Hasbro, Inc. (HAS) Q4 2022 Earnings Report, Transcript and Summary

Good morning, and welcome to the Hasbro Fourth Quarter and Full Year 2022 Earnings Conference Call. [Operator Instructions] As a reminder, 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, Senior Vice President of Investor Relations. Please go ahead.

Thank you, and good morning, everyone. Joining me today are Chris Cocks, Hasbro's Chief Executive Officer; and Deb Thomas, Hasbro's Chief Financial Officer. Today, we will begin with Chris and Deb providing commentary on the company's performance, then we will take your questions. Our earnings release and presentation slides for today's call are posted on our investor website. 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 exclude these non-GAAP adjustments. A reconciliation of GAAP to non-GAAP measures is included in the press 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. These factors include those 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. Today's guidance assumes we retain the noncore entertainment, Film & TV business, notwithstanding the current marketing process. While there is no guarantee of such an outcome, if this process results in a sale, we will update our guidance. 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 Chris Cocks. Chris?

Thank you, Debbie, and good morning. In October, we laid out our new strategic plan for Hasbro, Blueprint 2.0, built on fewer, bigger, more profitable brands; a sharpened focus on the categories where Hasbro can be best-in-class; an Operational Excellence program to speed our agility and improve our cost competitiveness; and growth initiatives in digital games, Hasbro content, direct-to-consumer and licensing. While Q4 proved to be a disappointment, particularly in our traditional toys and games segment, we made progress under the hood that meaningfully improved our bottom line and sets us up for margin expansion in 2023 despite what we anticipate will be a continued challenging consumer environment. Our transformation efforts are positioning Hasbro for success. In 2022, we identified $50 million in run rate cost savings that improved our Q4 earnings by over $20 million. In 2023, we anticipate our operational transformation will generate $150 million in run rate savings, money we are using to both reinvest in the business and improve our profit profile. We are also undertaking a significant organizational redesign that streamlines decision-making, puts the consumer at the center of everything we do and aligns the company behind core competencies in games and toys. Within our growth initiatives, our direct business comprised of MAGIC: Arena, D&D Beyond, Hasbro Pulse and MAGIC: Secret Lair was up 15% in 2022. Hasbro Pulse was our fastest-growing channel, increasing 70% on robust fan demand across premier industry entertainment properties. D&D Beyond delivered user growth in excess of 20% since we acquired the service in May of 2022; and, as forecasted, was EPS-accretive in Q4. Wizards of the Coast and Digital Gaming grew 5% in constant currency, outperforming a games market that, by most measurements, was flat to down, with MAGIC tabletop leading the growth. Importantly, we celebrated our first $1 billion brand in MAGIC: THE GATHERING, a huge milestone, not just for Hasbro, but for the thousands of hobby shops, our most important and assets growing channel for the brand and millions of fans who make both MAGIC and D&D more than just games, but vibrant, global communities. Our growth in Wizards was not without challenges. We navigated significant supply chain disruptions that while resolved for 2023, compressed our set release schedules in 2022, particularly in Q4. We were too aggressive in some of our pricing assumptions, notably our 30th anniversary edition of MAGIC and pulled back on available supply impacting Q4 results. Lastly, on D&D, we misfired on updating our open game license, a key vehicle for creators to share or commercialize their D&D inspired content. Our best practice is to work collaboratively with our community, gather feedback and build experiences that inspire players and creators alike. It's how we make our games among the best in the industry. We have since course-corrected and are delivering a strong outcome for the community and game. Our licensing business was up 5% for the year. Over the past several months, we've announced multiple strategic licensing partnerships, and we're excited to have top partners taking on iconic brands like FurReal Friends, Littlest Pet Shop and EASY-BAKE Oven, to name just a few. Our teams are focused on growing market share in the categories where we can lead. We had success in preschool with PEPPA PIG, creativity with PLAY-DOH and action, with strong growth in Hasbro's products from partner brands, Marvel, which had a record year; and Star Wars. Our focus on content is centering around Hasbro IP for the long term. Our sales process for the majority of eOne Film & TV is well underway, with strong interest in these valuable assets. We expect to have an update in the second quarter. Our content pipeline for Hasbro IP is set for growth in 2023 with the upcoming release of the feature films, Dungeons & Dragons: Honor Among Thieves; and Transformers: Rise of the Beast, and a host of new and continuing preschool and kids shows from Transformers: EarthSpark to the new seasons of My Little Pony and PEPPA PIG to the new Kiya & the Kimoja Heroes on Disney Jr. and Disney+. Looking ahead, we are excited about the recently announced D&D live action series; and for next year, the animated Transformers feature film with our partners at Paramount. For 2023, we expect the toy and game market to continue the trends of Q4 into the first two to three quarters of the year, given the lingering effects of consumer inflation. We also see approximately $300 million of revenue headwinds from foreign exchange and exiting low-profit brands, licenses and businesses as part of the fewer, bigger, better pillar of our strategy. As a result, we anticipate revenue for the company to be down low single digits for the year, with consumer products down mid-single digits, Wizards of the Coast and Digital Games up mid-single digits and entertainment up low single digits. The progress we are making in our cost savings, Operational Excellence and focusing on key brand initiatives is expected to drive continued operating margin expansion of 50 basis points to 70 basis points. We made progress on both our owned and retailed inventory in the fourth quarter but have more work to do. The teams are focused on clearing inventory in addition to supporting our innovation. This will impact our growth rates and profits, most notably during the first two quarters of the year, which Deb will provide detailed comments on. We ended the year with $513 million in cash. As we sell through inventory and drive profit expansion, our cash flow is projected to grow during the year. As we announced earlier this week, we are maintaining our current category-leading dividend. We continue to prioritize investing to grow, delevering the balance sheet and returning cash to shareholders. Given the challenging market context, our focus this year will be on increasing our operating profit margins and growing share in our focused categories. In outdoor, we are taking targeted pricing actions on NERF to compete at every price point, expanding the market with the introduction of NERF Jr. to kids 5 to 7 and winning share in the fast-growing JOE segment with all new innovations starting at a segment low of $19.99. In action, we have one of our strongest content lineups in a decade, including 6 blockbuster films, a host of new streaming series and some of the strongest new product innovation for Transformers in years, set against the launch of the Rise of The Beasts feature film in June. In preschool, we are excited by the continued global appeal of PEPPA PIG and our new line based on the upcoming hit series Young Jedi Adventures from Lucasfilm. In creativity, PLAY-DOH is growing share, and we are adding new compounds like Nickelodeon Slime and bringing best-selling innovation, our PLAY-DOH Ice Cream Truck, into the new year. And in games, we are adding all new innovation like the casual AR game, Twister Air, building on the best-selling CLUE: Escape Room series, extending our audiences in MAGIC with our newest universe Universes Beyond based on J.R.R. Tolkien's Lord the Ring series, Tales of Middle Earth, growing our distribution for MAGIC: Arena with our upcoming launch on Steam, and reaching all new global audience scale for D&D with our new blockbuster movie, Dungeons & Dragons: Honor Among Thieves; and AAA video game, Baldur's Gate 3, from our partners at Larian later this year. Over the next 12 months, we will share more about some of the innovation we have coming to market in 2024 and beyond. To give you a sense of a few, in creativity, we see an amazing opportunity to grow that market and maintain audiences as they age up with new, innovative, character-centric and story-based play. In video games, we are excited to reveal an all-new sci-fi IP from Archetype Studios in Austin that we believe will be one of Hasbro's biggest in over 20 years. Selfie Series, our new custom action figure line gives a glimpse of the possible and Hasbro's early leadership investments in high-fidelity custom 3D printing, which has a long-term potential to introduce the concept of mass customization for toys and collectibles. In traditional role play, we see exciting possibilities in all new virtual table tops that unlock new consumer value choices, bring imaginations to life, taps into the scale effects of user-generated content and create seamless remote and in-play play possibilities across phones, PCs and tablets with AAA graphics and intuitive controls. And last but not least, we have some fun new twists on old favorites that will delight new generations of fans and introduce amazing new low price points supported by magical play innovation. As we think beyond 2023, our focus remains on growing more of our franchise brands to $1 billion businesses, extending our blueprints through partnerships, content and new digital experiences and driving significant bottom line and margin growth through a more focused, agile and leaner organization. In the near term, we will execute our focus category and inventory reduction plans to grow share, transform our organization and cost structure to drive innovation and improve margins and continue to invest in new categories, competencies and partnerships to set up Hasbro for robust long-term growth as we celebrate our 100th anniversary in 2023. I'll now turn the call over to Deb Thomas, Hasbro's Chief Financial Officer. Deb?

