Funko, Inc. (NASDAQ:FNKO) Q2 2024 Earnings Call Transcript

Funko, Inc. (NASDAQ:FNKO) Q2 2024 Earnings Call Transcript August 9, 2024

Operator: Good afternoon, and welcome to the Funko 2024 Second Quarter 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 the time. Please be advised that reproduction of this call in whole or in parts is not permitted without written authorization from the company. As a reminder, this call is being recorded. I will now turn over the call to Funko’s Director and Investor Relations, Rob Jaffe, to begin. Rob, please go ahead.

Robert Jaffe: Hello, everyone, and thank you for joining us today to discuss Funko’s 2024 second quarter financial results. On the call are Cynthia Williams, our recently appointed Chief Executive Officer; and Yves LePendeven, our 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 second 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 company’s earnings press release issued earlier today.

With that, I will now turn the call over to Cynthia Williams. Cynthia?

Cynthia Williams: Thanks, Rob, and good afternoon, everyone. Welcome to Funko’s second quarter financial results conference call. My first conference call as the company’s new CEO. I am delighted to be here. For the second quarter, our financial results were better than expected. Moreover, the second quarter was our first quarter of year-over-year net sales growth and our first profitable quarter since the third quarter of 2022. Net sales were $248 million, up 3% over the same quarter last year. Gross margin was 42% and adjusted EBITDA was $28 million. Both were higher than our guidance range. And in the case of adjusted EBITDA, substantially better than expected. Our strong overall performance includes a number of positives.

I’ll call out just one here. Sales of Bitty Pop!, a recent entry into the miniature collectible space, more than doubled in Q2 compared with the same quarter last year. And we continue to build on that momentum. Last week, we announced the introduction of Bittyverse, an extension of Bitty Pop! that allows fans to mix and match with new IP-driven rides, towns and displays. For the full year 2024, we are reiterating our guidance range for net sales of between $1.047 billion to $1.103 billion and adjusted EBITDA of between $65 million to $85 million. We’ll discuss the second quarter financial results and our guidance in more detail in just a moment, but before we do, I’ll share some of my initial thoughts since joining the company a little more than two months ago.

Once officially onboard, my first priority was to immerse myself in many aspects of the company. I’ve met with key constituents, including customers, licensing partners and those in the investment community, some of whom I’ve known from prior roles at previous companies. Most importantly and where I’ve spent most of my time has been meeting and connecting with as many employees as possible with the objective of thoroughly understanding the company, what’s working and what might be improved. I’m pleased to say I learned we have a passionate team of dedicated professionals brimming with creativity and commercial savvy. I want to acknowledge the great work of my predecessor, Mike Lunsford, and the senior team for getting the company back on firm footing.

Perhaps the highlight of my immersion was attending San Diego Comic-Con and our Funko Fundays event. The passion of our fans was on full display. They loved the opportunity to pop themselves in Deadpool or Wolverine gear and accessories. Loungefly showcased amazing exclusives and had their best-ever sales at Comic-Con, and the Mondo team came to the convention with an awesome assortment of collectibles and posters with some sneak peeks that stopped the crowds in their tracks. And the Funko Fusion! panel was a huge hit, developed in collaboration with 10:10 Games and NBC Universal, Funko Fusion! is slated to launch on next-generation console and PC on September 13. Funko Fusion! is an action platformer that brings together 20 beloved franchises into one adventure, including Five Nights at Freddy, Invincible, Jurassic World and many more.

Our team displayed never before seen gameplay and trailers as well as previews of the next collection of pops from the game, all of which include a chance to unlock an exclusive character or special skin for a character within the game. My immersion within the company, my experience at Comic-Con and being surrounded by Funko fans crystallized my vision for the future of this company. Going forward, we believe Funko will grow by taking a fan-centric approach, which revolves around four fundamental principles. Delight our core fans, attract and serve new fans, sell where the fans are, and improve the fan experience. Let’s start with delight our core fans. Note that I am referring to our consumers who are true fans in every sense of the word. Everyone is a fan of something and our brands empower them to express their fandom with what they display, wear and carry.

We will continue to amaze and serve our fans with an assortment of unique and imaginative products from our beloved Funko pop figures, including exclusives and limited edition collectibles, our Loungefly bags and accessories and our high end Mondo collectibles. Second, attract and serve new fans. I believe we can unlock tremendous growth by expanding the fandoms that we serve. In the past few years, we’ve begun tapping into additional fandoms, including anime, video games, music and sports. We believe these fandoms present opportunities for further growth. Let me tell you about a recent proofpoint. Within 30 minutes of the final whistle, we went live with a one-of-a-kind limited edition collectible, Pop! Boston Celtics 2024 NBA Champions 5-Pack, on our direct-to-consumer website, funko.com.

