Funko, Inc.

Good afternoon and welcome to Funko's 2024 third quarter of financial results conference call. At this time, all participants are in 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 Funko's director of investor relations, Rob Jaffe. Please proceed.

Hello, everyone, and thank you for joining us today to discuss Funko's 2024 third quarter financial results. On the call are Cynthia Williams, our chief executive officer, and Yves Lapindevin, the company's chief financial officer. This call is being broadcast live at investor.funko.com. A playback will be available for at least one year on the company's website. I want to remind everyone that during the course of this call, management's discussion will include forward-looking information. These statements represent our best judgment as of today about the company's future results and performance. Our actual results are subject to many risks and uncertainties that may differ materially from those stated or implied, including those discussed in our earnings release. Additional information concerning factors that could cause actual results to differ materially is contained in our most recently filed SEC reports. In addition, during this call, we refer to non-GAAP financial measures that are not prepared in accordance with U.S. generally accepted accounting principles and may be different from non-GAAP financial measures used by other companies. Investors are encouraged to review Funko's press release announcing its 2024 third quarter financial results for the company's reasons for presenting non-GAAP financial measures. A reconciliation of the non-GAAP financial measures to the most directly comparable GAAP financial measures is also attached to the earnings release, press release issued earlier today. I will now turn the call over to Cynthia Williams. Cynthia?