Thanks, Chris, and good morning, everyone. Over the course of 2022, we made meaningful progress to strengthen Hasbro by completing our strategy review, unveiling and beginning to implement Blueprint 2.0 and undertaking a significant transformation project to streamline our organization and priorities. While the end of 2022 did not meet our expectations, our focus on controlling what we can and making decisions to strengthen Hasbro for the future improved operating profit margin in a challenging environment. Let me start with the balance sheet and our focus on disciplined cash management. Lower sales resulted in higher inventories on hand. At year-end, we had reduced our on-hand inventory levels by $168 million from the third quarter, but they were up $125 million from last year or 23%. This was driven by last year's revenue timing with early retailer purchases and our softer-than-planned Q4 sales. The timing of MAGIC releases in early 2023 and the increase in paper stock on hand also contributed to the growth. At retail, inventories were up low single digits across our top global markets, and Q4 POS trends indicate churn has slowed and with on hand increase. As a result, we estimate approximately $135 million of this is excess toy and game inventory at retail. Given our higher level of opening retail inventory as well as that from others in the industry, we expect a negative impact on first half retail orders. When we combine this with the fact that 60% of our approximately $300 million in revenue headwinds are in the first half of this year and the early timing of retail orders and shipments last year arising from supply chain challenges, we anticipate our first half revenue to be down approximately 20% compared to the first half of 2022 with Q1 revenue down approximately 25%. Operating cash flow was $373 million. We're forecasting 2023 operating cash flow in the historical $6 million to $7 million range. We continue to believe we'll reach a $1 billion-plus in operating cash flow level, but this is now most likely 2025 and beyond. We have sufficient cash to operate our business, meet our CapEx needs, including investing for growth, and funding our dividend. We continue to target debt-to-EBITDA of 2x to 2.5x. For 2023, we expect to make progress against this target. Pending the outcome of the sale of noncore Film & TV assets, we plan to prioritize the sale proceeds towards paying down debt. We remain committed to maintaining our investment-grade rating. At the same time, we're intensely focused on our cost savings goals and improving margins. Last year, we increased adjusted operating profit margin by 30 basis points, and we believe we have the potential to add an additional 50 basis points to 70 basis points this year. We achieved approximately $50 million in run rate cost savings and actualized $20 million in 2022, but this was partially offset in the year-end results due to the volume decline in consumer products. We remain on track for $150 million in annualized run rate cost savings for year-end 2023. This progress keeps us on the path to reach our targeted 20% operating profit margin in 2027, if not sooner, while also growing our existing business earnings and earnings per share over the period. As Chris mentioned earlier, the process for selling our noncore entertainment business remains on track, and we plan to update our guidance for our continuing business following the close of the transaction. With a portion of our cost savings, we're continuing to invest in our core initiatives: innovation, digital, direct and insights. We're focusing on higher-margin brands, moving out of lower churn businesses and simplifying our organization. We're in the middle of this transition and, as a result, reported charges last year for transformation activities, including severance and noncash asset impairments. In the fourth quarter, this included an impairment for POWER RANGERS. The impairment was triggered by our focused strategic approach to prioritize other brands in film development in the near term. Although an impairment charge was incurred, the brand continues to generate value and remains an important part of our brand portfolio. POWER RANGERS revenue grew last year. It's celebrating its 30th anniversary this year with a new scripted special on Netflix, the third season of Dino Fury and continued development on a young adult scripted series with writer/showrunner Jenny Klein and Jonathan Entwistle. Looking at our adjusted results for full year 2022, revenue, profit and earnings were impacted by lower-than-expected fourth quarter sales. Foreign exchange had a negative $166 million impact on full year revenue. Cost of sales was up 240 basis points due to higher product costs, inventory obsolescence, sales allowances and closeouts in our toy and game products. We benefited from higher product prices early in the year and lower freight expense as we moved through 2022. We anticipate an improvement in cost of sales to revenue share driven by our ongoing transformation efforts. Program amortization dollars declined on lower entertainment deliveries in the year. Royalties since declined on lower Partner Brand and entertainment revenue. At year-end 2022, we exited several third-party licenses, which will lower Partner Brand revenue and our royalty obligation this year while benefiting operating margin. We spent less on advertising last year, aligned with our focus on fewer brands and lower film advertising in our entertainment segment as we comped the MY LITTLE PONY movie in 2021 and supported our film releases in 2022. The team plans to increase advertising support of our key brands and categories in 2023, increasing the overall spend but with a much more targeted approach. SD&A declined in dollars in line with revenue, primarily due to lower bonus and equity compensation expense given the outcome of the year and lower depreciation related to 2021 video game launches. We also saw lower freight distribution expenses plans that have higher warehousing cost to