Spin Master Corp. (TOY) Earnings Call Transcript & Summary

Good morning. My name is James, and I will be your conference operator today. At this time, I'd like to welcome everyone to Spin Master's Updates 2019 Full Year Outlook Conference Call. [Operator Instructions] Thank you. Sophia Bisoukis, you may begin your conference.

Thank you, James. Good morning, everybody. I'm joined this morning by Ronnen Harary, Co-Chief Executive Officer; and Mark Segal, Chief Financial Officer of Spin Master. Ben Gadbois is away and is unable to participate in the call today. This morning, we issued a press release in connection with updating our 2019 outlook and have invited you to this call to provide further context to the extent that we are able. The press release issued this morning is available on the Investor Relations section of our website at spinmaster.com and on SEDAR. Please note that we are not issuing our 2019 Q4 or 2019 full year results nor our outlook for 2020 today. The MD&A and audited financial statements for the fourth quarter, full year 2019 will be published on March 4, 2020. Given that we are not issuing our Q4 and full year 2019 results, we will, unfortunately, have to limit the nature of the responses we can provide in the Q&A. Before we begin, please note that remarks on this conference call may contain forward-looking statements about Spin Master's current and future plans, expectations, intentions, results, levels of activity, performance, goals or achievements and any other further future events or developments. Forward-looking statements are based on the information currently available to management and on estimates and assumptions made based on factors that management believes are appropriate and reasonable in the circumstances. However, there can be no assurance that such estimates and assumptions will prove to be correct. Many factors could cause actual results to differ materially from those expressed or implied by the forward-looking statements. As a result, Spin Master cannot guarantee that any forward-looking statements will materialize, and you are cautioned not to place undue reliance on these forward-looking statements. Except as may be required by law, Spin Master has no obligation to update or revise any forward-looking statements whether because of new information, future events or otherwise. For additional information on these assumptions and risks, please consult the cautionary statements regarding forward-looking information contained in the update outlook -- that update dated today, January 21, 2020. Please note that Spin Master reports in U.S. dollars and all dollar amounts to be expressed today are in U.S. currency. I would now like to turn the conference call over to Ronnen.

