Funko, Inc.

Good afternoon, and welcome to FONCO's conference call to discuss financial results for the fourth quarter of 2021. 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 Ben Avina-Tapper, Director of Investor Relations, to get started. Please proceed.

Thank you and good afternoon. With us on the call today are Andrew Perlmutter, Chief Executive Officer, and Jennifer Paul-Young, Chief Financial Officer. Before we begin, I'd like to remind everyone that during the course of this conference call, management will discuss forecasts, targets, and other forward-looking statements regarding the company and its financial results. While these statements represent our best current judgment about future results and performance as of today, our actual results are subject to many risks and uncertainties that could cause actual results to differ materially from what we expect. In addition to any risks that we highlight during the call, important factors that may affect our future results are described in our most recent SEC reports and today's earnings press release. In addition, we will refer to non-GAAP financial measures during the discussion. Reconciliations to their most directly comparable U.S. GAAP financial measures and supplemental financial information can be found in the earnings press release in 8K that we released earlier today. All of these items plus a visual presentation that investors can consult to follow along with this discussion are available on our investor relations website, investor.funco.com. I will now turn the call over to Andrew.

Good afternoon, everyone, and thank you for joining us today. Today is my first earnings call as the CEO, and it is my pleasure to announce Funco's best quarterly and annual results ever. We surpassed $1 billion in annual net sales and reported the highest full-year adjusted EBITDA and EPS in company history. The strength was broad-based with growth in all channels, geographies, and brand categories, reflecting the power of the Funco brands to generate sustainable demand throughout the volatility of the past two years. Our employees, fans, and partners all deserve a tremendous amount of credit for helping make this past year possible. I'll begin with some highlights from the year before turning to the fourth quarter. In 2021, we grew figure revenue by 59%, sustaining excellent momentum in our core business with strength across geographies and channels. We expanded into an entirely new market With the launch of digital pop NFT lineups, we launched new physical products like vinyl gold and Popsies, extending our footprint with key retailers and introducing new fan bases to Funko, and we more than doubled our sales in the direct-to-consumer channel. These achievements contributed to more diverse revenue mix and top-line growth of 58% for the year with adjusted EBITDA margin expansion of more than 200 basis points. Our ability to deliver product while managing through supply chain disruptions has been critical to our performance. We took important steps this past year to onboard new factories, providing additional capacity and further diversifying our manufacturing footprint to partially mitigate these disruptions while strengthening our foundation for the future. The guidance we provide today assumes that the current level of supply chain disruption, and specifically freight inflation, will persist at least for the first half with only modest relief possible in the second half. However, as I just described, our business is resilient, as is the demand from our great fans. We are prepared for the challenges we anticipate, and we believe that we are well positioned should the operating environment improve faster than expected. Before I share some of the fourth quarter highlights, I want to call out how we'll be talking about the business going forward. One of my first actions since becoming CEO in January was to provide additional structure to the great collection of brands that make up Funko. This new brand structure will allow us to seamlessly execute against our growth targets and maximize strength of our brands. To that end, today, we have four main brand categories. Our collectible brands includes our iconic Pop Vinyl, as well as newer additions like Soda and the newly launched Vinyl Golden Posse's, Lounge Fly, focused primarily on soft lines represents our next largest brand. Our emerging toys and games brand, including some of our newest and highest growth opportunities, and finally, our digital brands, which today includes our digital pop NFTs. With this new brand structure, we're better aligned to execute against our four growth pillars. Our first growth pillar is continued innovation within our core collectible brands category, while our second growth pillar is sustained revenue diversification through products and brands adjacent to our core portfolio. Our third growth pillar is continued expansion of our D2C e-commerce platform. And finally, our fourth pillar is international expansion. Here, we will continue to leverage the breadth of our brands and selectively add resources and capabilities to open up key international markets. I'll now share some of the highlights from the quarter. Under our first strategic growth pillar, we delivered another excellent quarter with strength across our collectible brands and in all channels. The Pop brand grew 41% year-over-year in the fourth quarter. Our sustained success with Pop stems not only from our industry-leading breadth of properties, but also our strong fan engagement and innovation we bring to the Pop product line. We've introduced innovative new figures and designs and highly successful seasonal product lines. Our participation in the Macy's Thanksgiving Day Parade with our balloon featuring Grogu from the hit series The Mandalorian is a great example of the strong fan engagement and innovation we continue to bring to the brand. Our balloon generated one of the top social media events ever for Funko, serving as an introduction to the Funko brand for millions of new fans. As with other fan engagement events we hosted this past year, the products tied directly to these events continue to be among some of our most popular releases. Animating sports and music are also exciting opportunities for growth for our collectibles brands. We recently launched a new figure line, Vinyl Gold, targeting sports and music sneakerhead demographic. Early results have been very positive with a new slate of artists and athletes set to launch this spring. We also introduced Popsies, our collectible green line, launched at the end of Q4, and here, too, the responses have been excellent. We've had repeated sellouts in our D2C channel, and the feedback from our exclusive launch partner has been very encouraging. Turning to our second growth pillar, revenue diversification, we continue to meaningfully expand the breadth of our portfolio through the successful incorporation of new pop culture-centric brands. Most notably among these is Lounflot, which continues to experience high demand, leading to record results despite the