consume with increased levels of inventory. In 2023, while we're achieving cost savings in this line item, given the timing to achieve the run rate on those savings, this line is forecasted to increase with more normalized compensation expenses planned. We expect this to impact 2023 by approximately $80 million with approximately $65 million impacting SD&A and the remainder in product development. For the current year, our outlook translates to an adjusted operating profit margin improvement of 50 basis points to 70 basis points. Our adjusted underlying tax rate for 2022, excluding discrete items, was 21.8%, in line with our projected rate for the year. In 2023, we expect our underlying adjusted rate to be between 20% to 21%. Looking at our segments, Wizards of the Coast and Digital Gaming revenues increased 5% in constant currency. Tabletop revenues were up 12% behind strong MAGIC: THE GATHERING releases. Digital declined 23%, which is expected given the comparison with the 2021 launches of the premium game, Dark Alliance and MAGIC: THE GATHERING Arena Mobile. In 2023, digital revenue is forecast to increase with the launch of Baldur's Gate 3 from Larian with some revenue expected in the third quarter and increasing in the fourth quarter. MAGIC, D&D and digital remain investment priorities for Hasbro. Adjusted operating profit was $538.3 million, down 2% driven primarily by higher product costs, increased royalties due to MAGIC Universes Beyond and increased product development, partially offset by decreases in advertising, promotional and depreciation expense versus 2021 gaming launches as well as lower incentive compensation. As forecasted, adjusted operating profit margin decreased and was 40.6%. For the full year 2023, we expect mid-single-digit revenue growth in the segment. Also, as we continue to invest for future growth and expand our Universes Beyond products, we expect adjusted operating profit margin in the high 30% range. Consumer Products segment revenue decreased 7%, excluding a negative $117 million impact of foreign exchange, $92.3 million of which was in Europe. The segment's decline was led by lower revenues in North America and Europe, partially offset by growth in licensing in Latin America. Lower revenue, higher sales allowances, closeout and warehousing contributed to a decline in adjusted operating profit margin to 7.6%, which was partially offset by savings realized from our Operational Excellence program within cost of sales and distribution expense as well as lower airfreight, royalties, advertising and incentive compensation. For the full year 2023, Consumer Products revenue is expected to decline mid-single digits from full year 2022 with adjusted operating profit margin improvement of 150 basis points to 200 basis points from the adjusted op margin in 2022. The teams are executing against a robust entertainment play and strong innovation, but we're facing significant headwinds from exiting certain third-party licenses, transitioning several Hasbro brands from an in-house to license model, reducing recent inventory at retail, rightsizing certain markets and continued FX headwinds. As noted earlier, a significant portion of these headwinds are in the first half. Entertainment segment revenue decreased 15% in constant currency. When adjusting for music, the segment declined 12%. Revenue was impacted by the timing of deliveries to partners in the TV side of the business and fewer film releases this year versus last. The TV business grew building on several successful scripted series, including The Rookie, Yellowjackets and Transformers with several new shows like The Rookie: Feds and The Recruit. Family Brands revenue decreased given My Little Pony: A New Generation was delivered to Netflix in 2021 without a comparable release in 2022 combined with decreases in digital revenue and lower content deliveries. The decrease in Music and Other primarily relates to the sale of the music business in the third quarter of 2021. For 2023, this revenue should be close to zero as we have exited these businesses. Total Entertainment segment adjusted operating profit decreased 19%. Lower revenues impacted profit and were partially offset by lower royalty, advertising promotion and compensation expense. For the full year 2023, we expect entertainment revenue to increase low single digits, and adjusted operating profit margin is expected to increase slightly from 8.6% in 2022. As Chris mentioned, Dungeons & Dragons: Honor Among Thieves premiers in March. We co-funded this film with Paramount and will participate in the box office and associated entertainment revenues. Based on our share of box office, we expect entertainment revenue to begin being recognized in late Q3 and Q4 of this year. We expect the majority of the related cash receipts to occur in 2024. As we look ahead, the sales process for select Film & TV entertainment assets is ongoing. And the outcome will inform our long-term financials. We continue to anticipate growing revenue at a mid-single-digit CAGR and improving operating margins to 20% and potentially greater level in 2027. I couldn't be prouder of the work and dedication our teams have put into the business this past year. In the past several years, it's been dynamic, but they never shy away from a challenge. And while the year didn't end as we had planned, the Blueprint 2.0 strategy is in place, our teams are aligned behind us, and we're well along the path of executing that plan. Before I close, since we last spoke in October, I announced my plans to retire from Hasbro. I remain committed to this company and team and will stay until my successor is in place and there's an orderly transition. During my time at Hasbro, we've accomplished more than I could have imagined. And I know this company has even more amazing accomplishments ahead of it. Thank you for your partnership and support of Hasbro all these years. It's a hard decision, but I am confident that Hasbro is in good hands. We are now happy to take your questions.

