumer engagement to launch meaningful direct-to-consumer initiatives. Looking forward in 2018, there are going to be continued challenges while new opportunities arise. We believe we have made the best decisions to position us for a good year, and most importantly, to continue to grow our business going forward. Our medium-term guidance, which we shared in February, remains firmly in place. 2018 will be a year of adjustment. But beyond this year, we continue to believe that over the next few years, developed economies can grow low to mid-single digits through innovation, entertainment and market share gains and emerging markets can grow double digits, both absent the impact of foreign exchange. We believe operating margins are not only sustainable, but will improve over the next 2 to 3 years. Finally, we anticipate our annual operating cash flow in the range of $600 million to $700 million. I'll now turn the call over to Deb. Deb?

Thank you, Brian, and good morning, everyone. This was a challenging quarter. We said early on it would be challenging, and it became even more so when Toys"R"Us moved to liquidate its stores in the U.S. and the U.K. But our teams have shown great resolve and are working effectively through the issues. We're taking steps to strengthen our business, including accelerating actions to transform our commercial organization, in particular, outside the U.S. And we're positioned and planning for long-term growth. Hasbro is executing from a very healthy financial position. The first quarter is our smallest quarter, and changes in the business are magnified during this period. While we don't plan to completely offset all the Toys"R"Us disruption this year, the impact will decrease in the second half. Incremental store closures are happening now, and there is near-term uncertainty in several of their remaining International businesses. While this will further impact 2018 shipments, we do not expect further material expenses. Our cash flow outlook remains intact. And despite a $59.1 million bad debt charge related to Toys"R"Us, we are targeting operating cash flow in the $600 million to $700 million range for the year. We ended the quarter with just under $1.6 billion in cash while returning $109.6 million to our shareholders through our dividend and share repurchases. An 11% increase in the quarterly dividend takes effect for our next dividend payment in May. The impact of lost revenues from Toys"R"Us and our efforts to work through retail inventory is evident across both U.S. and Canada and International segment results. In the U.S. and Canada segment, revenues declined 19%. Partner Brand revenue increased slightly, but Franchise Brands, Hasbro Gaming and Emerging Brands revenues declined. Point of sale is up, with only Emerging Brands declining slightly. Retail inventory declined as we worked through inventory and managed the Toys"R"Us liquidation in the U.S. The U.S. and Canada segment reported an operating loss in the quarter due to lower revenues and $52.3 million of expenses related to Toys"R"Us, which was primarily bad debt. Adjusted operating profit was $28.9 million, which is the result of lower revenue in the quarter and higher freight and warehousing expenses. International segment revenues declined 17%, including a favorable $19.5 million impact from foreign exchange. Latin America and Asia Pacific grew revenues but were more than offset by a 28% decline in Europe. The lower revenues in Europe were the result of carryforward retail inventory we are working to clear through, and to a lesser extent, the U.K. liquidation and uncertainty around other Toys"R"Us operations. In addition, a French retailer was put in receivership during the quarter. The International segment reported an operating loss of $56.1 million. This includes $11.2 million of expense associated with Toys"R"Us. Excluding this item, the segment had an adjusted operating loss of $44.9 million. The operating loss was primarily the result of lower revenues. Entertainment and Licensing segment revenues increased 21% behind growth in Consumer Products and digital gaming. As we discussed at Toy Fair, the adoption of the new revenue recognition standard meant revenues received from our licensees will be recorded in a more ratable basis throughout the year as opposed to a bigger uptick in the fourth quarter. The adoption of the standard also contributed to the segment's higher revenues. Operating profits increased 23% on the higher revenues. Overall, Hasbro operating profit margin was negatively impacted by expenses associated with Toys"R"Us and severance costs from our commercial organization transformation. Adjusted operating profit declined due to lower revenues which could not absorb the company's fixed cost in the smaller first quarter. It is early in the year, however. Our current full year outlook, absent the expenses associated with Toys"R"Us and severance, is that we could achieve an operating profit margin in line with 2017's level of 15.6%. As Brian said, we believe we can increase operating profit margin in future years. Earlier this year, I outlined several margin levers to drive operating profit margin expansion going forward, including growth in higher-margin Franchise Brands, Hasbro Gaming and Entertainment and Licensing revenues as well as profit improvement in our emerging markets and efficiencies from our system investments. Our future outlook is not impacted by this near-term disruption. Cost of sales declined as a percentage of revenue, driven by growth in higher-margin Entertainment and Licensing revenues and a disciplined commercial approach to pricing and shipping product into our global retailers. We expect cost of sales to decline on a full year basis and approach, but perhaps not match, the 38% level we reported in 2016. Underlying royalty expense declined on lower Partner Brand revenues. However, our reported royalty expense in the quarter increased as we incurred accelerated expense associated with lower Toys"R"Us revenue for our Partner Brands. For the full year, underlying royalties as a percentage of revenues are expected to be in line to down slightly versus last year's rate of 7.8%. Product development declined in dollars in the quarter, but on a full year basis, as a percentage of revenue, is expected to be consistent with 2017. Program production amortization increased as we're amortizing MY LITTLE PONY: THE MOVIE production expense in addition to television programming. Program amortization as a percentage of revenue for the full year should be flat to up slightly versus last year. SD&A includes several unusual items, notably $59.1 million of bad debt associated with Toys"R"Us and severance cost from accelerating our commercial organization transformation. Absent these items, SD&A increased due to foreign exchange, investment in IT systems and higher freight and warehousing expenses. Our underlying full year SD&A forecast is for a slight increase as a percentage of revenue. Turning to our results below operating profit. Other income declined slightly, primarily due to a smaller gain on foreign currency this year versus last. Our underlying tax rate, absent the impact of tax reform, was 16.5% compared to an underlying rate of 24.9% last year and 19.9% for the full year 2017. The lower rate reflects the benefit of U.S. tax reform. But during the quarter, we also recorded a discrete charge of $47.8 million or $0.38 per diluted share related to an increase in our repatriation tax liability and a reversal of tax benefits no longer permitted under new guidance. As we stated at year end, the charge we took then was provisional and expected to change as there was clarification to the new law. We anticipate there will be additional guidance on tax reform that will require consideration and interpretation going forward. We expect our full year underlying tax rate to be at the high end of our previously projected range of 15% to 17%. For the first quarter, adjusted earnings per share was $0.10, and reported earnings per share was a loss of $0.90. Hasbro's balance sheet is strong. We ended the quarter with $1.6 billion in cash, and we paid $70.8 million in dividends and repurchased $38.8 million in common stock. Both our debt-to-EBITDA and EBITDA-to-interest ratios, at 1.9 and 9.2, respectively, are favorable to our targets. Receivables decreased 9% and days sales outstanding were 78 days. We recorded a bad debt charge for Toys"R"Us in the quarter, and we believe we are adequately reserved for our historical shipments. We don't expect to have any material expenses associated with Toys"R"Us going forward. Inventories increased on lower revenues as we held more in our warehouses during the quarter. Approximately 1/4 of the increase in inventory was the result of foreign exchange. As Brian discussed, we're working closely with our global retailers to reallocate this product. In the U.S., retail inventories declined in the quarter. Internationally, retail inventories have also declined, but we have further work to do in Europe. We are making progress and are on plan to lower retail inventories to our targeted levels. In closing, we are facing near-term disruption in the market, but we have confidence in our long-term prospects. Consumers are seeking out and purchasing Hasbro brands, and we have a very strong lineup for the rest of the year. We are deliberate in how we approach the market to ensure our global retailers have success with our brands this year and in future years. We are on solid financial footing and are taking the necessary steps to put Toys"R"Us behind us and return to profitable growth as soon as next year. We will now open the call up for questions.