supply chain disruptions of the past several quarters. The Lounsfly brand, which has come to define collectible fashion with its unique design and high product quality, generated strong growth in our D2C channels and across our retail partners with excellent results in both the U.S. and European markets. Lounsfly's excellent year was driven by multiple factors, all of which point to even more exciting opportunities to come. The average selling price increased double digits driven by a deliberate emphasis on premium, higher value products, which allow us to more fully capture Lounsly's quality and design advantages while continuing to diversify our wholesale channel as demand from independent specialty and online retailers has accelerated. And finally, Lounsly continues to be our fastest growing brand in our international markets, nearly doubling sales in Europe over the past year. We've grown the Lounsly brand from approximately 20 million in business when we acquired it in 2017 to over 140 million in sales this past year. And we believe we have only just begun to unlock LoungeFly's full growth potential. Domestically, the opportunity is broad-based with a particularly strong outlook for both independent specialty retailers and our D2C channels. Internationally, based on the strong demand that we're seeing across Europe and early indications from our other international markets, we believe a similar growth trajectory is possible. Our second area of revenue diversification is within our toys and games brand. While our collectible and lounge fly brands are category leaders, our toy and games brands are playing the role of disruptor in their respective markets with strong growth and share gains you would expect from a compelling new entrant into the market. We've made great strides in leveraging these brands to expand our footprint with key retail partners into the toys and game aisle. Funko Games launched more than 40 titles in 2021, a significant achievement that gives us great runway and opportunity in the category. We also had great success with our collectible gaming platforms, and we'll be introducing new titles in this space in the coming months. In November, we noted that our games business was able to be opportunistic when retailers were looking for product at the height of the supply chain disruption last fall. Today, we've held onto those gains in shelf space, contributing to a fourth quarter growth rate for games, more than double that of the overall games market. Within toys, our products designed for a younger audience continue to do exceptionally well, with an expanded Five Nights at Freddy's line already in the works at some of our key retail partners. Finally, the last area of diversification is our digital business, which today encompasses our digital pop NFTs. Q4 was our second quarter of digital pop sales and also marked the launch of Drop.io, and NFT marketplace developed by our affiliate, Tokenwave. To date, we've completed eight major drops and we've been thrilled with the enthusiasm for these products. While still in the early stages, we are encouraged by the exceptional demand we continue to see for digital tops across a wide range of licenses. Our third growth pillar, D2C growth, continues to be one of the best performing channels for Funko. In Q4, D2C grew 74% and now represents 11% of our total business. We believe there is substantial opportunity for future growth driven by expanded product offerings, greater use of exclusives, and technology enhancements designed to improve conversion. This past year, we increased the number of unique customers by more than 50% while increasing our annual customer value by double digits. Customer value is benefiting from growth in both orders per customer and average order value, reflecting strength of our D2C sites across multiple factors. These enhancements will provide improved integration across Funco and Loungefly sites and allow for more streamlined process to expand our e-commerce platform internationally. We're excited about the future of the D2C channel, which importantly continues to be incremental to the growth of our wholesale business. The fourth growth pillar, international expansion, is another area where we've just begun to scratch the surface. In Europe, The region with the most established international presence, fourth quarter revenue increased 58% to 64 million, one of the largest quarters ever in Europe and representing 19% of total sales. We're seeing a strong rebound across the entire region and some of the hardest hit countries during the pandemic were some of the best performers in Q4. Demand is strong across all brands led, as I mentioned, by some of our newer additions like LoungeFly. Outside of Europe, the opportunity is potentially even more exciting as we're still in the early innings. Globally, some of our largest retail partners report that Funco is one of the most searched terms on many of their international e-commerce sites. This is truly an encouraging sign of the strength of the Funco brand and the opportunity we see globally. Our progress and specific approach will vary by geography, but we have an exciting roadmap to extend our footprint globally. We will be focusing on near-term opportunities in Latin America, Canada, and Oceania, each with a tailored go-to-market plan that is already underway. We're in a great position to deliver against all four growth pillars. As always, we'll balance focused internal execution with prudent M&A where appropriate to extend our product portfolio and expand our geographic footprint. For 2022, we anticipate revenue growth of between 20% and 25%, an adjusted EPS of $1.75 to $1.91 with adjusted EBITDA margin relatively in line with fiscal 2021, reflecting one-time project spend that Jen will describe in detail, as well as freight headwinds that we are now expecting to remain in place for most of the year. Despite external factors that are largely out of our control, we've proven our ability to deliver in difficult environments, and I'm very confident we are well positioned to meet our objectives for the full year. Looking beyond 2022, based on the strength of our portfolio, the sustained demand we cultivate with our fans, and our proven ability to execute, we believe that Funco can deliver double-digit revenue growth over the next three years while consistently expanding margin. In closing, the fourth quarter capped off a truly remarkable year for Funco. We surpassed 1 billion in annual net sales, launched multiple new products, both physical and digital, generated exceptional growth across our brands, and delivered more than 200 basis points of adjusted EBITDA margin expansion in one of the most disruptive supply chain environments in memory. It's a testament to the iconic nature of our brands, incredible faithful fan base, and importantly, the dedication of our amazing employees and partners We entered 2022 with strong momentum, and I couldn't be more excited about the opportunity ahead. And with that, I'll turn the call over to Jen to take you through the financials.