[Operator Instructions] Our first questions come from the line of Arpine Kocharyan with UBS.

So down 20% in the first half means that back half needs to be up mid-single digits for the year -- for the second half. I guess, what visibility do you have on that 5% to 6% growth in the second half? And does that include any assumption for a recession or not particularly sort of steady-state macro picture? And then I have a quick follow-up.

No worries. Yes. So we look at the first half, we look at a couple of different factors. The first is we see -- we saw a difficult Q4 in the consumer discretionary sector as a whole and in toys and games, in particular. We would anticipate that, that's going to continue in Q1 and Q2 and potentially roll into at least part of Q3 as well before starting to normalize in Q4 back to a more traditional growth level. So that's one set of headwinds that we factored in. The other one that we're looking at is 2021 had historically an unusual sales pattern with it. Retailers were buying much earlier in the year. We were playing catch-up from 2020, particularly in Q1, in terms of fulfilling orders, and we don't see that happening this time. Actually, we see retail inventory not unhealthy but still having a little bit of an overhang given the slowing consumer demand that we saw in Q4. So we see kind of demand starting to normalize, I think something like -- we were something like 57% of our sales for second half last year. And this year, we probably see that in the 60% to 65% range, which is more historically normal for 2019 and before. So that has something at play. And then we just look at our overall release calendar across Wizards of the Coast, across our entertainment segment and across consumer products. And we have a pretty exciting Q3 in terms of new products across all of them and a lot of entertainment that's going to be coming out in Q2 and having a nice kind of halo effect into Q3 and Q4. So that's kind of what informed our overall quarterly mix and half mix and some of the assumptions we made in it. Deb, do you have anything to add?

Yes. No, I would just agree, Chris. I think we see 2022 was a bit of an anomaly in the order pattern early in the year. And we do expect to get back to those historical shipment patterns. We think retailers will closer to the holiday season, that's typical, and we also see that in our business. And with all the entertainment, we're really excited.

Great. Arpine, you had a follow-up.

Yes. This is super helpful, perhaps partially answers my second question, but I'm still going to ask this because I've been getting a lot of feedback from investors as well on this sort of math. So I'm calculating about 5 percentage points of revenue headwind from just giving up the Disney Princess and Frozen license for the consumer product mix, plus you have about 3 points to 4 points of inventory overhang. And you're guiding to that segment, Consumer Products business, to be down mid-single digit. Could you just walk us through what is growing to offset that 4 points of overhang? I think you had a good rundown on some of the TRANSFORMERS stuff, obviously, D&D. And also while we are added, could you give us a sense where the D&D merchandise is going to be reported? Is this going to be -- is there anything in Consumer Products? Or all of that is going to be within the Wizard segment?