Thanks, Rob. Good afternoon, everyone, and welcome to Funco's 2024 Third Quarter Financial Results Conference Call. We reported a solid overall financial performance for the quarter. Net sales of $293 million were, as expected, down compared with Q3 of last year, though at the high end of our guidance range. Growth margin was 41%, and adjusted EBITDA was $31 million, both of which exceeded the top end of our guidance range. turning briefly to our 2024 full-year outlook. We are seeing some indications that consumers are increasingly looking for value, which among other things has resulted in certain wholesale customers remaining cautious ahead of uncertain consumer spending during the holidays. We have therefore lowered the range for net sales to $1.037 billion to $1.05 billion, the top end of which is still within our earlier guidance range. Our profitability is a different story and a very positive one. Our improved gross margins have continued to produce better than expected bottom line results. Therefore, we are raising the range for adjusted EBITDA to $85 million to $90 million. Eve will discuss the third quarter financial results and our guidance in more detail in just a moment. On the last call, I told you about my initial impressions of the company and the team. Since then, we realigned certain responsibilities of the senior management team. Andy Otte, our chief commercial officer, is taking on global sales and business development efforts in addition to overseeing our licensing relationships. Moreover, he has moved to Los Angeles to be physically closer to many of our licensing partners, as well as our U.S. sales teams. And Johanna Gepford, our Senior Vice President of Growth Initiatives, is now fully dedicated to overseeing growth initiatives and our newer business lines, which includes managing our global direct-to-consumer channel, Pop Yourself, Mondo, and digital collectibles. We are actively recruiting to add expertise in a few key areas, including creative product development, brand management and marketing, and business development associated with organically expanding our reach and our fandom. Also, on the last call, I laid out our plan to grow Funko by taking a fan-centric approach, which revolves around delighting our core fans, attracting new fans, selling where the fans are, and improving the fan experience. Since then, our senior leadership team has been deep in the process of developing our strategic plan for 2025 and beyond. We expect to share details on our Q4 calls. In the interim, I'm pleased that we've already begun executing several elements of the plan. While these may not be significant revenue drivers this year, They are representative of the approach we are taking to grow fandoms and expand our points of distribution. I'll highlight several of these recent developments. In the area of sports, we expanded our collaboration with the National Football League to include the option for its fan base of more than 200 million people to customize Pop Yourself with any NFL team logo. The partnership kicked off in Kansas City, where we celebrated the season opener and introduced Funko and Pop Yourself to a new legion of fans. Sales of Pop Yourself with NFL accessory packs exceeded our launch expectations. To put a finer point on this, from launch through the end of Q3, more than 40% of Pop Yourself sales included NFL accessory packs, and total daily sales increased by more than 150%. We anticipate a new round of customer interest around the NFL playoffs and the Super Bowl. Next, C.D. Lamb, a Pro Bowl wide receiver for the Dallas Cowboys and holder of several NFL records for receptions at only 25 years old, has partnered with us on a clever advertisement that is part of our national NFL campaign. His Pop is being exclusively sold on our direct-to-consumer website, Funko.com, and it is flying off the virtual shelf. And within 20 minutes of the last out, we went live with a limited edition collectible Pop Los Angeles Dodgers 2024 World Series Champions 5-pack on Funko.com. This pre-order item will only be available for two and a half weeks through November the 18th. In the area of music, we launched a pre-order for Reba McEntire wearing the famous red dress she wore to the 1993 Country Music Awards. Reba is a huge country music star and actor. She is also a coach on the hit television show, The Voice. which has a weekly viewership of nearly 6 million people. On a recent episode of The Voice, Reba gifted an extremely limited edition Funko Pop of herself to the contestants who chose to join her team. I want to briefly mention some recent successes with our outbound licensing program, which elevates Funko's brand equity and delivers royalty income. First, Funko Fusion, Our indirect foray into the video game world provides a different way for new fans to engage with Funko. An action-adventure video game developed in collaboration with 1010 Games and NBCUniversal, Funko Fusion launched on both PlayStation 5 and Xbox Series X and S in September, and it was the best-selling new video game in the U.S. within its launch week. It will soon be released on both PlayStation 4 and Nintendo Switch just in time for the holidays. Second, we recently partnered with the Walt Disney Company and video game developer Gameloft to bring the world of Lounge Fly to life for the first time within interactive entertainment. The six million active fans of Disney's Dreamlight Valley video game are currently able to enjoy wearing in-game some of their favorite lounge flight backpacks and bags. And last, I would like to take a moment to shine a light on our longstanding and incredible partnership with Ferrero, one of the world's largest manufacturers of chocolate products. As of today, Ferrero has shipped over 1 billion Funko-branded Kinder Joy eggs. This is a remarkable milestone and a testament to both companies' reach and brand strength. We are excited about our future with the Ferrero team, and we're in discussions to expand and extend the partnership. In the area of selling where the fans are, we further built out our direct-to-consumer shipping capability to now include Canada. In the first weeks after launch, turning on Canada led to daily sales of Pop Yourself nearly doubling our average daily volume. We have now sold well over 1 million total units of Pop Yourself since the launch last Q3. I'm also pleased to share that earlier this morning, the Toy Association announced that Pop Yourself is a finalist for the prestigious 2024 Collectible of the Year Award. We are honored that Pop Yourself has been recognized for its uniqueness and creativity. And in the area of delighting our core fans, we have expanded our collaboration with Warner Brothers to allow Pop Yourself to be customized with Harry Potter accessories. Millions of devoted Harry Potter fans can now combine personalizing Pop Yourself with their passion for Harry Potter. You are the first to hear this. The official launch starts tomorrow. The last two items DTC shipping to Canada and the Harry Potter accessories for Pop Yourself are both well-timed for the upcoming holiday season. We are certainly excited about the breadth of these positive developments, as well as the other opportunities we are evaluating to grow and diversify our business. We know how to serve our core fans, and we are developing the muscle to attract and serve new fans. With that, I will now turn it over to Eve to take you through the financials. Eve?