Thanks, Sophia. Good morning, and thanks for joining us on the call today, especially on such short notice. As we addressed in the press release we issued this morning, our overall performance in the fourth quarter and for 2019 as a whole was disappointing relative to our outlook in early November. Despite the solid performance of several of our brands and franchises, we were unable to fully offset the year-over-year decline in Hatchimals sales. Furthermore, we did not execute at the level we needed in order to meet our profitability targets. More on this later. The traditional toy and games industry, representing an approximately $80 billion-plus global market, is stable and growing at a compound growth rate of approximately 4% to 5% a year. In the last few years, the U.S. market, however, has faced challenges that have created disruption. In 2019, various industry reports indicate that the U.S. toy industry contracted at least between 2% to 4%. We have had a major retailer, Toys"R"Us, exit the market in 2018. And in response, volume has been redistributed to new customers and channels, creating challenges in order patterns and distribution requirements. The growth of the trend towards online purchasing away from brick-and-mortar has continued to accelerate. The content landscape has continued to shift from traditional linear models to SVOD, AVOD and digital mobile platforms. All of this has occurred in a political environment characterized by trade tensions between the U.S. and China and the risk of U.S. tariffs. Fortunately, these tariffs were deferred in December for the foreseeable future. So what affected us in 2019 that drove our disappointing performance? Some of these are macro factors and others are specific to Spin Master: our decision in 2019 to manage our portfolio of brands more tightly using domestic replenishments; the evolving retailer trend away from direct import orders towards domestic orders due to the demise of Toys"R"Us, which created congestion in retailer supply chains; the threat of U.S. tariffs and our increased inventory levels arising from our decision to bring in inventory earlier to avoid U.S. tariffs; increased online purchases that drove more just-in-time shipments and buying later in the season than we have seen before. All these factors above were greatly exacerbated by the establishment of our new DC on the East Coast, together with the consolidation of 4 existing warehouses inherited under the Gund, Cardinal and Swimways acquisitions into this new East Coast DC at the beginning of Q3. This was a major reason behind the significant disruption and congestion that occurred in our U.S. supply chain. I want to tell you that this was a major error in judgment. We should not have undertaken this project -- we should not have undertaken a project of this nature at this point in time just as we entered our seasonal shipping peak. Our supply chain has become more complex, the macro environment has become more complex and our desire to drive efficiencies and cost savings in the midst of this was aggressive and potentially misguided. When you mix everything together, we had a failure in our supply chain and logistics areas. Additionally, as you know, our international growth strategy has included the opening of offices in Australia; Central, Eastern Europe; Germany; Austria; and Switzerland; and Russia. These issues were not isolated to one geography. Our plan to diversify sourcing away from China accelerated this year due to the U.S.-China trade disputes. Although new factories in Vietnam, India and Mexico will drive cost savings in the near future, we incurred additional cost and disruption this year as we expedited the changes. The integration of Gund, Cardinal, LA Games and Swimways into one office in New York City was also undertaken in 2019. When you take everything into account, these factors all combined together to put substantial pressure on our back-end systems, processes and people that culminated in the results that we released this morning. If we stand back for a moment and look at the big picture for Spin Master, our strategy is designed to achieve long-term growth. Our team remains diligently focused on successfully executing against our growth pillars. Despite an ever-evolving toy and content consumption landscape, we remain focused on the execution of our long-term plan. As a result, the strength, diversity and depth of our innovative brand and entertainment franchise portfolio give us confidence in delivering our long-term growth targets. This was evident in 2019 as we grew the business 16%, excluding the significant decline in Hatchimals from 2018 to 2019. At the core of Spin Master is our ability to create engaging kid storytelling for multi-platform consumption. Through the success of our properties such as PAW Patrol and others, we have proven that creating evergreen, compelling and engaging kids content and combining that with retail initiatives, such as toys, helps optimize brand equity and, in turn, drives higher growth, alternative revenue streams from licensing and merchandising and higher margins. This allows us to diversify and build broader, reoccurring revenue streams across our toy, entertainment content and mobile digital direct-to-consumer markets. We continue to remain focused on the execution of our long-term strategy. The problems that we have experienced in 2019 are solvable, and we intend to solve them sooner rather than later. We will keep you updated on how we are doing on a quarterly basis in this regard. As we look forward to 2020 and beyond, the strength, diversity and depth of our innovative brands, entertainment franchises and mobile digital portfolio, along with our track record of successful innovation, gives us confidence in delivering our long-term organic growth product sales growth target of mid to high single digits. To conclude, I want to personally apologize for our performance in 2019. We let ourselves, our customers, consumers and our shareholders down. This performance is not what we built Spin Master on. And again, we are sorry for this. With that, I will pass it to Mark.