Yes. So I think as we've reported in the past, the average that we experienced over the last several years on Disney Princesses was about $250 million of revenue with the peak in around 2019 with blast Frozen movie. Last year, we were well off that peak as we were starting to exit that business and it transitioned to another company. So that would be how I would think about in modeling that. And then, yes, we see about $135 million of inventory overhang at retail. And then we have a little bit less than that in terms of inventory that we're holding on to as well. We think that will take the full year to kind of move through, but I think we'll move through a good hunk of that and our fair share in the first two quarters of the year. And then when we look at kind of what the growth vectors are, we have a strategy where we want to grow in five focus categories, and we have a plan for each of those categories. In outdoor action, which is helmed by NERF, we have an exciting lineup of new gel blasters that go after older consumers. We launched that in fall of last year, and the Mythic was our #1 item and I think one of the #1 items in the category after that launch. We're going to be building out that category. And then on the opposite side of the market for kids 5 to 7, we have an all-new lineup of NERF junior products. That expands the markets down to lower age ranges with greater economics and I think really strong consumer insights associated with that. And then we're also doing some fairly aggressive pricing actions to make sure that we have compelling products at every winning price point from $10 to $20 to $30 on up. On action, we have a very robust entertainment slate. Between six blockbuster films and a host of new streaming series and kids animation supporting it, it's fair to say, you could quote me, that I think we have a stack lineup. And that's going to help us in Q2. It's not going to fully offset some of the headwinds that we see in Q2, but it's going to help. And I think that's going to have dividends in Q3 and Q4. Then in creativity, PLAY-DOH was one of our top-performing growth brands last year. It grew share inside of the creativity space. We have new compounds. I think we have some best sellers that we're going to be annualizing this year and expanding distribution on. So we feel pretty good about where PLAY-DOH is going to go. On preschool, PEPPA PIG continues to be one of the top entertainment brands for little kids of any stripe and we continue to feel good about that product line. And our partnership in Disney has never been stronger. Spidey and His Amazing Friends was one of the top new properties in preschool. And we feel really bullish on Star Wars: Young Jedi Adventures. We think that's going to be an amazing show and a super compelling product line that will come out later this year. In games, when you look at our games portfolio, we feel pretty good about the innovation we have there. We just came back from Nuremberg Toy Fair, got great feedback on Twister Air, a really strong feedback on CLUE and kind of the balance of the line. So we're feeling good about the innovation there. And then certainly, Wizards of the Coast, continues to crank out really strong products. Phyrexia, our latest Phyrexia set is doing quite well out of the gates. Early on in Q1, Dominaria Remastered was our January set release and that sold very, very well. So we feel good about the fundamentals of MAGIC. D&D continues to grow at pace, and we have a fantastic entertainment lineup there and really starting to build out the four quadrant nature of our products across that lineup. And then we have several new products that we've talked about in certain toy fairs and with retailers that we haven't yet had a chance to announce yet, but I think people will be pretty pleased with those. And the retailer reaction that we're getting I think, indicates some incremental growth vectors that we'll talk about more later this year. Deb, anything to add?

Yes. I would just -- just to comment on the D&D. We will see some revenue coming through our Consumer Products division as well as Wizards of the Coast. And as I commented earlier, from an entertainment standpoint, based on when the movie is released and our share of the box office, we expect to see that later in the year, maybe some in the third quarter, probably more in the fourth quarter. And the cash that's associated with that will come really in 2024 in a meaningful way. But we're very excited about that release. So Arpine, that's the first thing you're going to see traveling through the Blueprint. And well, it's a great brand, and we're very excited, and we're looking forward to bringing more fans into this brand who can really enjoy it for years to come because it is a great brand that can be enjoyed by people of all ages.

Our next questions come from the line of Eric Handler with ROTH MKM.

First, with regards to Wizards of the Coast, do you expect MAGIC to grow in 2022? And then as we think about the cadence, I imagine it will look a little bit different than Consumer Products, I would think your toughest comp for MAGIC is in the fourth quarter, your easiest comp is in the third quarter. I'm not sure how to think about the first half of the year.

Sure. Eric, yes, I think the question was will it grow in 2023. It grew pretty well in 2022. Yes, we expect MAGIC to grow. I think the growth will be a bit moderated versus what we saw in prior years. We're taking some of the feedback to heart. We had some supply chain issues last year, which forced us to compress our release schedules, particularly in October of this year due to a couple of releases slipping from April and August into October along with our regularly scheduled releases. We're going to be spacing those out in a more even basis. We think we've got to handle on all the supply chain issues that we had with paper stock and local paper production. So that will change the nature of what our revenue distribution is by quarter. In general, I think we expect MAGIC and Wizards to have a good Q1. Q2 is actually our toughest comp of the year, and we think that will actually be down just given the nature of moving some releases around. Q3 should be a very strong quarter. And actually, we think Q4 will be a pretty solid quarter as well when you look across the Wizards business.

Great. And then just as a follow-up to that. When you look at MAGIC and the vectors for growth, you have a very full release slate, you pulled a lot of levers there. So is the growth for MAGIC now pretty much just predicated on expanding the player base? And what do you do to keep that player base growing?