[Operator Instructions]. Our first question comes from the line of Steph Wissink with Jefferies.

Two questions, just to dig in a little bit more, Deb, to your comments on the inventory. I think you mentioned 1/4 of the inventory increase is related to FX. Can we unpack the other 3/4? Specifically, just curious if there's anything related to what you plan to ship in the second quarter, most notably Avengers and STAR WARS and then home entertainment release for Black Panther. Should we be looking at some of that inventory as allocated to those initiatives?

Yes, Steph. And you're exactly right. About 1/4 of the increase in our inventory balance was due to FX. The remainder is really good -- due to good inventory. We've got Avengers shipping. We are leading up into all great the new initiatives that we have coming this year and all the great entertainment as well as the new initiatives that we haven't released, really, out into the market yet. So what we're seeing in our inventory is all good inventory. Part of it was from our deliberate decision not to put some into the market because we didn't want to have a lot of our good, new initiatives competing with liquidating inventory at our retailers. So we will see that inventory moving into the market throughout the year, and we're not worried about it at all. From a retail inventory standpoint, our retail inventories are down, particularly in the U.S., and internationally as well.

All right. And then one follow-up. A vendor that had talked about higher freight expenses, and that's something we're hearing consistently across many vendors. Can you talk a little bit about how long in duration you expect that inflation to continue and where you're seeing it within your markets around the world?

Absolutely. We're seeing it -- a lot of it is really coming in the U.S. and it's a little bit throughout Europe as well. And it's really coming from the trucking industry and higher due to the new electronic logging device rules and driver shortages. The contracting supply and increasing demand is expected to manifest itself really kind of throughout 2018, but it is in our outlook. We highlighted it for the first quarter because it's a bit different from last quarter. And you see that impact in SD&A as opposed to upping cost of sales because it's really a selling expense and getting the inventory to the retail location for selling. So it's in our outlook and in everything we've talked about for the year.

And then one for you, Brian, just bigger-picture, as you sit back now and observe some of the channel shift, and I see you're making some changes to your commercial organization. But how should we think about the 2- or 3-year trend in the business? And where do you see the biggest opportunities to really drive the advantage versus your competitors?