Thanks, Cynthia. Hey, everyone. Thanks for joining us today. For the third quarter, total net sales were $292.8 million. Direct-to-consumer sales were down 7% year-over-year and comprised 20% of our gross sales compared with 20% in last year's Q3. Our pop yourself business modestly comped up year over year, even though there were no special gifting occasions or holidays in Q3. I'll add a bit more color on direct to consumer sales in a moment. Gross profit was $119.8 million and gross margin was 40.9%. The higher than expected gross margin was driven in part by lower than anticipated inventory reserves. SG&A expenses were $92.7 million, which was in the middle of our guidance range. Adjusted net income was $8 million, or 14 cents per diluted share, which was well above our guidance range for the quarter. And finally, adjusted EBITDA was $31 million, which also was well above our guidance range. Turning to our balance sheet. At September 30th, we had cash and cash equivalents of $28.5 million compared with $41.6 million at the end of Q2. The primary uses of cash in the quarter included a $10 million payment on our tax receivable agreement liability as well as a slight build in inventory. Net inventory was $118.6 million up slightly from $109 million at June 30, 2024. The buildup was driven by new inventory to service demand during our peak shipping month. Our total debt was approximately $223.4 million, marginally down from $223.9 million at the end of the second quarter. And total company liquidity decreased to $83.5 million from $101.6 million at the end of last quarter. Before I provide our outlook, a bit more detail on our direct-to-consumer sales. In Q3, we saw signs that our direct-to-consumer customers were more responsive to promotional activities. We believe shoppers are increasingly looking for value, which we anticipate will shift a higher percentage of our sales into Q4. when we ramp up our promotional activities and marketing spend ahead of the holidays. We expect direct-to-consumer sales in Q4 to return to year-over-year growth. In our wholesale channel, we believe this trend of consumers seeking for value has resulted in a softer-than-expected order book for Q4 as certain wholesale customers remain cautious ahead of uncertain consumer spending during the holidays. Turning now to our 2024 full year outlook. We are lowering the range for net sales to $1.037 billion to $1.05 billion, the high end of which is just above the low end of our previous guidance range. Again, our profitability is another story. Our improved gross margins have resulted in a better than anticipated bottom line performance. So, for adjusted EBITDA, we are raising the range to $85 million to $90 million, which is above the high end of our previous guidance range. For the 2024 fourth quarter, our guidance is as follows. Net sales between $280 million and $294 million. Gross margin between 38 and 40%. SG&A expense of $93 million to $99 million. adjusted net income between an adjusted net loss of $3 million, or 5 cents per share, and adjusted net income of $1 million, or 2 cents per diluted share. Finally, we expect adjusted EBITDA between $17 million and $22 million. Cynthia, that's it for our financial results. Back over to you.

Thanks, Ebe. In summary, our overall financial performance for the quarter was better than expected. we slightly lowered the range for net sales and raised the range for adjusted EBITDA for the full year. We've made solid progress on developing our strategic plans to grow the company with a focus on our fans. We expect to finalize our strategy by year end and anticipate that some of the initiatives will take time to implement. We expect to discuss these plans on our next call. With that, We'll open the call for questions. Operator?

Thank you. If you would like to ask a question, please dial star followed by 1 on your telephone keypad now. If you change your mind and would like to exit the queue, please dial star followed by 2. And finally, when preparing to ask your question, please ensure that your phone is unmuted locally. And our first question will be from the line of Eric Walt with B Reilly. Please go ahead. Your line is open.

Thank you. afternoon everyone appreciate you taking the questions um a few a few questions i guess one talking about the um the cautiousness you're seeing i can understand you know wholesale or you know remaining cautious in this environment and maybe you know being a little tepid on the order book from those that you have access to um pos are you seeing anything to pos that would help you know corroborate their cautiousness or is it more on the retailer side and then on on dtc becoming more responsive to promotional activity, maybe dive into that a little more if you can. Was that something that you were seeing slowing trends and pumped up promo to reverse that? Or maybe kind of what drove that? I mean, with guidance, GM, gross margin guidance still in that 38 to 40% range. Seems like you're still able to kind of push through that even with the additional promo.

