Funko, Inc.

Good afternoon, and welcome to Funko's conference call to discuss financial results for the first quarter of 2020. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session, and instructions will follow at that time. Please be advised that reproduction of this call in whole or in part is not permitted without written authorization from the company. As a reminder, this call is being recorded. I will now turn the call over to Andrew Harless, Manager of Best Relations, to get started.

Thank you and good afternoon. With us on the call today for management are Brian Mariotti, Chief Executive Officer, Andrew Perlmutter, President, and Jennifer Fall Young, Chief Financial Officer. A fresh release covering the company's first quarter 2020 financial results was issued this afternoon and is available on our investor relations website, investor.funco.com. Before we begin, I need to remind you that management's remarks on this call may contain forward-looking statements with the meaning of the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors, including those discussed in the risk factors section of our Form 10Q for the three months ended March 31, 2020, and your other filings at the SEC. Any forward-looking statements made on this call represent our views only as of today, and we undertake no obligations to update them. We'll be referring to certain non-GAAP financial measures on today's call, such as EBITDA, adjusted EBITDA, and adjusted EBITDA margin, which we believe may be important to investors who assess our operating performance. Reconciliation of non-GAAP financial measures to the most directly comparable GAAP financial measure are included in our earnings release. We've also prepared a visual presentation that investors can consult to follow along with this discussion, and it can be accessed at investor.funco.com. I'll now turn the call over to Brian.

Good afternoon, everyone, and thank you for being on the call today. We hope you're all staying safe and healthy during this unprecedented time. Since our last call, only nine weeks ago, we have all had to adapt to a new way of life, and Funko has pivoted accordingly. We are remaining nimble and acting swiftly to navigate the dynamic environment and best position Funko for both the remainder of 2020 and the long term. Amongst our foremost priorities is the well-being of our employees, partners, and communities across the globe. We have implemented measures to safeguard the health of our employees, made strategic moves to mitigate business disruption, and taken steps to strengthen our financial position. Let me provide a brief summary of the actions we've taken to date. We have closed all corporate offices as well as our two flagship retail stores. We have implemented practices to safeguard workers at our distribution centers, including reduced staffing, staggered work schedules, heightened cleaning procedures and temperature screening. We have intensified our focus on our e-commerce initiatives and increased the number of SKUs on our website. We have lowered expenses by implementing executive and senior level management salary reductions, furloughing a significant portion of our employees globally, and cutting other areas of SG&A. We've reduced non-product development related capital expenditures. We are proactively reducing incoming inventory to better align with the current demand we are seeing in the market. And most recently, we have secured an amendment to our credit facility, which provides us with covenant relief over the coming quarters. Equally important, we are actively exploring opportunities to further increase our flexibility and liquidity. Like many organizations out there, we've had to make some tough decisions in recent weeks. As a company, we are learning to do more with less and evaluating opportunities to eliminate redundancies and shift resources toward key growth priorities. We believe Funco will emerge from this crisis as a leaner and more efficient organization. Also, we believe we'll be better positioned to reach our highly engaged and growing fan base with our broad array of product categories in a more cohesive way as we further align our operations and go-to-market strategy. Now I'd like to turn to the first quarter and how our business trends evolved as stay-at-home orders, business closures, and social distancing guidelines took effect. Up until mid-March, we were tracking to meet our revenue expectations for the quarter, and we were seeing solid consumer demand at retail. Additionally, we were optimistic about how our second quarter order book was filling up. However, in the final weeks of the quarter, as non-essential retailers across the globe began to close their doors and consumer demand shifted toward household essentials, orders started to get deferred and canceled, and this has persisted into the second quarter. Additionally, some of our customers that remained open began to prioritize restocking essential goods and slowed replenishment orders. These trends developed more quickly in regions outside the U.S., especially Europe, which drove a significant decrease in our international business in March. Despite the top line pressures, we