Thanks, Ronnen, and good morning. I just want to ask you to excuse me up front for the cough and cold that I have. So I will try and do my best to get through these remarks. As we mentioned in Q3, our performance remained strong through October, driving orders and shipments to date, ahead of where we were at the same time last year on an October year-to-date basis. At that time, we had orders and shipments that made up a decline of 8% in Q3 year-to-date gross product sales. However, as we reiterated at that time, we still needed to perform well during the order replenishment cycle in November and December to achieve our low single-digit gross product sales outlook for the year. Although we started the fourth quarter with positive momentum based on the progress we had made in October with both orders and shipments off to a strong start, order levels, shipments, and in particular, our operational performance in November and December were considerably below our expectations. As a result, 2019 gross product sales were down approximately 1% compared to last year. On a currency-adjusted basis, however, 2019 gross product sales were flat year-over-year. Excluding sales of Hatchimal products, which declined over $230 million year-over-year, gross product sales for 2019 rose approximately 16% over 2018, led by the strong performance of the Boys Action and High-Tech Construction business segment. The decrease in gross product sales was driven by a decline in gross product sales in the U.S. caused by industry-wide softness of toy sales during the shortened 2019 U.S. holiday shopping season and operational performance challenges primarily related to the consolidation of our new East Coast DC that Ronnen just described. Let me give you a little bit more color on the issues that affected us in 2019. We have evolved toward a more domestic replenishment model to ensure our collectible product lines, such as Bakugan and Monster Jam, which were a big part of our business in 2019, remain fresh on shelf. This strategy gives us more control to ensure that we have the right product mix on the shelf at the right time. During 2020, we will carefully evaluate what the right FOB versus domestic mix is to the business. The absence of Toys"R"Us in 2019 had an important underlying effect on the industry this year. TRU was a large direct import or FOB Asia buyer and purchased most of their goods early for the full season in Q3. This shifted volume more domestically and added to the pressure on industry supply chains, including ours. Also, with an ever-growing e-commerce penetration, retailers' order lead times have narrowed, shifting the buying patterns closer to the holiday season in Q4, which reduces the potential replenishment cycle. The on again, off again, on again but less items news on tariffs on List 4 items including toys was only resolved very late in 2019 and was very disruptive to our and the industry supply chain. At times, we saw some retailers facing stretched domestic warehouse capacity issues as they have also employed mitigation strategies on unrelated List 1 to 3 tariff product lines. This situation caused a degree of uncertainty in retail order patterns as retailers shifted orders in anticipation of the tariff implementation, which then put pressure on our supply chain as we brought in inventory earlier and domestically in order to avoid tariffs. With long lead times from Asia, we could not flex as quickly as the news unfolded. And as a result, we tried to maintain a measured approach while, at the same time, continuing to diversify production outside of China. As we discussed in Q2 and Q3, we established an East Coast DC to serve our customers better and, at the same time, consolidated Gund, Cardinal and Swimways warehouses into the new DC. This was disruptive to our third and fourth quarter shipment flow. For the reasons described above, these factors combined to affect us negatively in a number of areas. We lost a considerable amount of sales that we could otherwise have shipped on the solidly performing parts of our portfolio. We incurred fines and penalties for late shipments, which increased sales allowances and reduced our gross margin. We were required to increase the levels of promotional spending as customers shopped later and in order to ensure we kept retail inventories as low as possible at the year-end, again, which increased sales allowances and reduced our gross margin. As a result, sales allowances as a percentage of gross product sales in 2019 was significantly higher for the year compared to last year. We also incurred significantly higher-than-normal freight, warehousing and distribution costs in order to get deliveries to customers due to delayed shipments, the movement of goods between warehouses and much increased inventory storage costs. We also undertook higher levels of lower-margin closeout sales to reduce inventory in our warehouses on those lines which were not performing and which we did not want to carry forward into 2020. In addition, variable selling expenses increased as the mix of licensed products, including Monster Jam, Bakugan and How to Train Your Dragon, increased, resulting in higher variable royalties. As you might expect, lower gross product sales, higher warehousing and distribution, higher promotional spending, higher selling expenses and deleveraging of fixed operating costs combined to reduce adjusted EBITDA margin. Our adjusted EBITDA margin for 2019 was approximately 14% compared to 18.6% last year. Previous guidance provided on November 3 was for adjusted EBITDA margin to be slightly below those achieved in 2018. Please note that actual results will depend on some factors that have not yet been finalized. Decisive management actions are currently underway to rectify our issues, and we intend to improve execution going forward with a strong focus on cost management, operational efficiency and productivity initiatives. We believe we are better positioned for 2020 and look forward to discussing our outlook when we release our audited fourth quarter and 2019 results. To conclude, we remain committed to our growth strategies and long-term financial framework, which targets organic gross product sales growth of mid to high single digits. While we acknowledge the short-term uncertainty caused by the various factors which affected 2019, Spin Master's solid track record of innovation and generating growth, backed by a diverse portfolio and very healthy balance sheet gives us a strong position to take advantage of growth opportunities. Ronnen and I are now pleased to take a few questions. Please note that as Sophia mentioned, given that we are not issuing our Q4 and full year 2019 results, we will have to limit the nature of the responses we can provide in the Q&A. Operator, please open the line.

[Operator Instructions] And our first question comes from the line of Sabahat Khan from RBC Capital Markets.

Of the factors that you outlined for the margin hit during Q4, can you maybe break out or quantify the contribution from the discounting versus the DC issues? And then the follow-up, I guess, with the DC issues, would you -- where would you be in sort of resolving those as you head into 2020?