The product significantly outperformed last year’s offering. This kind of fan-driven moment excites both casual fans and collectors and keeps them coming back. Another excellent example is Pop! Yourself, a recently launched product that allows fans to celebrate the moments in their lives by creating custom pop figures to commemorate special events such as Valentine’s Day, Mother’s and Father’s Day, graduations, birthdays, weddings and many other occasions. Since launch in August of last year, over 80% of Pop! Yourself customers are new to Funko, which is a proofpoint that there are large untapped fandoms we have yet to serve. Third, sell where the fans are. Although our distribution network of retail partners is incredibly diversified with no single retail partner representing more than 10% of our total sales, we still have the opportunity to reach many more new customers.

To do this, we plan to continue to grow our direct-to-consumer channel. Our direct-to-consumer business has doubled from 12% of our business in 2022 to approximately 25% today, and it generates a significantly higher gross margin than our wholesale business. Second, we anticipated expanding our test and learn license store model. We have three today operating in Dubai and Abu Dhabi. And third, within our wholesale channel, we plan to establish new points of sale with new partners both domestically and abroad. To give you one example, I believe we can make great strides in growing our sports business by selling our products where the sports fans are, in stadiums and arenas, on college campuses and in sporting goods stores, both brick-and-mortar and online.

Finally and underpinning everything is to improve the fan experience. This encompasses everything from improving our e-commerce experience to providing excellent customer service. These four principles are core to our future growth because, number one, great products keep fans coming back. Number two, new audiences grow the business and there are lots of them we haven’t tapped. Number three, new distribution is available to us to improve our margins and to reach new fans. And number four, keeping fans at the center of all we do breeds love, loyalty and long-term value. Before we discuss our financial results, I’m pleased to announce that we have removed Acting from his title and appointed Yves LePendeven as our Chief Financial Officer. Yves joined Funko five years ago, and during that time, has held several senior finance roles.

He is extremely knowledgeable about the company and highly regarded by the entire team as well as our investors, bankers and investment analyst community. He has been my right hand since I joined Funko, for which I am personally grateful. He is deserving of this new role and I look forward to working closely with him as we work to scale Funko and take it to the next level. And with that, I’ll now turn it over to Yves to take you through the financials. Yves?

Yves LePendeven: Thanks, Cynthia. Hey, everyone. Thanks for joining us today. For the second quarter, total net sales were $247.7 million. Direct-to-consumer sales mix in Q2 was 23% of our gross sales, up from 18% in last year’s Q2. This represents 33% direct-to-consumer sales growth, which we achieved despite a lack of new entertainment releases due primarily to the Hollywood strikes. Our Q2 sales included a pull forward of approximately $9 million as certain customers placed orders earlier than usual in part to secure vessel space due to rising freight costs and container availability issues. The bottom line impact was approximately $2.5 million. Gross profit was $104 million and gross margin was 42%. The higher than expected gross margin was driven by better than expected margins on value channel sales and a corresponding relief in inventory reserves.

SG&A expenses were $77.9 million, which was better than expected due in part to a non-recurring net benefit of $1.5 million. We’ve also shifted some marketing spend into the second half of the year. Adjusted net income was $5.6 million or $0.10 per diluted share, which was above our guidance range for the quarter. And finally, adjusted EBITDA was $27.9 million, which was well above our guidance range and the result of the combined effect of higher sales and gross margin and lower SG&A. Turning to our balance sheet. At June 30th, we had cash and cash equivalents of $41.6 million, which is after we paid down $22.5 million of debt in the second quarter. Our total debt was approximately $223.9 million, down from $246.4 million at the end of the first quarter.

Total debt includes the amount outstanding under the company’s term loan facility, net of unamortized discounts, the balance on our revolving line of credit and our equipment finance loan. Total company liquidity increased to $101.6 million from $69.1 million at the end of last quarter and up from $36.8 million at the end of Q2 last year. And net inventory was $109 million, down from $112.3 million at March 31, 2024. Turning to our outlook. We are reiterating our 2024 full year guidance of net sales of between $1.047 billion and $1.103 billion and delivering adjusted EBITDA of between $65 million to $85 million. Before I provide our third quarter guidance, I’d like to note a couple of things. First, as I mentioned earlier, we estimate about $9 million in net sales were pulled forward from Q3 into Q2.

Second, unlike in years past, we expect net sales to be higher in our fourth quarter than in the third quarter due to our higher mix of direct-to-consumer sales and the giftable nature of product lines like Pop! Yourself and Bitty Pop! This, of course, is dependent on a strong holiday season, which we’ll have a better sense of on our next conference call. With that background, for the 2024 third quarter, our guidance is as follows: Net sales between $282 million and $297 million. Gross margin between 38% and 39%. SG&A expense of $90 million to $95 million. Adjusted net income between $0.5 million or $0.01 per diluted share and $3 million or $0.06 per diluted share. Finally, we expect adjusted EBITDA between $21 million and $25 million. Cynthia, that’s it for our financial results.