delivered strong gross margins and carefully managed operating expenses, which enabled us to preserve profitability in the quarter. Currently, we anticipate that Q2 is likely to be our most challenging quarter this year as we face the continued effects of COVID-19 around the world. Looking at our U.S. distribution channels, In the mass channel, we are seeing durable consumer demand and we anticipate we will see somewhat softer order volumes while customer capacity limits remain in place. We are continuing to gain traction in this important channel and expect to expand our shelf space by over 20% with one of our key mass market partners later this year. This will include an expanded product offering of accessories and soft line goods. In our specialty channel, most of our retailer doors remain closed, however, some are offering curbside pickup and continue to serve customers via their e-commerce sites. Until stores reopen, we expect that the shipments of our specialty customers will be limited. In our third-party e-commerce channel, we are seeing customers begin to restock non-essential items resulting in improvements in order trends. In Europe, many of our key accounts remain closed or are operating at significantly reduced volumes. As a result, we have made the strategic decision in Europe to ship any new products that were planned to hit shelves in the second quarter into the third quarter to preserve demand for these new items. Therefore, we expect shipments in the region during Q2 will be minimal. Given all these puts and takes across the global retail landscape, we are anticipating a Q2 net sales decline of about 60% versus a year ago. That said, our relationships with our retail partners remain strong, and we believe Funko will continue to be an important traffic driver in stores and online as the world emerges from the present situation. At the same time, Funko's relationship with our consumers and fans continues to deepen as we add new categories, products and properties that they want to connect with. In the face of today's challenging environment, we are focused on initiatives that will further strengthen our brand equity. We are encouraged to see some states beginning to ease stay-at-home restrictions and reopen stores this week. Recognizing this will be a gradual process, which we will likely see be somewhat uneven, we are optimistic that COVID impacts may begin to lessen in the second half of this year. Importantly, as retail customer and supply chain dynamics continue to evolve, we have to begin acting quickly to mitigate inventory risk by working closely with our factories to reduce future purchase orders to align with demand trends. We've also shifted exclusive and mainline products to our retail customers that remain open and have decreased those offerings on Funko's website. As we look at the new content slate for 2020, many studios have shifted movie release dates to the latter half of 2020 and into 2021. As a result, we have adjusted our manufacturing timeline to match the new release schedules. And for items that were already in production, we will be holding them at our factories and in our warehouses. While we do expect these movements to impact the timing of revenue, Whatifunco's key strength is its ability to produce against evergreen properties, which we will continue to lean on. While we are confronting the challenges and mitigating the impacts of COVID, we remain committed that our key growth strategies, which we believe are critical to our long-term health and value of our business. On our year-end conference call in March, we outlined four key strategies for 2020. Let me provide you with a brief update on each of these priorities. Our first strategy is continuing to expand our pop culture business. This includes building fun and nostalgic evergreen programs at retail, as well as expanding within the unpenetrated genres. In the first quarter, our evergreen properties made up 58% of our total sales compared to 45% in the same period last year. This was driven by solid execution against some of our mainstay properties, such as Star Wars Classic, Harry Potter, DC Comics, and Marvel. We also saw positive initial response to both new and expanded lines. Our new Marvel Venomized line propelled Maximum Venom into the number eight spot on our top 10 property list for Q1. Our expanded offering of Pokemon performed extremely well, making it our second largest property in the quarter. And the Mandalorian was our third largest property, driven by shipments of our first products of the child. We saw tremendous demand for these items, which included Pop, Vinyl, T-shirts and accessories, and we'll be building on this in the coming quarters. Our second area of focus in 2020 is driving continued product diversification. We are launching new products and building on current platforms to create new revenue streams and expand our consumer base. In the first quarter, we saw a positive initial response from both retailers and fans to our launch of Vinyl Soda, which was our fourth largest figure line in the quarter. Also, our Loungefly brand continued to perform well, growing 4% compared to last year. As consumers shifted