Yes. So year-to-date, we've seen through NPD that the industry has grown, and we've kept pace with that growth and we've kept pace in the United States. And in fact, we remain #1 company in the G11 markets and in fact grew market share in 5 of those 10 markets and held our own in the others. We believe the industry will continue to grow low to mid-single digits. We've made and had lots of meetings with our key retailers. They're very excited about the opportunity to garner share in markets like the U.S. And for perspective, as Toys"R"Us liquidates, the Toys"R"Us U.S. business represented about 2/3 of our global Toys"R"Us business. So as we move through this, there's a real market share opportunity for our other retailers. We are seeing that converged retail marketplace take hold. We had made significant progress in the U.S. We have lots of great capabilities. We had begun to onboard those capabilities in markets like Asia. And we needed to accelerate those efforts that we had indicated to you back at Toy Fair that we were doing. For example, the global online business, that we'd set up the team, as well as the global retail channels team. And we felt that we had an opportunity to accelerate those efforts in Europe. And we also have new leadership there that we're very excited about. So taking a new approach to markets, recognizing that there is growth in the industry. And our global retailers are also wanting to grow with us. We have market initiatives that are really growing our brands. And POS have grown and retail inventories are down. But as Deb said, we made some decisions about how we deployed new inventory, really good inventory, in light of the liquidation that's taking place in the near term that we expect to conclude by June.

Our next question is from the line of Arpine Kocharyan with UBS.

Could you please give a breakdown of exactly what percent of decline was from Toys"R"Us this quarter? And I know you talked about the impact being less later in the year, but could you specifically talk about what percentage of Toys"R"Us retail disruption is being absorbed by competitors at this time?

Yes. So first, Arpine, if you look at the situation in this first half of the year, it's directly related to Toys"R"Us. Clearly, this conversation and our business would be in a very different short-term position were Toys"R"Us still in existence in the United States, but the fact is it isn't. And so our teams are moving quickly to transition and transform and to move forward in an appreciable way. What's really exciting is that our global retailers are very excited about garnering that additional market share. They're building additional promotions. They're building additional space for the industry. Having had a number of good retail meetings recently, our retailers are very excited, I believe that the opportunity to absorb all of the Toys"R"Us business is present. And in fact, we're just building those plans to do that. It just takes some time from the moment that we finally heard of liquidation to the time when you can execute new plans with new initiatives does take some time as you build out those new windows of opportunity for other retailers.

That's helpful. And then just going back to the retail numbers, could you clarify, was that Easter-adjusted? So POS is up for Hasbro and the industry easter-adjusted because Easter started early? And then I have a quick follow-up on inventory.

Yes. So retail in the first -- POS was up for the first quarter. And it was up globally, it was up across every one of our categories, except for Emerging Brands. Very strong growth for Games, Franchise Brands, Partner Brands. And then Easter-to-Easter, the business was up and it was up around the world as well and was up for all of our categories, with the exception of Emerging Brands. So Easter-to-Easter, the business was up.

That's helpful. And then one more follow-up on the inventory on hand. I'm not surprised that it was 72% of top line because you have a weaker seasonally quarter that sort of things get magnified in this quarter. But I was surprised to see it still up substantially year-over-year, FX-adjusted. Because if you -- even if you were to sort of adjust for Toys"R"Us sort of holding a little bit more on hand, Easter was early this year, which means that, that inventory on hand should have actually been lighter when you closed the quarter. Or am I missing something?

Yes. So we've made some specific strategic decisions on how we're deploying our inventory around our new initiatives for brands that are selling incredibly well. Recognize that the first phase of the Toys"R"Us business was announced bankruptcy last fall, followed by, around Toy Fair, the belief that they would begin to close some stores. And then following Toy Fair and our opportunity to talk to investors, they then declared that they would liquidate. So at that point, we really made some decisions about where do we deploy new, good inventory for brands that are selling really well in the face of a short-term liquidation. So we took some decisions. Obviously, we've deployed inventory for new initiatives where there are shelf-set dates, like Avengers and Solo: A Star Wars Story. All those areas, that's where we've deployed, but we've also been thoughtful about where to put those inventories as we head into the second quarter as we have new initiatives coming from our Quick Strike initiatives that we sort of previewed for you at New York Toy Fair. And so we feel very comfortable about the quality of our inventory. We feel very good about the POS we're seeing across the different categories of the business, and the fact is our retail inventories are down in the U.S. and around the world. So we're really planning to run out some of those inventories and then build our initiatives with our global retailers, who, as I said, are excited about our business and we're really excited to grow with them. And we're building those plans now.

Next question comes from the line of Michael Ng with Goldman Sachs.

I have one for Deb and one for Brian. Deb, gross margins held up surprisingly well this quarter, and I think you guys gave a good outlook, too. Can you talk about why that was the case despite fixed cost deleveraging from the lower-than-expected revenue?

Well, thanks, Mike. We had talked about at Toy Fair that we expected our gross margins could approximate 2016 levels. And in fact, we planned our business that way. We've gotten some questions about with the Toys"R"Us business going away, does that mean our gross margins will go down? Is that a more profitable business? And in fact, as we've said many times, we're agnostic to that. It's not a more profitable business from a gross margin standpoint than other retailers. So that's really been our focus. And when we talk about in our prepared remarks, we've been very disciplined as to what we've put into the market, how we've priced it and when we put it in to maintain those gross margins.