Thanks, Andrew, and good afternoon, everyone. We're pleased to report record fourth quarter results highlighted by net sales growth of 48% over the prior year and 57% over pre-pandemic 2019 results. This strong performance reflects continued demand and broad-based strength across our categories, geographies, and channels. The overperformance relative to our expectations was primarily driven by wholesale, both domestically and internationally. All comparisons are to the fourth quarter of 2020 unless otherwise stated. Net sales in the U.S. increased 47% to $253 million, while net sales in Europe grew 59% to $64 million, and other international markets increased 32% to $19 million. with growth in all primary regions. On a product category basis, Q4 net sales of figures, including action figures, grew 50% to $255 million, driven by strong growth in our core pop brand. Non-figure product sales increased 44% to $81 million, primarily driven by bags and wallets under our LoungeFly brand, as MixGift drove higher LoungeFly AFPs. While small on a dollar basis, we also had strong growth from games, plush, and accessories. Under our existing brand structure, the pop brand grew 41% to $238.7 million, while the lounge fly brand grew 57% to $49.7 million, and other brands grew 88% to $47.9 million. As part of our continued focus on building the leading pop culture branded company, beginning in the first quarter of 2022, we will begin providing revenue under our new brand structure of Funko Collectible Brands, the lounge fly brand, and other brands, which will include Funko toy and game brands and digital. The number of active properties in Q4 increased 26% to 915. Net sales for active property were 360,000 in the fourth quarter, an increase of 17%. For a list of our top performing properties in the quarter, please see our company earnings presentation. Fourth quarter gross margin was 33.9%, a decrease of 330 basis points versus Q4 2020, due primarily to supply chain inflation, as freight expense in the fourth quarter created a headwind of roughly 500 basis points. SG&A for the quarter was 78 million, or 23.3% of sales, leveraging 40 basis points year-over-year due to revenue outperformance. Moving down the P&L, adjusted EBITDA was 39 million, with an adjusted EBITDA margin of 11.6%, above expectations due to top-line outperformance. Adjusted diluted earnings per share were 38 cents. Turning to the balance sheet and cash flow, we ended the quarter with 84 million of cash and cash equivalents and 100 million of availability under our revolver, representing total liquidity of 184 million. We ended the quarter with total debt of 173 million, down 9% compared to Q4 of last year. Inventory at quarter end totaled 166 million, up 178% relative to sales growth of 48%. The year over year increase in inventory was primarily due to an increase in our inventory in transit, which represented over 60% of the balance, as well as a uniquely tight inventory position in the prior year as we were still adjusting to pandemic disruption. The business generated operating cash flow of 87 million year to date. Before I provide guidance for the year, I'll briefly describe what we expect from freight rates in 2022. Our guidance now assumes that the cost of freight will remain at near record highs for the year, with a potential for only modest relief in the second half of the year. If rates do begin to normalize in the second half, we expect new rates will remain well above pre-pandemic levels. While we believe we have been prudent in our assumption regarding the new normal, In terms of freight expense a continuation or escalation of the current level of supply chain disruption throughout the second half would put additional pressure on gross margin beyond what our guidance currently contemplates. With that for full year 2022 we expect net sales growth of 20 to 25% with the first quarter revenue growth rate expected to be in the mid 40% range. We expect our adjusted EBITDA margin to be relatively in line with 2021, reflecting a significant freight inflation headwind, as well as approximately 80 basis points of pressure due to one-time project spend from the consolidation and relocation of our distribution centers and our new ERP system. We expect adjusted net income of $95.8 to $104.8 million, based on a blended tax rate of 25%, and adjusted earnings per diluted share of $1.75 to $1.91 based on weighted average diluted share count at 54.8 million. Because of the dynamics I just referenced, I'll provide some additional commentary on our gross margin and SG&A expectations throughout the year. Our gross margin is heavily influenced by the current inflationary freight environment. As a result, we expect first half gross margins to be consistent with the second half of 2021 with some limited improvement in the back half of 2022 as our 2021 price increases go into full effect and in line with our expectations for modest relief in freight rates in the second half of the year. SG&A as a percent of sales is also expected to be slightly higher in the first half of the year due to the timing of project costs associated with the consolidation and relocation of our distribution center as well as our ERP implementation. We appreciate your time this afternoon. Now, Andrew and I will be glad to take your questions.