Well, MAGIC is arguably one of our most innovative product and design teams. I would never discount their ability to figure out new ways to engage players and delight our fans. They've had a pretty good track record. We've grown that brand for 13 out of the last 14 years. And I think the one year, it was down, it was down maybe 2% or 3%. That was actually my first year on the business. We turned that around pretty significantly, I think, over the last five years. So as we think about growing MAGIC, we always think about, okay, how can we engage our existing players more, how can we find new fans and then how can we attract lapsed fans. And I think that's going to be the magic formula for this year as well. I think we have some exciting new initiatives. I think one of -- the one I'm most looking forward to, and I think we've seen some early success is Universes Beyond. Our Warhammer set that we released in October of last year, we couldn't keep in stock. That's on its third reprint. It's doing very, very well. I think our hobby shops and our retail partners are thrilled by it. And as big of an IP as Warhammer is, we're going to be going out with the OG of fantasy with Lord of the Rings come this June. We think that's a big fan base. It's a very ripe adjacency for MAGIC: THE GATHERING. And we think it's a great opportunity for Lord of The Rings to introduce them to our fan base and help kind of grow their business. And an awesome opportunity to introduce Lord of the Rings fans who love Fantasy into a deep strategic game like MAGIC. So I think that will be both an opportunity to attract new fans and also add some collector surprises as well for our existing fans.

Our next questions come from the line of Megan Alexander with JPMorgan.

Maybe just ask Arpine's question in a little bit of a different way. So is the $300 million that you cited in brand exits and market exits, is that all in Consumer Products? And if so, the excess inventory and that $300 million would represent a 12-point headwind which would suggest you expect core growth maybe in that high single-digit range in the context of the overall consumer products guide. So first, is that right? And then if so, can you maybe tell us how that compares to what those brands the core brands did in 2022? And what drives your expectation for such strong share gains relative to your expectation for the industry to be flat to down?

Sure. Megan, good talking with you. If you -- in our investor deck, we have a waterfall, which walks through our expectations of $300 million of headwinds in the -- on the slide that says 2023 outlook, just in case you want to take a look at it after the call. We do see that $300 million headwind spread across business, but it is concentrated in Consumer Products. We're exiting several rather significant licenses this year like Disney Princesses and Sesame Street and Trolls. Those were pretty low margin businesses for us. Frankly, they were negative margin businesses for us in aggregate, but it does have a top line effect. We've transitioned several of our in-house brands like EASY-BAKE Oven, Littlest Pet Shop into an out-licensing model. So we think that will be accretive on a bottom line basis, but it will impact our top line because some of those brands drive meaningful revenue. And we'd likely have a few more planned that we have yet to announce. FX is certainly a continued headwind that we're anticipating certainly in the first half of the year, more notably than the second half as we comp FX, and that will affect all of our businesses. But CP tends to be our most internationally exposed. We exited a couple of entertainment businesses last year. One that's called secret location, had meaningful top line, not so meaningful bottom line, that was a location-based business, and then a couple of digital businesses and also some theatrical distribution that will impact entertainment. And then, of course, Russia, we exited Russia in March of last year. And so that comp will be most difficult in Q1. So when we add all that together, it adds up to about $300 million of total revenue headwinds. We see about 60% of that hitting in the first half of the year and the balance in the second half. But then when we look at kind of like our release calendar for entertainment, for Wizards and for our Consumer Products business, we look at kind of the retail promotions we have lined up, the feedback we're getting and the volumetric testing that we're doing on the items because we've expanded that basically threefold this year versus what we did for 2022, we feel like the second half of the year, when you combine that with what we anticipate will be improving macroeconomic conditions, should yield the growth that we have projected.

Okay. And maybe a follow-up for Deb. When you look at the expected margin improvement, can you just talk through some of the puts and takes? It seems like from what you said, you should have SG&A deleverage, advertising, deleverage, so the improvements coming mostly from cost of sales and royalties? And can you maybe give any more color on the phasing or timing of that improvement considering the retail overhang and your owned inventory being a bit higher?

Right, of course. And you actually have hit it. I mean we're spending more on advertising, and we're making it much more focused. And again, if you look at Blueprint 2.0 and our focus on the consumer, you'll see more of that spend clearly against the consumer as we go forward. In 2022, we had a significant amount of sales allowances, and we talked about that in our prepared remarks. And we had a significant amount of closeouts. We do have some additional inventory. We'll be looking at closing out over the course of this year. That's built into our assumptions. We have that every year. And our inventory build, if we look at it, a big piece of it was preparing for the early releases of MAGIC: THE GATHERING and making sure we have paper on stock to print because that was in shortage -- short supply last year. . So as we look at that, the closeouts that are in our own inventory, we see sending -- selling those out at the right time for both us and for retailers to maximize the profit on that. So you see the impact on our gross margin won't be as significant as it was in 2022 and all of the sales allowances. I mean it was important for us to reduce our inventory on hand at retail from where it's at in the third quarter. And we did have a lot of sales allowances in 2022 associated with that. So when you look at the reduction in sales allowances, you look at maximizing our closeouts go forward and, honestly, our cost savings. And we have a slide on this as well in our presentation. I think it's on Page 24. We continue to expect a very large percentage of our cost savings initiatives as part of our Operational Excellence program to come out of our cost of sales line. So it's -- that’s the piece that -- and I'm sorry, I apologize if we're getting some feedback. It seems to be me. That's not -- that gets -- it gets a fuzzy sound, but that's okay. As we look at that, we do see a significant portion of our cost savings coming out of our cost of sales line. So we expect cost of sales to be much more normalized as a percent of revenue in 2023 than we did in 2022 because of all those actions we took to make sure that we are being better positioned for 2023 as well as retail.