Okay. And then Brian, can you talk about how the exit of Toys"R"Us might affect industry toy sales and the landscape? For example, what happens to some of the smaller toy manufacturers that may have relied more on that channel than Hasbro has? Do you see the opportunity to take some market share from these players? And will this create some tuck-in M&A opportunities for Hasbro and other well-capitalized toy players? And then lastly, do you anticipate other retailers, like a Walmart or Target, to allocate more shelf space to toys?

Yes. So if you -- as I've mentioned, we've been having lots of meetings with our retailers, and there's lots of interest in continuing to grow with us and in this key category. As retailers see it, the toy and game business are key categories for them. And yes, I would expect to see incremental space assigned to toys. I think they're building robust plans, and it just takes some time to build that out. There's a great opportunity across a number of dimensions for a number of different kinds of consumers that were Toys"R"Us shoppers, particularly in the United States. For us, we continue to believe there's great opportunity for growth. Obviously, we see opportunities to pick up brands. Most notably, we talked about it at Toy Fair, the fact that we are going to be now managing the Power Ranger business. We're very excited about that. And we'll continue to look selectively at new brand opportunities. Having said that, we also have some great brands in our vault that we're beginning to develop and develop storytelling around. We've kicked off our relationship with Paramount, a more robust relationship that will give us an opportunity to take some of our brands, like M.A.S.K. and ROM and Visionaries and Micronauts out to the marketplace. And then you've also heard from us opportunities to work more significantly and substantially with Netflix. And we're excited about Super Monsters. And of course, with Nickelodeon on their Top Wing property. So again, thoughtfully and smartly adopting some new brands that we'll bring into the portfolio. And then lots of new innovations coming for a number of our different brands. Really, it's just about that transition and transformation of our business that we need to go through, through the first half of this year in the U.S. particularly. And then we're beginning to hear some positive notes around some retailers, some of the Toys"R"Us regions perhaps being picked up by other retailers or other companies. And so we'll have more on that shortly, we hope.

The next question is from the line of Greg Badishkanian with Citigroup.

Could you just quantify the POS in the U.S. and maybe just the global number? I don't think I heard the number.

Yes. So the number in the U.S. POS was up double digits, and that was up double digits year-on-year, Easter-to-Easter. And globally, it was up double digits and up high single digits in the Easter-to-Easter view globally.

Okay. All right. Good. And then just as we think about the Toys"R"Us impact, does that go away in the first quarter of next year? Is that what you meant about -- is that -- can we infer that from what you had said?

Yes. Look, Deb and I both believe, and our teams are lining up great growth plans for 2019 and beyond. I believe we'll get back on the kind of growth trajectory you've seen from us. We've reaffirmed our medium-term guidance here this morning. We're absolutely certain that we have the brands, the portfolio, the marketing initiatives and the innovation to achieve that kind of a growth. So that's what we believe. It's going to take, as I said, about a year to work through this, particularly the first half of this year. And then depending on what happens in the other regions around the world for Toys"R"Us, that will obviously have that impact in Qs 3 and 4. But by Q3 and 4 in the U.S, where, as I said, historically, Toys"R"Us 2/3 of the Toys"R"Us business was being done in the U.S., that goes away. And we begin to build really robust plans in earnest with other retailers around our brands that are selling quite well and retail inventories that are down.

Our next question is from the line of Felicia Hendrix with Barclays.

So Brian, and Deb, I know you don't like to give very specific revenue guidance. Deb, thanks for all the color on the below-line item stuff. But it would be helpful if you could just give us a more specific road map for the rest of the year in terms of revenues. Because when you reported this morning, I think a lot of us believe that you can -- shouldn't think the year regarding Toys"R"Us, but the color that you've given is you've indicated that there would be further disruption, but at declining levels. And we know that the impact will be more on the revenue side, likely on not the expense side, based on what you've said. But just really in the spirit of trying to eliminate the potential for your company to miss sell-side revenue and estimates for the remainder of the year, I think it would be very helpful for us if you could walk us through how to think about the rest of the quarters in light of the continued liquidation.

Sure. Well, Felicia, if we think about Toys"R"Us, we think about -- we'll just -- we can go back to Toy Fair and what we said, that we knew there would be disruption in the early half of the year. And we continue to believe that. But we have overall confidence in our business. And as we look at the spread of the year, the first and the second quarters are normally very low-revenue quarters. So of course, we believe that we'll see a bigger impact in the first part of that year. When you start to get into the holiday season, we believe it'll be less disruptive, and we'll work through the impact overall in about a year. And whether that's first quarter next year or stretches out a bit, it's still within a year period. But overall, we're very confident in our business. We have a plan that gets us through 2018 in good shape. We still are confident in our plans to grow our business in 2019 and beyond. We've reiterated our medium-term guidance. So it's really -- and consumer takeaway is good, so that's there as well. So for us, it's really about just working through the disruption, which we think will be much more pronounced in the early half of the year.

Okay. So let's peel back the layers a little bit. So it sounds like, for 2018, you probably won't see revenue growth. Is that fair?