Okay, Sabahat. Thank you. I don't want to be actually too specific on numbers, but I can tell you that the warehousing and distribution and gross margin impact was roughly equivalent in size to the sales allowance impact if you actually look in dollar terms year-over-year. And those 2 items together comprised a big chunk of the year-over-year EBITDA miss that we had. So those were the 2 most significant items by far. And then obviously, there's an impact on profitability of the sales miss as well, but that was much smaller than the 2 that I just described above. In terms of resolving the issues, Ronnen, could you...

Just in terms of -- Saba, we are extremely focused on resolving these issues. We jumped into them for the last 45 days, 60 days very intensely, and we're very focused on resolving everything. We will be giving you guys more updates in March quarterly, but I can just assure you that there is a 110% focus on resolving these issues. The last thing we want as a company is to miss sales, which is what we classify as a sin, missing sales. We had an opportunity to ship more product in 2019, which we weren't able to do and obviously lost the margin from those dollars. And we're very, very focused on resolving the issues ASAP.

Our next question comes from the line of Derek Dley from Canaccord Genuity.

And just one for me. Just in terms of the cadence in terms of sales shifting from Q3 into Q4, which we -- based on your guidance, implies that we did see that. We did see a pickup of your percentage of sales in Q4 versus what we've seen historically. Is that something you expect to continue given your commentary on sort of shorter lead times from many of the smaller retailers and not having Toys"R"Us in the mix anymore?

Yes. So the underlying secular trends that we described in Q3, Derek, are still prevalent. We still do anticipate a shift from Q3 to Q4. I think you will actually see when we release our results that Q4 was actually up, and it would have been up significantly more had we not had the operational challenges that we both just described. So I think that point is still intact. And as I said and as Ronnen just said, again, we would have had -- we would have hit our guidance numbers that we issued in Q3 had we not had our operational challenges, and you would have seen that shift from Q3 to Q4 being more pronounced than it actually was.

Okay. And I guess just following up in terms of the operational challenges. I mean that comment to me implies that you had the view that you'd be able to rectify these operational challenges quite quickly given, I think, your call was early November. So is that how we should think about your ability to rectify the situation heading into Q1, it should still be pretty rapid?

Yes. I mean we -- I think we made a strategic judgment error, where we consolidated all our warehouses into one big East Coast warehouse. We've put in Cardinal, Swimways, Gund, everything into this warehouse, and we did it in the third quarter, which with hindsight should have been done in the first quarter. So when you take that and you compound that with all the macro issues that the industry was facing and changing in terms of changing order patterns and tariffs and stuff like that, it did not put us in a good situation to execute at the level that we wanted to execute on. So going into first and second quarter, we're very focused on taking all the pain and the learnings from the third, fourth quarter and smoothing out the order patterns and supply chain in the first and second quarter and obviously to be ready for the big third, fourth quarter of next year.

Your next question comes from the line of Steph Wissink with Jefferies.

I wanted to just follow up, Mark, on one comment you made on inventory just to make sure we're understanding that your channel inventory and your own inventory at the end of the year are clean based on the actions that you took to rectify some of the excess.

So I would say to you we undertook a lot of promotional spending, Steph, in the fourth quarter to ensure that retail inventories were as clean as they possibly could be. I would say from warehouse in our -- sorry, from inventory in our warehouse, we did the same thing with closeout sales. I would not say to you that at the warehouse level, we are fully satisfied with where we landed up. We are still seeing much higher inventory in -- at the end of the year in our warehouse relative to what we had in 2018. I think at retail, we're okay. But in our warehouse, we still have some inventory levels that we are not happy with. So we are carrying more into 2020 than we would like to.

Okay. Then just a follow-up on the ex Hatchimals being up mid-teens. It's quite impressive you'd still be able to grow your underlying business at that pace. Can you just give us a couple of highlights on what you found worked well in the category even the headline being a bit weaker? But just looking at your underlying business, what were you most proud of in the quarter?