We will now begin the Q&A session. If you would like to ask a question, please press star followed by one on your touch-tone keypad. If for any reason you would like to remove that question, please press star followed by two. Again, to ask a question, press star one. As a reminder, if you are using a speakerphone, please remember to pick up your handset before asking your question. We will pause here briefly to allow questions to generate in queue. The first question is from the line of Stephanie Linsick with Jefferies. You may proceed.

Thank you. Good afternoon, everyone. We have two questions. The first is just on the diversification by property. really impressive to see the top 10 at that 30% level. So Andrew, maybe talk a little bit about the diversification. You mentioned some new categories in the arts and sneaker world that you're entering. How do you think about that concentration effect continuing to mitigate over time?

Hey, thanks for the question. Yeah, we've put forth an effort to continue to diversify our revenue streams. And we're starting to see the fruits of that labor, as you can see. So what you would reference was the gold program that we did that really focused on sports and music. We've talked about the diversification that we're seeing with the lounge fly brand, the toys and games, which are smaller but also create a lot more diversification. So I would say that what you're seeing as a result of a conscious effort to continue to diversify across all avenues of fandom. And that goes, you know, anything from sports, music, video games, TV, movies, et cetera. And you're starting to see us continue to grow our universe of properties.

That's helpful. And then, Jen, just one quick one for you. Thank you for all the information on freight rates. That's really helpful to hear. Anything we should be thinking about on your raw cost of goods in terms of resins? Anything you're seeing within the cost of goods basket beyond shipping that we should be thinking about within gross margin? Thank you.

Yeah, and good to hear from you, Steph. Yeah, really the main headwind for us is the uncertainty in the supply chain, and that's what we've really reflected in our guidance. So that's where I would really stay focused in terms of, you know, as you're looking at each of the quarters.

Okay, I'm going to throw one more in. You gave 80 basis points of pressure from, it seems like, more of a transitory DC and ERP implementation and transition. Any context on when that 80 basis points is concentrated? Is it first half, second half, anything we should be mindful of?

Yeah, first half for sure. We will probably launch in the beginning early of the Q3 for the ERP, but the distribution center move will happen in the first half.

Okay, helpful as always. Thank you, everyone. Thanks, Beth.

Thank you. The next question is from the line of Linda Bolton-Weiser with DA Davidson. You may proceed.

Yes, hello. Congratulations on a strong quarter and year. So, you know, your growth outlook for the top line for the next year is quite a bit above what the street had. and maybe you could just give a little more color. Is it that there's going to be just so many more entertainment properties as we come out of the pandemic, or is it new distribution, more geographic expansion? Just can you kind of give us a little more flavor on just why you have confidence in that very high growth rate continuing?