their purchases towards stay-at-home activities, we also saw a seasonally strong pickup in consumer demand for our Funkoverse board games. While the board game business is still nascent for Funko, we are excited about the opportunity in front of us. We are moving aggressively to launch our new games and toys into the market during the latter part of this year. will be releasing dozens of new offerings from Funko Games, including new Funkoverse titles, as well as licensed and non-licensed board games. Late in the second quarter, we'll be launching our first-ever battle-inspired game that will be targeted at a younger demographic and mixes cooperative gameplay and micro-collectibles. Additionally, our new non-licensed toy offerings, Snapsies, Boogie Monsters, and Gas House Gang, are all expected to hit toy aisles in the second half of 2020. Our third area of strategic focus is international expansion. Most of our overseas markets have been hit hard by COVID, and we expect to see greater impact on our business internationally than domestically. As I noted earlier, we are limiting the shipments of the new items in Europe and Q2 to preserve demand while our stores remain closed. However, we are encouraged to see that countries such as Spain and Germany are beginning to relax guidelines. We continue to believe that there is significant opportunity to expand internationally and as the global economy begins to reopen and recover, we will be focused on capturing more international business across Europe, Latin America and APAC. Our fourth area of focus, which we view as an increasing priority, is expanding our e-commerce business. We are accelerating our plans and investment to build a robust online platform and enhance our digital capabilities. The size and scope of our e-commerce business is evolving as we focus on transitioning to a more powerful selling model and ensuring that we have the operational infrastructure to build scale as demand grows. In the first quarter, our e-commerce business grew more than 50%, but represented only a small percentage of the overall business, reflecting the significant opportunity in front of us. In early summer, we plan to relaunch Funko.com to provide our fans with a more expansive e-commerce experience. The refreshed site will allow consumers to shop across new fandom categories such as movie, anime, Sports, and Music, as well as broader site catalog, which has grown significantly since January. Additionally, the site will feature a recommendation engine that showcases related products to increase depth of purchase. To help drive traffic, we will be offering special promotions to our fan club and app users and collaborating with our studio partners and influencer communities through social media and other digital campaigns. To ensure we have sufficient resources and capabilities to meet demand, We are converting existing warehouse space in the U.S., which will be dedicated to our direct-to-consumer business. Additionally, we are planning to accelerate the expansion of our e-commerce capabilities in Europe later this year. As we focus on leveraging the significant D2C opportunity in front of us, I am particularly excited to tell you about our new Chief Marketing Officer, Ginny McCormick. Ginny comes to Funko with 15 plus years of toy industry experience, substantial expertise as a global brand leader, and two decades of digital transformation work. Ginny was most recently head of global media for Hasbro and joined us in late March. We couldn't be more thrilled to have Ginny on board as we continue to strengthen the Funko brand, expand our reach of consumers and broaden our product offerings while ensuring we are surprising and delighting our fans. We believe our initiatives to diversify Funko's revenue streams coupled with the strategic acquisitions we've made over the past three years will pay dividends over the long term. We believe Funko's competitive advantages will provide resiliency in a challenging macro environment, diversity of products, licenses, consumers, and channels, as well as low price points, speed to market, and connection to key secular trends. We believe in the rise in pop culture and fandom will endure as entertainment and content continues to become ingrained in everyday life, and Funko will continue to create products that connect fans to the content they love. We are operating and planning our business conservatively, but we are remaining nimble and acting decisively to ensure that when the economy begins to reopen, we are prepared to ramp up as quickly as needed. Before I turn the call over to Jen, I would like to offer a huge thanks to the entire Funko team as they have taken every challenge head on and adapted quickly over the past couple of months. We would not be in the position we are today without tireless efforts of everyone in our organization. Also, we are grateful for the continued support of our partners and our shareholders as we navigate these dynamic times. And finally, a big shout out to our fans who continue to be the lifeblood of Funko. We will always be committed to our fans and connecting them to the properties they love. I will now turn the call over to Jen.