Yes. I think that Bakugan was delivering for the company and was building as the year went on, which is very nice to see. Things like Monster Jam, consistently building. I think we had the best year that Monster Jam as a licensor has had in many, many years. Things like Kinetic Sand were very strong for the company. The RC part of the business, which in previous years was down, really performed. They've done an incredible job transitioning away from just basic flight commodity products into really innovative flying products. And when you looked at -- and then also the big monster truck, $100 Monster Jam, RC was a sellout. So I think that a lot of other areas of the business really pulled. So it was across the portfolio, which was nice. It really got spread out. It wasn't one runaway Hatchimals-type success that made up that drop of Hatchimals.

But Steph, I think it's an important point that you raise here because I think when you actually realize that we're comping a negative comp of over $230 million, we still grew 16%. Outside of that, I think it's -- I think it goes to our brand innovation pipeline. It goes to the way we have tried to diversify our business. And so I think it is an important point for everyone.

Our next question comes from the line of Adam Shine with National Bank Financial.

Ronnen, just going back to the dynamics around this East Coast DC. When we reflect on some of the comments made during Q3, obviously acknowledged some issues that undermined the performance in the Q3, presumption was that some degree of resolution to that was at hand going into the Q4. Was it just the amount of product that was coming through that just choked you guys? Were there other things that materialized? It seemed as if there was either a compounding of issues or -- I don't know what further undermined the Q4 versus the Q3. You would have thought that some lessons would have been learned in the prior period.

Yes. No, for sure. I think we underestimated the capabilities, okay, of the warehouse and our setup of the warehouse to be able to handle the volumes that we were looking at. And when you just looked at the shift of volumes, October -- traditional October became November and December. So those really big months, we did not -- I don't think we tested the strength and structure and underlying capabilities of that warehouse to handle that type of volume. I think we had a bit of hubris. We were gunning for consolidation, cost savings, integration, all these things in the midst of all these macro factors. And again, I reiterate it was -- with hindsight, it was a mistake. But to answer your question, we saw -- when we spoke to you guys on the phone, we saw early signs of challenges happening in the warehouse, but we thought that they were resolvable. We didn't realize that the structure there was not -- the underlying structure was not as strong as it needed to be. And so it really -- it caught us all by surprise. And then it became an all-hands-on-deck situation to resolve the situation and actually ship all the product out and get the products to the customers. And for us, first and foremost is delivering the products to the customers and keeping our promises and delivering to the consumers because we make promises to the consumers through our marketing. So we had to stand behind everything and incur a lot of costs to actually keep our commitments, which is the most important thing. So I'm proud of the fact that we kept our commitments because that's exactly what our company does. So -- but it costs a lot of money to keep those commitments. And it was a judgment error. It was really a judgment error on our part.

Well, maybe just a follow-up for you and then one after for Mark. We've looked at the post Toys"R"Us dynamic as a sort of 2-year dislocation period, the presumption being that, and you guys have said this, a cleaner year ahead in 2020 was to be expected. I think we're now talking about some work that you guys have to do, albeit in a seasonally lighter period in the first half of the year. But how should we think about 2020? And I'm not asking for guidance. I'm just thinking, is 2020 yet another transitionary year for the industry or perhaps more specifically for you guys? How would you characterize it?

Well, I would say like this. I think that -- I think we have done a lot of things in the last 24 months to adapt to this environment, first starting with our factory diversification in Asia and then with the consolidation into these warehouses and with the acquisitions. So I think that from a Spin Master perspective, there's a lot of learnings -- and not only learnings, but we're actually -- we've done a lot of things. And I would say that we are -- a lot of them are under our belt. And I would say a lot of them are -- they are -- a lot of them are actually -- we've -- a lot of them are underhand. And I'd say from a macro perspective I think that the industry after 2 years has adjusted to everything, and it's continuing to adjust. And I think this is the new reality that we're living in. What we described to you today in terms of all these issues, this is the new reality. And I think that we've adjusted, and we will continue to adjust to it and run the company to match with that environment. That's what we do, and that's what we've done for 25 years. We've always adjusted. I think that this year, we had to just adjust with a lot more variables at play and also take into account some other variables in terms of our own product line shifting and changing and a lot of learnings in terms of the integration of the acquisitions. So there's going to be a huge amount of focus, just the same way we have an incredible amount of focus on our 36-month brand innovation pipeline. And as you can see, that's doing well and everything is very focused on that side of the business, the same type of rigor and focus and attention will be paid on this part of the business to make sure that we've adjusted to this new environment. So to answer your question -- I gave you a long short answer, but the -- I think this is the new normal. I think online patterns, shopping is the new normal. I don't believe that we're going to see any more tariffs issues. That's personally my personal opinion. But I think the consumer buying later in the season, domestic replenishment and understanding how to supply consumers on domestic replenishment basis is the new reality. And we are adjusted and we're ready for that reality. Mark, anything else you want to add?