Back over to you.

Cynthia Williams: Thanks, Yves. In summary, we reported a strong overall financial performance in Q2. Our outlook for 2024 reflects the stabilization of our business despite a weaker content slate and some uncertainty around freight cost and consumer spending going into the holidays. We’ve made solid progress on developing our strategic plans to grow the company, with a focus on our fans. As you would expect, some of these plans will take time to develop and implement. We’ll give you further updates in upcoming calls. Finally, and on a personal note, I want to thank all of my new colleagues at Funko for the warm welcome. And with that, we’ll open the call for questions. Operator?

Q&A Session

Operator: We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Eric Wold from B. Riley.

Eric Wold: Thank you. Good afternoon, guys. Great quarter. A few questions from my end. I guess, first off, I’ll start off, not sure who wants to take the question, but, obviously, huge upside on EBITDA for the quarter. Maybe just walk us through the biggest surprises on your end or biggest deltas in your end to take you to $27 million versus the $9 million to $15 million range. And what in that — besides the one-time thing you called out around SG&A, what may not be repeatable with the performance like that?

Yves LePendeven: Sure, Eric. Hey. Thanks for the question. I’ll take that one, and I’ll call out a couple of the main ones. Right? So, we beat our net sales guidance. We came in above the top end of the range, and as I mentioned, about $9 million of that was pulled forward from Q3. So, that was primarily from our direct import customers and as you’re aware, the rising freight costs and also the uncertainty about being able to secure vessel space. We had some customers’ orders that basically shipped in June versus July. So, that was one part of it. The other part is the inventory reserve relief. So, approximately 2.5 points of our margin favorability, gross margin favorability, came from that. We continue to see a really great environment in the value channel.

And as we continue to sell aged inventory into that channel at good margins, we were able to relieve some of our reserves. And so, that’s one item that we wouldn’t see in Q3 and Q4. So, between those two, I think those drove a lot of the adjusted EBITDA favorability, but we also came in under SG&A, not just because of the non-recurring benefit that’s normalized out of adjusted EBITDA anyways, but we just continue to stay focused on managing expenses.

Eric Wold: Got it. That’s helpful. And then thinking about the guidance, if I look at the $37 million of adjusted EBITDA in the first half and take the low end of the guidance for Q3 of $21 million to get to $58 million through three quarters, what would need to happen in Q4 from this point to only generate $7 million to get to the low end of the $65 million? Obviously, you kept it out there because it’s possible. So, kind of from your standpoint now, what would really need to happen to only get the $7 million at the low end maybe for EBITDA in the fourth quarter?

Yves LePendeven: Yeah. I’ll take that one as well. I mean, obviously, we’re pleased with the progress we’ve made in the first half on adjusted EBITDA and getting to our full year target. I’ll answer your question, I guess, by going to the top line first. And as we said in the call, a little bit more of our sales are going to be weighted in the second half than they have previously. Part of that was due to the pull forward from Q3 into Q2. The other part is the higher mix of direct-to-consumer sales and additional weighting into the fourth quarter. So, with that being said, we’ve made more progress on the bottom line than on the top line. And we feel confident in achieving our initial guidance that we put out there, but it’s just an uncertain environment right now.

We’re watching a lot of indicators, as I’m sure you are too, between interest rates, the labor market, consumer spending, it’s just — it’s a lot — a lot of our sales are still ahead of us and the environment is uncertain. And so, that’s why we just reiterated our initial guidance.

Eric Wold: Got it. So, I guess, the biggest — if I’m hearing you correctly, I think the biggest part is given the significant strength and importance now of DTC, a little less visibility into that than you would into a wholesale order that’s already come in for the holiday. And so, you kind of want to see how that plays out. Is that fair?

Yves LePendeven: That’s exactly right.

Eric Wold: Okay. And then just last question, if I may. Obviously, based (ph) on where wholesale channel inventories are right now relative to where you want them to be heading into the holiday, and what are you kind of hearing from your retail partners or already seeing from orders about their comfort taking product into the holiday versus prior years?

Yves LePendeven: Yeah. I mean, for the same reasons I just mentioned, we’re staying very close to our retail partners and watching inventory levels very closely. We’re being prudent about the buys that we’re making. And the good news is that the inventory that they have for those customers that report POS sales and POS inventory to us, they’re in a healthy place right now. We typically want to see 15 to 20 weeks of supply out there in the marketplace and they’re right around that range. And so, the quality of the inventory, the levels of inventory are good right now. But as I said before, I think a lot is going to depend on how the consumer shows up in the holidays and we’ll have a lot more visibility to that in our next call.