Eric, Great to speak with you again. I guess I'll start by taking a few of these questions. So first on the POS trends, I'll say it's a little bit of a different story depending on the region. Globally, in Q3, the POS sales that we saw were down single-digit year over year. However, in the U.S., we saw that that was down low double-digits versus EMEA is going down pretty strong and saw double-digit growth. So what we're seeing in the U.S. market, I think, to draw a comparison with what we saw with our D2C consumer, is that, you know, it seemed like sales were kind of slow during full-price periods, and then when we ran some promotions, we had a promotion in September that was planned in advance, and we saw a good response to it. So what we believe, you know, how that translates to the wholesale channel is that while POS was down in Q3, a more significant portion of consumers will be shopping during that Black Friday, Cyber Monday period. And I think that's the kind of cautiousness that we're seeing from buyers. They've kind of got this wait-and-see approach to see how that period of the holiday goes. So I kind of addressed a little bit the D2C. I'd say, you know, what we saw in Q3 we expect to translate into Q4. And we are also, like everyone else, going to be running some promotions starting, you know, a little bit before Black Friday and extend through Cyber Monday. And we expect a pretty significant portion of our Q4 sales to happen during that period. So we're looking forward to that. As far as the gross margin, that's a little bit related. I would say that during Q4, while we expect DTC sales to rebound to growth year over year, you know, a higher portion of them will fall during that promotional period, and hence a little bit lower gross margin there. And we'll also have to support those sales promotions with a higher level of marketing spend, so a higher level of SG&A in Q4 relative to Q3. So I think those would be kind of the main drivers, and hopefully I've hit all of the questions that you asked there.

I think I'll just add a little bit of color on what we're I think I'll just add a little bit of color on the D2C side, more from a market perspective. You know, what we're seeing is that major e-commerce sites like Amazon are actually starting their holiday sales the week ahead of Black Friday, like on November 22nd. It's certainly partly in response to the shift in the calendar, but we are seeing it go from $11.22 up until Cyber Monday. And so we're essentially matching that to be in line with the market, but it is another part of the indication of the consumer searching for value.

Got it. And if you do see strong trends, you know, during these kind of, you know, sale periods in the Black Friday, Black Monday around then, Is that something, and maybe, you know, retailers get a little more enthusiastic on that. Is that something you'd be able to address with additional shipments into the year end? Or is that something more that, you know, we'd look to early 25 to be a beneficiary?

We were just looking at our cutoff dates. And we are extending, we are able to extend the number of days that we'll be able to ship to various regions this year. So we do expect to extend it a bit. This is why eventually I want to open a 3PL on the East Coast. That would add at least another three days for more than 50% of the U.S. So we can extend it, but not as much as we'd like to be able to.

Perfect. And then just final question, if I may. You know, coming off the election earlier this week and Trump's victory and his rhetoric on tariffs, maybe give us your thoughts on potential impact of if there are tariffs coming in, kind of where you are in terms of your mix from China or effective regions?

Yeah, thanks for that question. You know, as we've been working on our strategy, we've been doing some scenario planning and scenarios around the U.S. elections were actually part of that. We are fortunate that over the past several years, we have been diversifying our supply base away from China And in fact, at the company level, it's about a third of our products are actually manufactured in China. And of that, a little less than 10% is part of our lounge fly business that is already tariffed. So we've got a sense of what the size of that would be. It's a bit lower than some of the others in the industry. That said, we're going to continue to work on plans for how we could further diversify away to try and manage that situation. But we do feel like we're in a better position coming out of the gate than some others are. Now, that said, that's the tariff side of it. Let's talk about the secondary impact of it. The thing I am worried about in the shorter term, let's call it Q4 and Q1, If those tariffs are enacted early in the administration and people have a strong signal of that, I think we will see a rush for people to ship especially higher priced items into the United States early, like ahead of when they would actually normally need it. Now, while we have 70% of our freight rates under contract, and so that's not a risk for us, what is a risk is the capacity. And so if we see a real push to get more products into the United States ahead of tariffs if they are enacted, we might have some challenges that we'll need to overcome with that. And the team is working on plans for that now.

Very helpful. Thank you both. Appreciate it.

Thank you.

Our next question will be from the line of Steven Leszczyk with Goldman Sachs. Please go ahead. Your line is open.

Hey, Greg. Thanks for taking the question. Maybe two from me. First on margin, I was curious if you could talk perhaps a little bit more about the drivers of the higher margin. in 3Q and then as well as the increased outlook from Origin in 4Q. It sounds like there were some lower reserves in the third quarter. Not sure if that's benefiting 4Q as well. It also sounds like maybe on the opposite side of that, some higher sales and marketing that you're expecting in 4Q. Just curious how that plays through. And then second question on just the film slate picking up in the second half of the year here. I've had some bigger movies come through in 3Q and 4Q. I'm curious if you could just touch on those, the theatrical slate at large, and then maybe as we look into the end of the 4Q slate, if there's any movies in particular that you feel particularly levered to. Thank you.