Okay. So just to put a fine point on that, it doesn't sound like you -- the profit improvement is as heavily weighted to the second half as the revenue is. Is that fair?

I think the challenge -- we expect to get the profit improvement throughout the year. I will say, based on some of the actions we've taken in connection with our Operational Excellence program, you will see more of the savings in the back half of the year. And that was really the comment we were trying to make on SG&A and admin. We'll see that impact in product development and in SG&A. However, we do have some headwinds in those lines, too. Overall, the first half of the year is a smaller part of the year for us. So the impacts are a bit greater when you look at the overall revenue.

Our next questions come from the line of Gerrick Johnson with BMO Capital Markets.

I wanted to pick apart the $300 million revenue headwind just a little bit more. In particular, the brands that you're out-licensing to other toy partners. What portion of that $300 million is that? Because I thought you said on your Analyst Day that it will be about $250 million to $300 million or somewhere in that range or $200 million to $250 million maybe. So what will it be this year of that $300 million?

Of the $300 million this year, it would be slightly -- it would be -- maybe about -- it will be less than 1/3. Think about the timing of it. So we said, over time, we expect that revenue to be about $250 million. You're 100% right. If I look at that impact from '21, it would be about $100 million. This year, it would be -- from 2022, it would be less than that. And the reason why is we're providing an orderly transition to a license model. That's what's helping our operating profit as well. So we are losing revenue on that. We still will have some in 2022, but you'll see us transition out of that over time, and it will be a lower revenue number but a more profitable revenue number for us.

For instance, FurReal would be a handoff throughout the year.

Right.

Sorry, what was that, Chris?

For instance, Fur Real Friends would be a handoff that would happen throughout the year and a couple of the ones that we haven't announced yet would be a handoff throughout the year with the full transition by 2024.

Right, right. It's going to take them a little while. I got it. Okay. Then my second question would be on the inventory number, the $676 million of inventory. Also your channel inventory why couldn't you be more aggressive in liquidating your owned inventory? Why couldn't you be more aggressive in in-store promotions to get rid of the inventory at retail? It just didn't seem like you were very aggressive in in-store promotions.

Well, we can. I think it's just a choice of how do we maximize the asset and maximize the returns for it. So our view is by being a bit more parsimonious about how we dole it out quarter-over-quarter, we'll be able to maximize the margin return that we have on the inventory.

Our next questions come from the line of Jamie Katz with Morningstar.

I have a couple of clarifications actually. I think during the prepared comments, you guys had noted that Q4 POS turns had slowed, but I don't know if you delineated whether that meant they went negative or if they were still positive at retail. So would you be able to clarify that?

Yes. Our POS was down in toys and games last year by the mid-teens kind of mark overall, which was slower than what we saw for the balance of the year. So that's kind of where that comment was generated. Wizards of the Coast saw strong turns, but that's not captured in our POS tracking, at least the public POS tracking. And our direct business and our licensors saw healthy gains as well.

Okay. And then I think there was a comment that EBIT could be higher than 20%. And I want to make sure that's not contingent on the sale or divestiture of that entertainment business that, that comment was made sort of as the business as is. But theoretically, if you guys did divest that entertainment business, that cost structure or profit structure would actually have more upside opportunity if I'm thinking about that right.

Yes. So I think all of our forward guidance is on an as-is basis, where it's assumed that entertainment stays with us. Now obviously, we're in a sales process, and that's pretty far advanced. So we feel like, by midyear, we'll be able to have a significant update on where we see that going. The comment that Deb made was we're still targeting 2027 for a 20% operating profit margin. We might be able to beat that by a couple of quarters. But right now, we're maintaining 2027 as a target. Assuming a sale happens as the majority of the noncore TV and film assets, I think we could accelerate that target quite significantly.

Our next questions come from the line of Linda Bolton-Weiser with D.A. Davidson.

I got on a little bit late. So sorry if like I missed this. But I think the thing that was surprising the most about the fourth quarter results we all understand what was going on with toys. But the miss on the entertainment revenue, to me, that's something that was projectable because you have deliveries, et cetera. So can you -- sorry, again, if I missed it, but what are the key reasons that you had trouble projecting what the revenue would be for entertainment in the fourth quarter?

No problem. Linda, thanks for joining the call. for entertainment, it really just had to do with timing of deliveries that our partners, our network partners wanted. And to a certain degree, we're a vendor working on their behalf, and they have a fair degree of flexibility about when they'll accept deliveries on products. We had assumptions that we would be able to achieve by end of December some of these deliveries. And some of them got moved out not just by a couple of weeks but by several quarters as they're managing their own P&Ls. And so that's what really drove the material difference.

Okay. And then just -- there's just so many things going on here in 2023. But if you had to just boil it down to maybe the one or two key things that you have to execute in order to drive the top line and then the same question on the margin performance, like what would be the key thing in your mind out of all these different things you need to do are the most critical to succeed at?