No.

Adam, did you have a follow-up?

Yes. Yes, maybe just 2 questions for you, Mark. I mean, one, is your intention to give 2020 guidance? I know you alluded to it earlier, but just curious if indeed that's going to happen. And second, as we look for the stock to obviously take a check backwards and acknowledging that you guys have a lot of work to do internally, and that's not to say you can't walk and chew gum at the same time in regards to doing M&A, but we've not seen much in the way of material M&A, do we start to anticipate a buyback being instituted or at least food for thought being considered at the Board level?

Okay. So 2020 guidance, yes, we intend to provide guidance. If you remember, our cycle for guidance or outlook is to give preliminary guidance in March, which we'll do. We'll update that in May based on our Q1 results. We'll then do the same in August on our Q2 and then Q3, as we did last year. So just given what has happened in 2019, my view at least is that we need to, and we should, be providing you and the market with as much information as we can to help us evaluate our performance and our stock. So we will continue to do that. Regarding M&A, I think we actually talked about it quite a bit at the end of Q3. We have seen stretched valuations. We have a very strong balance sheet. We still generate strong cash flow. And we continue to look at M&A as a prime growth driver. I think we do need to pause and look at how we executed some of the M&A that we've done in the past in relation to the integration that we just talked about now. I would say to you we have made some mistakes in the past, but that doesn't change the underlying thesis or the strategy, and we're going to continue to look at that. I don't believe and we're not announcing any buyback or any nature -- any capital structure -- a strategy like that at this time. If we're sitting here in another year, we'll reflect again and figure out how that works, but I think we're still driving forward with M&A, I think, with a slightly more intelligent and jaundiced view of how to integrate.

[Operator Instructions] Our next question comes from the line of Brian Morrison with TD Securities.

Mark, just going back to the elevated merchandise level at the warehouse. What's the plan to lower that? And have provisions been made in the Q4 with respect to that inventory?

So Brian, what we did in Q4 was we focused -- when we realized what was actually going on, we were aggressively focused on making sure we got the inventory out of our warehouse that we didn't want to carry into 2020. And I would say to you we largely did that. It did come at a cost because it affected gross margins through the closeout sales, which was an impact on EBITDA as well. But I would say to you the vast majority of what we're carrying forward into 2020 is inventory that still has relevance and can be sold in 2020. So it's not like we're carrying some kind of huge liability into 2020 that you need to be concerned about. The reality is that the lines that we can carry forward, we did. All I was pointing out to Steph in relation to the earlier question was that in absolute dollar terms, we are carrying more inventory dollars into 2020 than we did in -- from '18 into '19. But it's mostly good inventory, and it will be sold at normal margins.

Okay. So it's current. Ronnen, just -- I hate to repeat things here, but just I appreciate your candor. But just in terms of the DC. So overall here, you've had a shift in OB domestic. It's brought merchandise -- more sales in November and December. There is too much flowing through the new DC, and so you had troubles getting product out the door, and that resulted in extreme cost. Is that a summary of what's taking place?

That is a good summary.

Okay. And then the last...

And if...

Sorry, go ahead.

And if I was -- if we were to do it all over again, it should have never been done in the third quarter, right, going to a new DC in -- yes, anyways, I just wanted to reiterate that.

Understood. And then the last question on a different note. Maybe, Ronnen, you can just talk about the performance of your key entertainment properties to date, specifically PAW Patrol and maybe Bakugan as well.