Hey, Steven. I'll start with the margin question. And what you saw in Q3 was really driven by a favorable gross margin. I called out inventory reserves, and that's really a continuation of the trend we've seen throughout this whole year. We continue to have some product that we sell into the value channel that had been reserved, and because, you know, the inventory that we have at this moment to sell into the value channel is high-quality inventory that we're selling above cost and getting, you know, good margins for that channel. were able to have better than expected inventory reserves in the quarter. There were a couple other drivers in cost of goods. We also saw a little bit lower than anticipated freight costs as well as duties. So that led to the overperformance on gross margin in Q3. What I'd say in Q4 is that we also expect to have, you know, a little bit more discounting during that promotional period that I called out. during Black Friday, Cyber Monday window, and so that would cause a little bit of gross margin erosion quarter over quarter, as well as the ramped-up marketing spend, which is what you see factored in our SG&A guidance. But overall, I think the bottom line, we're quite pleased with how we did in Q3, and we feel like we'll be delivering a solid Q4 as well, bottom line.

Hi, Steven. It's Cynthia. I'll take the film slate. Certainly the big film for us in Q3 was Deadpool. While we shipped a lot of that in Q2, we continued to see strong uptake and people really responding to it, both with the cosplay version of Deadpool and Wolverine for Pop Yourself, which, by the way, continues to show up on my top 10 items for Pop Yourself even today. So that has done very well for us. The film for Q4 that our fans are most excited about is Wicked. And we had a good moment this week. We've got fantastic product across the Funko Pop line as well as Lounge Fly. And as the cast is out touring around going to various premieres, Ariana Grande landed in London last decked out in pink and sporting the Glenda crossover bag by Loungefly, which was captured quite a bit. So there's a bit of excitement around that. We have had some of the cinemas order some of the bags to make sure they have them in their shops when people are coming for the opening weeks of the film. So we've got a lot of excitement around Wicked.

That's great. Thank you both.

Thank you.

As a reminder, for any further questions, please dial star 1 on your telephone keypad now. And our next question will be from the line of Linda Bolton-Weiser with DA Davidson & Co. Please go ahead. Your line is open.

Yes, hi. So I was wondering, in terms of the comments about consumers being more sensitive and responding more to promotions, I guess I'm a little surprised to hear that because in general, your products are fairly low price point type of items. And especially like your bitty pop is a lower price point even than the regular pop figures. So maybe you could give a little more color. Was it mostly sensitivity around the higher priced items that you sell, like some of the collectibles that are a little more pricey? Or I don't know, can you just kind of maybe give some color? Like, is it by category, by type of property, anything like that?

Hey, Linda. Yeah, I'll be happy to take that one. It's not quite on the price point. We still feel like we have a great product and an accessible price point in our core kind of POP offering. Like you called out, we do have a pretty nice range at this point from Bidipop, which is just a few dollars, to our standard pop, which is around $12 to $15. And then on the high end, we have our Mondo brand collectibles, which can be several hundred dollars. Really, what we saw is not so much on that kind of Mondo high end. We still see excellent sell-through. Every time they drop a product, it sells out very quickly. So no concerns there. I think, you know, the bulk of our sales happens kind of in that average price point range. And that's where we saw consumers were just more responsive. I mentioned a sale that we ran in September called the Funko Funiversary Sale, and we saw a really great response to that. And we expect to see a continuation of that trend. And I'll just remind you, I mean, people think of our business as, you know, kind of the core business is collectibles. But over the last few years, we've really diversified our business. And we now have a wide range of products. And many of them are great for gifting. And I think that a lot of people kind of wait for these holiday promotional periods to buy gifts. And Top Yourself definitely fits within that category. And so that's just the kind of trend we've been seeing these days.