Well, I think on the top line, when you're looking at a market that's flat to potentially down for a year, it's a share gain. So we need to execute against our five focus categories and deliver the right pricing, the right promotion at retail and make sure we get our product in there and well assorted. We missed our marks on that in 2022 in too many areas. We grew in 2. We grew in creativity and preschool, but we need to grow more fulsomely across all of them. . And so when we look at our product road map, when we look at the quantitative testing we've been doing and we look at the promotions we have in place, both pricing as well as what we're doing just to drive kind of availability of product, we feel better positioned for that for 2023. I think the second thing we have to do to drive the top line is responsibly manage down our inventory. And we'll be doing a good hunk of that in Q1 and Q2, but I think that also gets back to your bottom line question, which is, hey, we need to do that responsibly and not just make a fire sale because that's not going to help our bottom line and ultimately not help our capacity to be able to fund our growth initiatives. And then the last thing I think you really need to look at for bottom line, last two things, internally, this wouldn't be as available to you, but it's a big area of focus for us. It's making sure we have really robust demand planning and supply chain management in place. I feel really good about the team that we're building around that, but that's going to be something that we need to improve our marks on and then driving our savings goals. We have $150 million gross savings goal for this year. We'll be reporting on that every quarter in terms of progress. And that's going to be a meaningful bucket of money that will drive both bottom line performance and help to fund increases in our advertising and promotion budget and our ability to be price competitive.

Our next questions come from the line of Jason Haas with Bank of America.

I had one follow-up on -- I think the question was asked on the cadence of Wizards of the Coast segment revenue. I think you said -- or I think the guidance is for mid-single-digit revenue. It sounds like, last year, there were some releases that got pushed to the second half of the year. So I was just curious is the expectation that Wizards will again have sort of a back half weighted year? Or is that mid-single digits is sort of a fair run rate to use in each of the quarters? Just trying to get a sense of the cadence there.

Yes. So on Wizards of the Coast and MAGIC in particular, as I talked in Eric's question, I think you should expect in up Q1 down Q2, a significant up Q3 and then a fair up in Q4. And that's just based on release timing. Last year, we had an April release that had to push by about six months into October, and we had an August release that had to push about two months into October. We don't feel like we're going to have that issue again. We feel like we're pretty well ahead of our supply chain issues, and the capacity of our vendors is pretty good. But that's generally how I think about it. Wizards doesn't have the seasonality of the overall Consumer Products business. It's more release-driven. So that's how I would look at it. MAGIC is going to be a pretty big component of their revenue for this year. The other thing I'd note -- the only other thing I'd note is there is quite a big D&D component that will happen in Q3 and Q4 with the release of Baldur's Gate 3. Even though that's a licensed product, it's a pretty -- we have fair sized expectations about what that product is going to do. It was one of the most successful early access products in history on Steam. And that will have meaningful revenue impact starting in Q3 and even more so in Q4 for D&D.

That's helpful. And then you mentioned -- I think you described it as a misfiring on some of the proposed changes for the OGL. Was there any sort of financial impact to that in the first quarter? I think that, I guess, the controversy is kind of behind us at this point, but just curious if there's anything to look out for in 1Q.

Yes. I mean we had some subscription cancellations, but they were comparatively minor in the totality of both the D&D P&L and the Wizards P&L. Of course, we take anything like that seriously. We're in contact with the people who canceled. And in general, what we're finding is a lot of them are very open to restarting their subscriptions. D&D Beyond is a great platform. It's a really good value. And it's something that's been a good growth vector for us. We find it -- we feel about eight months into owning the asset, it's been a really good purchase for us. It was EPS accretive within six months of joining the company. And we had over 20% user growth through the end of 2022, and the revenue growth was roughly commensurate with the user growth as well. So I think D&D should be on pace for a healthy 2023 with everything we have going on. .

Our next questions come from the line of Matthew Catton with Jefferies.

The only question that I have left would be around -- you talked about some of the impacts of D&D Beyond being fully in the model for 2023 as well as the impact in the back half from Baldur's Gate. But is there any initiatives to maybe jump start revenue again within MAGIC: THE GATHERING Arena on mobile and PC during 2023? Or are some of those initiatives further out in the out years?

Matt, thanks for joining. Yes, I think the biggest thing on arena is going to be the release on Steam in, I think, we're targeting Q3. the reason for the time line to get to Q3 is we're reinventing what the new player experience is as we start to expand that so that it's an easier onboarding and a more fun way to learn how to play what is a super deep but can be a difficult learning curve game. . So we think Steam is going to help open up the game to more users. Obviously, we think there will be some decent revenue growth associated with that. Over the midterm, we continue to evaluate consoles, particularly Xbox and PlayStation platforms. And I think that will be an interesting opportunity for us but likely in 2024 and beyond. And then we continue to invest in figuring out new ways in which we can express MAGIC digitally. I mean if you think about the success of MAGIC over the last five years, the success really has been driving like this, what we call, a segmentation strategy where we are offering bespoke products to new segments of consumers that we either were underserving before or not serving it all before. And there's formats like Commander, which is a four-player version of the game that's highly social. I'm enthused, as I know Cynthia and the team is, figuring out how we can get like a true multiplayer experience beyond two players for MAGIC digitally. And then I think we're still intrigued by digital collectibility. I don't think you'll find us kind of going after the passing fad at the minute. But we do think digital collectibility is going to be a thing, and it's going to stick. And so we continue to invest R&D about what the right approach is for that, whether doing it ourselves or doing it through a partner.

We have reached the end of our question-and-answer session. I would now like to hand the call back over to Debbie Hancock for any closing comments.

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

Thank you. That does conclude today's teleconference. We appreciate your participation. You may disconnect your lines at this time. Enjoy the rest of your day.