Yes. So as it's mentioned before, I mean, Bakugan continues to build, continues to build globally. We have our second season, which is starting to air very shortly. We have our partnership with Netflix, which is great. We have a partnership with Cartoon Network, which is great. So we're very happy with that. We're in production of season 3. We're working on a movie. So lots of things happening with Bakugan. And in regard to PAW Patrol, globally it's doing very, very well. In the U.S., we had a couple of product lines that didn't do as well with the airplane and with our...

The Lookout.

With Lookout Tower, a little bit of fatigue with the Lookout Tower and with the airplane. So in the U.S., some of the POS was a little bit down in the fourth quarter. But overall, going into 2020 and coming out of the Hong Kong toy show, the retailer is very, very strong on PAW Patrol, very strong in terms of not a lot of competition in this year. I think we experienced a bit of competition last year with...

Toy Story.

Toy Story, so it's amazing how well PAW Patrol did up against something as powerful as Toy Story. But coming out of Hong Kong, the response to our new themes in terms of the dinosaur theme was amazing. And the way -- everybody is very, very excited about it, and the competition set doesn't seem high. We're very focused. We're in production with our feature film, which is coming out in 2021, and we'll have some more information to share with you guys on that in March.

Our next question comes from the line of David McFadgen from Cormark Securities.

Just a couple of questions. So you talked about the outlook for gross -- or what the expectations for gross product sales for 2019 and EBITDA margin of 14%. But you also said that the sales allowance is up significantly in 2019 versus 2018. And can you give us an idea what it is in terms of a range? Because we need that number to calculate revenue and then calculate EBITDA given the EBITDA margin you've given us. So can you give us any additional details on that?

Yes. I'm a little cautious here as Saba asked earlier. Just in terms of actual numbers, I don't want to be too specific just because our numbers are still being audited. And we'll obviously give you precise numbers when we release our results. But David, I can tell you that our typical range is 10% to 12%. Last year, we were at about 11.6%, so towards the top end of that range. And we were in the zone of around 100 to 200 basis points above the top end of the range.

Okay. Okay. That's helpful. And then when you look at what you've cited in the press release in terms of focusing on efficiency and you have a little higher inventory than you would like in the warehouse and you're also dealing with some more licensed product this year versus the past, it would seem to me that you're not going to bounce back quickly to that 18% EBITDA margin level. It might take a couple years to get back there. What do you think about that?

Well, I want to be, again, a little cautious as to provide any kind of specific guidance at this point in time. I will say to you that we have been at around 18% for quite some time. So I think we've proved that as a company, we can do that. I think 2019 was an aberration. Dropping to around 14% is obviously a significant drop. We do not want to be at those levels. We think we can get it back up quickly. How quickly exactly we can do that remains to be seen. We will update you constantly, but I can tell you that both Ronnen and I are extremely focused at getting adjusted EBITDA margins back up to the high teens and not staying at the level that we're at now for 2019. Add anything?

Our next question comes from the line of Saba Khan.

Follow-ups. The comment earlier around shifting your inventory between kind of FOB versus domestic relative to 2019, I guess is that a decision you're making internally? Or is that in conversation with your retailers that you're sort of looking to maybe make -- change that mix?

Want a go? I think it's a combination of both, Saba. I think we actually made some decisions in 2019 independent of retailers. We actually -- because of tariffs, we took some views about what we were actually going to do in preparation for tariffs, which obviously never landed up happening. I think there's no right answer as to what the mix is. It is, at the end of the day, a negotiation between retailers and ourselves. But we do have some influence over the matter. And there are obviously considerations from a pricing perspective, from a P&L -- free cash flow perspective that we have to weigh up and from a risk management perspective. And so it is a negotiation. But my personal view is that we over-indexed in 2019 with a shift towards domestic. And we probably have to tweak that a little bit. If you look at where we had been historically as a company, we're about 60% FOB, 40% domestic. In 2019, we landed up well more than 50% domestic. So that is a big shift in 1 year. Now the industry is going in that direction anyway, as Ronnen described, because of online purchases, which does make it more favorable to carry domestic inventory because retailers are ordering more on a just-in-time basis. The question for us is to hone our supply chain, to hone our understanding of customer supply chain and our supply chain to get that optimized. And that's what we're going to try and do in 2020.