Eric Wold: Perfect. Thank you both. Appreciate it.

Yves LePendeven: All right.

Cynthia Williams: Thanks, Eric.

Yves LePendeven: Thanks, Eric.

Operator: [Operator Instructions] And our next question comes from Stephen Laszczyk from Goldman Sachs.

Stephen Laszczyk: Hey, great. Thanks for taking the questions. Maybe first for Cynthia. Now that you’ve been in the seat for a few months and maybe going off of some of your prepared remarks, I’d be curious if you could reflect on some of what you learned since taking over as CEO. What have you learned that this maybe reaffirms some of the thoughts coming in to the position? And then are there any areas of the business that you think might have more opportunity for improvement?

Cynthia Williams: Yeah. Thanks, Stephen. First, I’d say what I’ve been really pleasantly surprised — I mean, pleased to see is two things. First, the employee base is incredibly passionate, engaged and creative. That just reinforces for me that we can stay focused on our fans and deliver product that they’re going to love. I’d say the second has been the engagement with the fans. I don’t know if you’ve ever had a chance to go to San Diego Comic-Con and attend a Funko Fundays, but that is an experience unlike any other fan event I have ever seen. And I thought I had been to some crazy fan events. These folks are so passionate. They’re so engaged. They are a real community. What I saw with their engagement with us at the booth where we were selling product demonstrates to me that they are very much with us.

They’re core and real fans and they want to see us succeed. And so, I think those together have left me with real optimism that as long as we’re putting out high quality creative product, this business has an exceptional future.

Stephen Laszczyk: Got it. Thanks for that. Maybe two financial questions for Yves. Looking at Europe versus international versus the U.S., could you maybe talk a little bit more about the drivers of the strong growth you’re seeing in Europe international, and perhaps how those trends differ from what you’re seeing in the U.S. at the moment? And then just lastly on logistics, I think you called out some of the volatility in the freight market. Curious, if you could expand on this a little bit more and how you see and handicap the risk of vessel procurement as you head into the tail part of the year? Thank you.

Yves LePendeven: Sure, no problem. So, I’ll speak first to your question about the sales, the sales difference, I guess, between the U.S. and the European market. We’ve focused a lot on the U.S. market in the past few quarters on these calls. One of the things you’re seeing in Q2 is two-fold, right? In the U.S. market, we had expanded very quickly into the mass channel. And about 18 months ago, we started the process of strategically pulling back and making sure that we had the right products in the right channels. And so, that’s one part of it. We also did a 30% SKU reduction last year, which was a long tail of SKUs and not a material impact to sales, but still more of a factor in the U.S. than in Europe. And then the third thing, I’ll call out, again, the weaker content slate.

I think that had a little bit more impact on the U.S. market. Although we’ve shifted our mix of product to more evergreen product, we’ve made more headway in Europe than in the U.S. And so, that had a little bit more of an impact in the U.S. So, in contrast to that in Europe, we saw really nice 20% sales growth in the quarter. I’ll just kind of call out that within that region, Eastern Europe, Greece and the Middle East were really drivers of that growth. So, that’s something that we’re taking those lessons, bringing them over to the U.S. and continuing to expand our distribution and then expand our mix of evergreen content in what we sell.

Cynthia Williams: I’ll just share one additional highlight since you covered the evergreen, which I do think that Europe got far out ahead of the U.S. on, and it’s been a real wonderful lesson for us to bring into the U.S. The second, though, is the licensed store model that we were talking about a bit earlier. We have three in the Middle East, and in that model, we partner with a retailer who has experience in that market, understands those customers, will deliver based on our brand requirements, and in addition to a bit of a licensing fee then, of course, they’re buying product from us. And that for us is a no to very low capital way for us to expand our markets and you’re starting to see that take hold in the EMEA region as well.

Yves LePendeven: And then, Stephen, I’ll answer the second part of your question on freight. So, a couple of months ago, we were watching that market very closely. I think the good news is that rates seem to kind of have stabilized and so they weren’t a material impact in our Q2 results. We do capitalize freight costs to the balance sheet and then you’ll see some of those higher costs impact us more in Q3 and Q4. I’d say right now it’s not very material, but it is something that we factored into our guidance for our gross margin of 38% to 39%, which is slightly lower than Q1 and Q2, that was one of the factors that caused that.

Stephen Laszczyk: Got it. Thank you for all that.

Operator: [Operator Instructions] As we currently have no further questions on the queue, I will hand back over to Cynthia Williams for any final remarks.

Cynthia Williams: Thank you, everyone, for joining us on the call today. We look forward to sharing our progress with you on our very next call.

Operator: Thank you, everyone, for joining. You may now disconnect from the call.