Well, look, I think the way to look at it is you're transitioning in the U.S. and Qs three and four that are a bigger quarters with new initiatives, entertainment and robust retailer support, it's all present. Now we just have to put all the plans together. Obviously, this has all happened over a very short period of time. So we see the opportunity there. We just need to now build and develop those plans and execute those plans. So that's the thought process there. And then if you go out around the world and look at our Entertainment and Licensing business, it continues to grow. We saw growth in digital gaming and Consumer Products in the quarter. We've seen growth in Latin America and in Asia Pacific. We continue to believe in our Wizards of the Coast team and their business, and we've seen great response to Dominaria, which comes in Q2 as well, as Magic: The Gathering Arena, which is still in closed beta, but increasingly spreading the opportunity to play the game. And the feedback has been phenomenal. We continue to enhance that. So I think we have one of the broadest portfolios with strengthened sell-through, with retail inventories down, strong retailer support and plans that the teams are developing in real time across the U.S. and around the world. So we just -- it's early days relative to the Toys"R"Us liquidation, and we'll update you as we get closer to the third and fourth quarter.

Okay. So maybe just to better understand the mechanics, which would be helpful. You're obviously not shipping any more into Toys"R"Us, so on a year-over-year basis, that's decline.

That stopped in -- that would stop -- that had stopped in the first quarter.

Right. And then the other impacts would be just the unknowns, would be just how the liquidation would affect your sales elsewhere, just in terms of competitive pricing and what people take.

No. Remember, so they're not getting any new inventory, they have to sell through the inventory they had. So as we said, we've been thoughtful about the initiatives coming to the market that wouldn't get caught up in the Toys"R"Us liquidation and shipping those outside of that window, and of course, building plans with our retailers for Qs 3 and 4, where retail space is inherently historically grown. And now you'll see even more robust plans from our partners around our brands that are really growing. So it's -- again, it's just a matter of latency, the lag between an intention to develop new plans and grow and then executing those plans. But it's -- there's no controlling weakness, and executing. And our retailers are very ambitious and enthusiastic about our business. And we are about their business.

Okay. So given the size of the second quarter, probably, you would say magnitude somewhat less than the first, but kind of in the ballpark -- like a similar ballpark?

Yes, look. Yes, I think that the unknown here a bit in Q2, and again remember, historically, a lower-revenues quarter historically, is the size of the discounts that come along with liquidation. As the liquidation goes on towards conclusion, the discounts, the percent discounts get bigger. And then it will all conclude, as we understand, in June. So the discounts go on larger. However, there's no new inventory that they have. It's the inventory that was shipped to them in the earlier part of the first quarter, and then that will sell through. We begin to execute new initiatives throughout the second quarter, so certainly, a number of new initiatives coming in Q2, particularly around entertainment and home entertainment for Black Panther, Avengers and other new initiatives coming from our teams and the Quick Strike initiatives. And then for the third and fourth quarter, the more robust plans around new innovations for the fall and for holiday.

Okay. That makes sense. And then just last for me is just with your reiteration of the $600 million to $700 million in operating cash flow, impressive, given what's going on here. But I presume just, like, where you fell in the range shifted because otherwise, I'm just having problems putting to you reiterating that number.

We still believe in the range of $600 million to $700 million of operating cash flow for this year.

Yes. I know that, I was just thinking kind of...

Well, I'm not going to tell you exactly the number, Felicia.

No. I mean, it's just, logically, it would seem that where you fall...

Suffice to say, it probably isn't at -- we would probably have moved from the top end of that range. However, our cash flow generation remains strong. And as Brian said, we have a strong business. The consumer wants our product, and it will find a home. So our cash, we still believe in our cash flow generation. Financially, we're sound. Our debt's not going up. And we will work through this.

Our next question comes from the line of Jaime Katz with MorningStar.

So I'm curious, you guys had recently mentioned at one of the events that you'd spoken at, that there are these 3 new initiatives that are coming out this year that haven't been announced. And I assume that's going to be postponed until the second half, given the commentary surrounding Toys"R"Us and what you've just said about not introducing anything new until some of that is behind us.

Yes. No, please don't take what I said as that we won't introduce new initiatives. We have plenty of new initiatives for Q2. I was trying to comment on the fact that we would, in first quarter, with additional good toy inventory that was of good quality. So obviously didn't want to deploy that until we had a good perspective on what the liquidation looked like and what the timing looked like. Obviously didn't want to put new initiatives in the market that would be caught up in shipping to and in liquidating through Toys"R"Us. But we have plenty of new initiatives in the second quarter. We have initiatives around the home entertainment release of Black Panther. We have Avengers. We have at least one Quick Strike initiative coming in the quarter. We have lots of new innovations from a number of our brands. And I have to say, across our Franchise Brand portfolio, we've seen great growth in POS for every one of our retail Franchise Brands, and strong growth for those brands and continued momentum. So no, all that we were trying to say is where are we, how are we deploying new-initiative inventory between Qs 1 and 2 and then going into the third and fourth quarter.

Okay. Thank you for clarifying that. And then for -- I think you had mentioned Top Wing, but I'm curious for some of these other license partnerships. I think you're having more competitors that are interested in participating, obviously, in content-driven licenses. Is it getting a little bit easier because you guys have such a significant portfolio of experience with this, like, proven track record? Or is it actually getting more expensive to obtain these licensed partnerships because there are more people sort of coming to bat for them?