Okay. And then one on just the promotional cost or promotional activity that you undertook during Q4. Just trying to understand the dynamic there a little bit more. Was it that product shipments got a little bit delayed and once it got on shelf, you wanted to move them so you promoted them? Or was it sort of payment to retailers for things being delayed? Sort of to understand sort of the dynamic around the promotional spend during Q4.

Okay. So Saba, what happened was it was a 2-pronged issue. When you can't perform at a warehouse level, you can't get the goods that are moving well to your customers, right? So we had actually strong-performing items that we couldn't get replenishments to our retailers. And then conversely, the items that weren't performing as well were sitting on the shelf longer than we wanted. And so that's what we had to attack with our promotional spending. We had to get those moving by increasing promotions, call up advertising, whatever it took, markdowns. And that's what impacted us in Q4. Does that make sense?

Yes, it does.

And our last question of the day comes from the line of Tim Conder with Wells Fargo Securities.

Just to maybe kind of rebucket it, if you didn't have somewhat your own, let's call it, self-inflicted warehouse issues, how much would you bucket that as far as the shortfall and not being able to deliver products that were selling well, the additional cost to meet the commitments to get them to the retailers and to the customers that you described? And it's the right thing to do long-term for your business, obviously. But if you just had to strip out that, how much of the percentage of the total shortfall would you put into that bucket versus just core market weakness for the industry or your products all kind of collectively if you put it in one of those 2 buckets?

Let me answer it like this, Tim. From our perspective, we had warehouse and supply chain issues regardless. So we would have had increased warehousing and distribution costs under any circumstances because of the challenges that we were having. So that was always going to be a problem. However, from our perspective, if we could have delivered what we would have liked to have delivered, we would have at least met, if not beaten, our top line guidance for the year. So that -- if you look at consensus, that gives you a sense of the order of magnitude that I think we left on the table when it comes to 2019.

Okay. And again, the underlying, ex Hatchimals, obviously, the business still looked good. So thank you for that color also. Now one last thing here. If -- let's just assume the Trump administration remains -- is reelected. What if the China situation then would -- if there's not perceived enough forward movement and then things would go downhill again, have you started to -- would you change anything from what you know now? I guess just to say, do you think you would see the similar or even more accelerated domestic demand needed? Or would you maybe change some of those incentives to sort of give yourself an option if the customer takes product in Asia? And then if those tariffs would reemerge, then you would make them hold -- somewhat a contingency from that perspective, would that be an option?

I would say like this. I'd answered it from 2 ways. One is we need to continue to refine our supply chain to have the most resourceful, fast-paced, quick supply chain that can adapt and adapt to the online world. So we need to have a very, very, I would say, nimble and responsive, okay, supply chain, and that's what we're gunning for, and that's what we're building. It doesn't matter what happens with the Trump administration, elected or not elected. And then from a diversification perspective, from a manufacturing -- we started diversifying before Trump came into office. We'll continue to diversify when he's in office, and we will continue to diversify, okay, if he's elected or not elected. It's a healthy thing for the business overall. We have now products being manufactured in India. We have a projects (sic) [ products ] being manufactured in Vietnam, Mexico and decreased reliance on China. So that's going to continue to happen. And I'm very proud of our team for being able to actually actualize on that. And I think if you look at -- anyways, I'll pause there and just say I'm very proud of our team that's actually able to make that happen because it's a very -- it's much more difficult than it was 15 years ago when you can make everything in China and when I was running operations.

And Tim, just to answer -- one point on your question was pricing. Obviously, during 2019, we were having a lot of discussions with retailers about different models based on that. So we have those plans in place should the need arise. I sincerely hope that, that need does not arise. But as Ronnen said, I think from a supply chain perspective, we've done a lot of work already to diversify, and we also have plans in place should there need to be a change in how retailers purchase because of tariffs. So with that, let me just thank everybody for participating on short notice. I really appreciate it. Obviously, we're not happy to be in this situation or to have the call, but we do look forward to seeing you in New York at Toy Fair. We have a great line for 2020, which we'd love to show you and talk about the business some more. And then we'll be publishing our results on March 4, our full P&L and balance sheet and cash flow. So thank you, everyone. Much appreciate it. Operator?

And this concludes today's conference call. You may now disconnect. Thank you for your participation.