I'll add just a little bit of color since you brought up Bidipop. We weren't seeing this on Bidipop. In fact, what we're seeing right now is as people like Target have been preparing for the holiday season, the sales of Bidipop, the POS has been quite strong. Target is still setting some of the 475 stores that they're doing a specific Bidipop set in, but the stores that are set are outperforming the other stores in their chain. So we're very happy with the performance of Bidipop. The price point range there is probably helping, but we certainly aren't seeing the need for discounting there. It's more on these giftable pops.

Okay. And then... I was this is kind of a bigger picture question, just trying to gain a better understanding of your core competencies and your competitive moat. In looking at like fanatics, which I'm not that familiar with, quite frankly, but it does strike me that they sell this sports related memorabilia apparel and all these items similar to some of the stuff you do. So do you view fanatics as a competitor or as a partner? Or or a customer? Like, can you just describe kind of how you see yourself relative to them? Thanks.

Great question, Linda. And we do see them as a partner. There are places where there's some similarities in what we sell. When we did not have pre-order capabilities, we would have done this Dodgers World Championship from the World Series with Fanatics, and now we're able to do it on our e-com site. But we do partner with them on various items. They sell, among other things, our NFL Santas that are always a hit for gifting at this time of year. Our lounge fly bags are also one of the items that are, you know, Leigh Anne Touzeau- Maybe complimentary to what they sell those clear stadium bags have been really popular with a lot of our nfl fans, so I we see it as very complimentary.

Leigh Anne Touzeau- Okay, and then um my last question has to do on the cost side. Leigh Anne Touzeau- I know you did some you know some headcount reductions and there were some cost savings, can you remind us like. What those savings are sort of planned to be expected in 2024? And then are there incremental savings or just carryover savings that we'll see in 2025? And going along with that, you mentioned wanting to bring in some other executives for these important roles. I'm just wondering if you need to build out more in terms of people skills or other types of, I don't know, infrastructure or something. without giving guidance for next year, just kind of generally, how do you think about the cost side and does it need bulking up or is there still room to improve the cost structure, I guess? Thanks.

Sure, yeah, Linda, I'll take that. I mean, if you recall, we did several rounds of cost reductions last year. Some of the bigger ones happened towards the end of Q1 and then in Q3 of last year. At this point, when you think about Q4 and then going forward into next year, we've kind of annualized a lot of the cost savings there. We do see within our SG&A, if you were to kind of look under the covers, we are reallocating some of the dollars that we've saved and ramping up marketing effort. That's been something that we've been, you know, really trying to focus on, not just this year, but over the past several years is promoting the Funko brand and raising awareness of Loungefly and Mondo. And so we're reinvesting those dollars into marketing. I think, you know, we have continued to see some cost efficiencies coming out of our operations. And more specifically, our warehouse labor is operating much more efficiently this year than it was last year. And we almost like every quarter see it now a continuous improvement in how we're, you know, fulfilling orders, and so we expect to continue to find efficiencies and reduce the operational costs as we head into next year as well. And I'll let Cynthia speak to the additional executives that we're currently recruiting for.

Linda, one of the ways to think about this is there were some exits that happened around the time I came in that needed to be backfilled. And that's part of what's happening with these folks that I'm mentioning we're bringing in. I think there is a piece of like us building up the capability. And I'll hint to you that what we're going to be talking about is a foundation to grow. And when we're talking to you in Q4 about our investments for 2025, that's going to be a lot about making sure we've got the right capabilities and the right talent to be able to grow. Part of that includes the ERP. Part of that includes a customer data platform that will allow us to grow our direct-to-consumer business using things, capabilities like personalization. And we do see with the investments we're making in fandoms like sports that we are going to need to do a different type of marketing than we have been doing in the past, hence the need to bring in someone with more of a brand and marketing background background, but I think what you should hear is a commitment to continued profitable growth, and that includes continuing to look for cost savings.

Okay, great. Thank you.

Thanks, Linda.

Thank you. And with no further questions on the line at this time, I will now turn the call back over to management for any closing remarks.

Thank you everyone for joining us on the call today. Thank you for your questions. And we look forward to sharing our progress on our next call with you. Thank you very much.

This will conclude Funco's 2024 Third Quarter Financial Results Conference call. Thank you to everyone who was able to join us. You may now disconnect your lines.