We're working with partners earlier and earlier stages and in more strategic ways. We're very pleased to continue to build our relationship with Netflix. As you know, we built -- we produced an original series for them on Stretch Armstrong, an animated series. It's performing well on the network on their -- in streaming. And then we began to work with them on Stranger Things in the very early days, and we're rolling that product out now nationally, but it was with a retailer for last fall. And it sold incredibly well, both the MONOPOLY game as well as an Eggo game. If you know the story, you know what I'm talking about. And then continuing to build relationship with Paramount and Nickelodeon as part of Viacom. And again, what we would say is that we do have a lot of experience and we are selective and strategic about the partnerships we take on. Obviously, we continue to be incredibly excited about the lineup from the Walt Disney Company, focusing on MARVEL. We have 6 MARVEL movies this year where we are supporting in a significant way and really extending and expanding our reach there. STAR WARS, the POS really has lined up well, and we're very excited about the Solo movie. And of course, going into 2019, additional entertainment. And then DISNEY PRINCESS and FROZEN, with FROZEN 2 coming next year. So again, lining up with some of the best partners. And I think the adage we talk about here at the company is we treat their brands like our brands and bring great consumer insights and innovation to those brands with dedicated teams, resources. And that's been our focus. And I really haven't seen a change in the landscape in an appreciable way.

The next question comes from the line of Drew Crum with Stifel.

Could you give us an update on expectations around clearing the inventory overhang in Europe? And then I guess specifically, as it relates to STAR WARS, address the inventory situation there and retailers' willingness to take on more STAR WARS inventory ahead of the Solo film.

Well, we continue to work through the inventory overhang in Europe. We feel that the U.S. retail inventory is down in those pockets that we had excess inventory, but we still think there's a bit of work to do in Europe. So we'll see that impact us throughout the year, albeit to a lesser and lesser extent as we move through the year. And Brian, do you want to take the STAR WARS question?

Yes. Look, we've seen good -- really good sell-through STAR WARS in the first quarter. The retail inventory of STAR WARS is down double digits, and it really sets us up well. The team's done a really good job of moving through inventory there. We'll -- obviously, we'll continue to sell an array of STAR WARS-branded inventory throughout the year. And then we're very excited about the Solo movie that's coming now. And that product hit shelves in April for the May movie. And then, of course, we will track through. We're also very excited about new kids-oriented entertainment coming for the second half of the year. And I know that announcement is coming any day now from the Walt Disney Company, but we're very excited about that. We think that's also well-timed. And it's a very exciting initiative that we'll support in a considerable way.

Got it. And then shifting to BEYBLADE, I think you've mentioned that it was off to a very strong start. And year 2 of the license, can you talk about how that trajectory looks as compared to, I believe it was 2011, you guys did about $480 million of BEYBLADE revenue that year, and that was year 2 of the license. So just curious as to how BEYBLADE is tracking relative to the last product cycle.

Yes. BEYBLADE is tracking incredibly well. It is the second year of the cycle this time. We're seeing great uptake. We have dual exposure, both from broadcasters around the world as well as streaming content on Netflix. And we also have an incredible number of young people playing the digital app and hundreds of millions of games being played, competitions being played online, which is inspiring their off-line analog play. It's a new play pattern with this burst. And in fact, the SwitchStrike product, it's launching in this period, is really fun because they can change the way the tops actually rotate and that adds a level of strategy and thought to the game play. But as you know, Drew, I'm not going to comment specifically as it pertains to the last time. However, I think we've told you now that we're incredibly excited about this. And it's certainly accelerating as it has in other second years of the cycle. I'm not going to try to range it partly because it's sometimes hard to range because, of course, this is a lot about word-of-mouth and kids playing it and seeing it out at retail being played and online. And then also obviously, we have this near-term disruption going on that we need to think about and replan that part of the business with other retailers who obviously want to grow with BEYBLADEs.

Okay. Got it. And then just one last one for me. Brian, is there sense that there's any impact across the portfolio from Fortnite, which is this phenom free-to-play battle layout video game that just -- it's been an incredible success with kids and teenagers, is there sense that there's any impact on your business? Or maybe not.

Well, we really like Fortnite. It's a really fun game. Our digital gaming business is also up both in the licensed area as well as at Backflip. People increasingly are playing games, and we think that's fantastic. They should them play them any way they want, anytime and anywhere. And obviously, we're serving our games similarly. We like the Fortnite game. And I would say we haven't really seen an impact with respect to that game.

Our next question comes from the line of Susan Anderson with B. Riley FBR.

I was wondering if you could give -- I know you gave some color on just the performance of products, but maybe if, by segment, how things performed versus your expectations include -- excluding Toys"R"Us. Were there any other pressure points more than you had expected? Like, was Europe worse than you saw it? And also maybe if you could talk about NERF and how that performed in the quarter. And I think you have some new product coming out in second half. What will that mean for revenues? And is this something similar to the impact like NERF NITRO was?