Hey, Linda, it's Andrew. Thanks for the question. Good talking to you. So I would say that as we take a look at the at the business and where we're coming off of 2021, it's not necessarily about content or theatrical. You're seeing the reflection of us diversifying our business, and that goes across channels of distribution. That goes across geographies. You're starting to see the company really action some of the initiatives that we've been working on over the past couple of years. And I think that is being reflected in what you're seeing in that. I'll hand it over to Jen to add in.

Yeah. Hey, Linda. Thanks so much. And keep in mind, too, that we did announce we were putting into play a price increase last year that will go into effect mid to late Q1. So that is contributing to the top line as well. And at this point, we're not seeing pullback in units. So it's a combination of units and price increases.

Okay, great. Um, also, can you, you know, I have several brand companies that are pushing on their DTC strategy and trying to really drive that business. But sometimes there's cautionary tales about being able to balance that initiative with your relationships with your retail partners. Can you talk about how how you're kind of balancing that and making sure that your DTC doesn't threaten that important business with retailers?

Absolutely. So that is one of the differentiators about our business, and it always has been. Whether it's differentiation of retailers, in the marketplace of which now Funco is one. We drive differentiation through products, so exclusivity on different products that we drive different people to various retailers. We have retailers that over index in anime properties and retailers that over index in sports and music. The variety of products that we make and our ability to make specific products for specific retailers Drives foot traffic to those retailers. That's our key differentiator. Very different than I think some of the competitors that you might be referring to or other branded businesses that you're referring to where they don't have that breadth of SKUs that we have. That's always been sort of a differentiator for Funco and it will continue to be in the future.

Gotcha. Thank you. And then... Finally, just in terms of your game and toy expansion, you know, you are small, but you're getting bigger. And let's see, I see that Funcoverse, I think that was one of your first products, is still out there on the market. But have you had any major lines or products in the toy game area that did not succeed that you've discontinued since you've entered the category?

You know, for the most part, there are different lifespans when it comes to various items. And some items are not meant to be in the market for a long time. I think with games and toys, I'm sorry, games for example, that is not necessarily the goal is actual longevity. So to see Funkoverse still on the shelf is a great sign. We think that there's tremendous longevity in that category with titles that really resonate with consumers. If you take a look at some of the great games out there that have been around forever, that's sort of tied to that specific industry. Not everything will be on the shelf forever, but the longer the better. We really like that about the games business. It's very different than some of our other businesses. In the toy business, It goes both ways. There are smaller initiatives that are more in and out programs that we've had a couple of, and then there are bigger initiatives that we want to build on more of a branded approach in the toy aisle than an unbranded approach, which is more of a short-term opportunity. I'm not sure if that answers your question, but I would say longevity on the game wall is definitely a goal. and then it comes down to the toy release. For example, I'll use the Turbo Man that we had last year in Walmart. You may see an iteration of that on the shelf, but you won't see most likely that exact same item the next year, but it was a tremendously successful item. That's part of the strategy around keeping things fresh. Again, something that slightly differentiates Funko from some other people in the aisle.

Great. Thank you very much.

Thank you.

Thank you. The next question is from the line of Megan Alexander with JP Morgan. You may proceed.

Hi, thanks very much and congrats as well on the strong results. You know, on the gross margin, can you just remind us historically, you know, how much of your freight contracts are, you know, contracted for spot and how are you thinking about planning that this year? You know, are you going to try and maybe lean more on spot given it seems like, you know, hopefully people think freight rates, the spot rate could come down later in the year?

Yes. So historically, we've been a little bit different in that we do operate in the spot market and we anticipate continuing that given all the uncertainties in the freight world right now.

Got it. And then, you know, in terms of the price increases, you know, can you just talk about Do you look to maintain gross margin rate? And I guess if freight does pull back a little bit more than expected, could that be a good guide to gross margin in the back half relative to what you're expecting right now?

Yeah, there's really a lot of uncertainties in that. And so we tried to make sure we were prudent in looking at the full year and trying to provide some guidance. From a price perspective, I think that's the first part of your question, eventually, yes, that would be the margin, a creative piece to it. But we really do need to see kind of where freight kind of settles and normalizes.

Got it. That's helpful. Thank you.

Thank you.

Thank you. Again, to ask a question, please press star 1.

So there are no additional questions at this time.

I will now pass it back to the management team for any further remarks.

Thank you all for joining today. Appreciate it. Special thank you to our employees and our fans and our partners for a wonderful 2021. Look forward to a great 2022.

Thank you. That concludes today's conference call. Thank you and have a great day.