Yes. So a number of new initiatives coming from NERF this year. Obviously, our fastest-growing segment is Nerf Rival, and then our largest segment is Elite and then we have Modulus. All 3 of those segments are up sizably in POS. We have some new product in there and expanded product development and growth in addition to new channels because of a new development we've made at different price points and building that opportunity. Our retail inventory for NERF is down. And we'll bring new initiatives for the second half. We have a major new initiative that we haven't talked about specifically for the second half of the year that we're excited about. And so that we continue to believe, over time, that NERF will continue to track well. NERF NITRO has performed incredibly well internationally and well in the U.S. And obviously, we're excited about its continued progress. If you look at categories, I think if you just consider the fact that there was an evolving situation with Toys"R"Us, we obviously shipped, Toys"R"Us a year ago was our number three customer, significantly less in the first quarter this year than a year ago, of course. And so we are redeploying, transitioning and transforming our business, including our retail sales organization, to bring on new capabilities and changing that composition of our retail team, including how we manage digital assets, content to commerce, digital and social marketing, data analytics. All of those elements are really important for how we build the business. So I would say, clearly, Toys"R"Us is the reason that the business is where it is in this first quarter. Obviously, that's what we're working through. And we will put Toys"R"Us in the U.S. in the rearview mirror in the next few quarters. And that's our point of view. And we'll continue to grow in 2019 and beyond.

Okay. Great. That's helpful. And the last one on Black Panther. Obviously, a great success, and it looks like Avengers: Infinity War is also setting up well. Do you think that sets up MARVEL to continue to outperform this year? And then has there been any early reads on the early products for this movie?

Yes. So MARVEL has outperformed and performed incredibly well in the first quarter. The point of sale for MARVEL is very strong. We have -- there are 6 theatrical releases throughout this year that we're supporting, including Black Panther, Avengers, and then even a lineup that's really fun for Deadpool, Ant-Man and Wasp, Venom and Spider-Man: Into the Spider-Verse, they're all supported by robust product lines, and that stretches throughout the calendar year. We're very excited about the lineup and innovation in our product lines. We have new products coming for Black Panther beyond the home entertainment window for the holidays, including product in the MARVEL LEGENDS series for Black Panther, which is great. We're very excited about our Hero Vision product, which is a augmented reality product that's coming around Avengers: Infinity War. And we also have the Assembler Gear, that's that modular and customizable role-play system. So again, a lot of innovation and very robust entertainment coming from MARVEL, so we're very excited.

The next question is from the line of Tim Conder with Wells Fargo.

A lot of questions have been answered, but a couple here. Deb, on the inventories, it sounded like, in a previous answer, you had mentioned that those should be normalized, take the year in Europe to get those normalized in the channel. And it sounds like elsewhere in the channel, you feel pretty comfortable. So just to reaffirm that. And then -- and when do you then see the company-level inventories back to levels that you would term normal?

Well, yes, that is what we said about Europe. We still have a bit of work to do there, although the levels have come down quite a bit on the retail side. From our inventory, we've talked quite a bit about why it was up and that it's a good quality with items like BEYBLADEs and Avengers and NERF and BABY ALIVE in it. And we also said at Toy Fair, and we continue to believe, as we move more to an online retail model, and we saw the acceleration of that cutting into the end of last year and certainly with Toys"R"Us going away, we see that being a large piece of what's going to pick up those revenues, go-forward, be it through our omni-channel retailers like Walmart or Target; or a more pure play, like Amazon or Alibaba or Tmall. You -- I would expect that our inventory levels would run higher than they have in the past because we want to make sure that we have the right inventory on hand to supply those retailers when they want it. And they tend to take it much closer to when they're going to sell through than when -- than put it in a warehouse and have that longer lead time like more traditional brick-and-mortar retailers have. So we expect our inventory levels to be a bit higher, probably not as high as this quarter because we deliberately held inventory and with the revenue decline. It is all good inventory. It will move, but we would expect they'd probably run a bit higher than they have in the past.

Yes. To Deb's point, if you just look at the mix shift of domestic to direct import in the first quarter, it was five points higher on the domestic side. So it's 80-20, 80%, 20%. So it went five points higher on the domestic side.

Okay. And then I guess in a little bit in relation to that in the International front, not much comment on China or Russia, which has been very strong for your sales and the industry over the last couple of years. Any update you could provide us there?

Yes. China, it continues to track very well for us. We talked about the impact of the emerging markets was really in Brazil as we finalized that cleanup, and move forward, we're more optimistic about the Brazilian retail economy and consumer sentiment for the full year 2018. And just moving through and finishing up some work there. And then in Russia, similarly, it was where we had some inventory that we wanted to clean up in the first quarter. But again, feel very good about the Russian business. It's been a growth business for us. And we continue to reiterate our beliefs that emerging markets overall will grow double digits, absent FX, over time. We've seen our Asia business perform well and our Chinese business perform extremely well.

Okay. And then lastly, any more organizational changes that you anticipate here? Or were those pretty well expensed and accrued for in Q1 here?

So there's always things that we do throughout the business. And as we said, we had planned this to happen, actually, throughout the year. However, we wouldn't expect anything of this level throughout the year.

Our next question is from the line of Gerrick Johnson with BMO Capital Markets.

So what was the onetime revenue and bottom line impact from ASC 606?

It was immaterial.

Okay. And can you tell us what the Toys"R"Us gross revenues were in the first quarter?

No. We've said that the Toys"R"Us revenues were down sizably, obviously significantly, Q1 '18 versus Q1 '17.

I would say they weren't material either. And don't forget, there's disruption remaining in some of the rest of their business. So while the U.S. is a big piece, we're also being very careful and prudent throughout the quarter with their other businesses as there remains this uncertainty as to what's going to happen to them long term.

Okay. An accounting question for you. So when Toys"R"Us goes into liquidation, do you reserve -- or do you reverse those sales allowances that were booked against the prior revenue since that inventory isn't going to be supported by you anymore?

Depending on what the allowance is. Because if you recall, some of it is for promotional items that actually happened within the quarter. So we record our revenues net, and what net balance we have is what we would reserve for that we felt we wouldn't collect at the end of the day.

Okay. And then the $61 million after-tax bad debt, what was that on a pretax basis?

It was $59.1 million on a pretax basis -- or about $50 million on a pretax basis. In total, the impact was $70 million.

So wait, on just on the Toys"R"Us bad debt, just to be clear, what was the pretax and what was the after-tax impact just from Toys"R"Us bad debt?

On just the bad debt, I believe I said that it was $59.1 million on just the bad debt.

Is that pre or post-tax?

That's pretax.

Okay. My last question is, you said you stopped shipping some items because you did not want to compete against Toys"R"Us liquidation. How much of that also is from retailers not wanting to compete against that liquidation and their decision to cut back on orders?

No. It wasn't really related to that. We've been flowing goods throughout. We have very strong POS, so the demand is there. It was a really decision about some new initiatives that could have occurred in one quarter versus the other. It's just timing on certain things. But no, our retailers are very interested in growing with us. Obviously, historically and for this year, Q1 and Q2 are lower-revenue quarters on average. And our retail partners are gearing up for the Q3 and Q4. Just takes time for them to expand their plans with us and to continue to add new initiatives that should enable them to pick up the Toys"R"Us business in any number of ways.

The next question comes from the line of Eric Handler with MKM Partners.

Deb, one question for you. Wondered if you could dig in a little bit more on the puts and takes into the gross margin. It seems like with the gaming business down -- or the Games business down 20%, that seems like it's a big headwind for your gross margin. What was in Entertainment and Licensing that really helped drive the growth in the gross margin?

Well, very exciting in Entertainment and Licensing. And Brian mentioned it earlier when we talked about our relationship with Netflix is Stretch Armstrong. So we see quite a bit of revenue coming from that new initiative in the first quarter in Entertainment and Licensing. And the rest was a mix within our digital business. TRANSFORMERS: EARTH WARS continues to do well. And on the digital side, that business is performing well. As well as our Consumer Products business from a licensing standpoint as well. But I get very excited about Stretch Armstrong, so I'll point that one out again. And really, from a mix standpoint in gross margin, in addition to the impacts from Entertainment and Licensing, it really was just a function of mix and getting better margins on some of the things that we normally would have flowed into the business and having reasonable hedges to protect our pricing and not going overboard on allowances. So it's really the discipline that we instill in our business to try to hit that gross margin goal.

Our next question is from the line of Linda Bolton-Weiser with D.A. Davidson.

Is there any way, just to help with modeling, if Toys"R"Us was 9% of your sales in 2017, in the first half quarters, would it be 15% of your sales or 10% to 15% of sales? Can you give some -- like, what percent was Toys"R"Us in the first quarter '17? That would be helpful. And then secondly, there's been some talk in the industry that actually having fewer brick-and-mortar locations for toy sales, because it's an impulse-purchase item, actually will curtail demand over the long term. And I've heard estimates of even 10% to 20% of demand would kind of go away. Do you have any views on that?

Yes. That's not really, Linda, what we've seen with demand in the toy industry. We've expanded our retail footprint. We obviously produce different kinds of products for different kinds of retailers at different price points with different levels of sophistication and interactivity so that every child can participate in our brands at every price point. We want them to be able to have a toy or a game that enthralls and delights them. So what we're seen is an expanding retail footprint. I've mentioned that we have more than 21,000 new doors net of all the closures we just described in the United States over the last 3 years, and these are all kind of new channels. We built this team to enable us to build the right kind of product for the right kind of retail destination. We don't believe that there will be any business that will go away in natural course because again, we're building innovative products. We're telling great stories around those products, either us or our partners. And we're building new play patterns. So we see people buy online. We see increasingly this pickup in store, which adds to the basket, so people do come into retail on an increasing basis. You're going to see a number of new ways that consumers can pick up product, get product, from reserving online to picking up today to buying online and picking up in stores. And so again, I think we're building the capability in this converged retail model that allows the consumer to move in any number of ways across the shopping and buying environment. And there is -- there's no reason in our minds, and the evidence is there, that there should be no gap in what's available to people to purchase. And we believe the industry will continue to grow. We've seen it grow year-to-date, even with this disruption.

Thank you. At this time, I will turn the floor back to Debbie Hancock for closing comments.

Thank you, Rob, and thank you, everyone, for joining the call today. The replay will be available on our website in approximately two hours. Additionally, management's prepared remarks will be posted on our website following this call. Thank you.

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.