Funko, Inc. (NASDAQ:FNKO) Q4 2022 Earnings Call Transcript

Funko, Inc. (NASDAQ:FNKO) Q4 2022 Earnings Call Transcript March 1, 2023

Operator: Good afternoon, and welcome to Funko’s conference call to discuss financial results for the fourth quarter of 2022. Please be advised that reproduction of this call in whole or in part is not permitted without written authorization from the company. And as a reminder, this call is being recorded. I would now turn the call over to Ben Avenia-Tapper, Director of Investor Relations, to get started. Please proceed.

Ben Avenia-Tapper: Thank you, and good afternoon. With us on the call today are Brian Mariotti, Chief Executive Officer; and Steve Nave, newly appointed Chief Operating Officer and 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 the most directly comparable U.S. GAAP financial measures and supplemental financial information can be found in the earnings press release and 8-K that we released earlier today. All these items, plus a visual presentation that investors can consult to follow along with this discussion are available on our Investor Relations website, investor.funko.com. I will turn the call over to Brian.

Brian Mariotti: Good afternoon, and thank you, everyone, for joining us today. As most of you know, this is my first earnings call as I step back into the role of CEO in December. I’d like to use this call to provide an update for the important work that is underway at Funko. I want to first emphasize that I step back into the role of CEO because I fully believe in the power of the Funko brand and its potential, but also recognize significant operational issues confront us. Our first priority is a reset of our operations, which we are addressing with urgency, but it won’t happen overnight. Recognizing our current situation, I think it’s important to understand how we got here. Since we IPO-ed approximately 5 years ago, we’ve more than doubled our revenue.

We have taken a nascent direct-to-consumer business and growth of 15% of total revenue this past quarter. We’ve expanded into multiple neuteography and we’ve added amazing new brands for our pop-culture platform. This rapid growth brought challenges that we are now addressing. Our history proves that we can deliver reliable, profitable growth. But to do so, we will need to reset our operational foundation. With that context, let’s turn to the results for the quarter. Demand for our brands is stronger than ever, but we’re still early in our operational reset. Looking at our financial results for the fourth quarter, net sales were $333 million, down 1% year-over-year, wrapping up the year in which we grew 29% year-over-year. In our direct-to-consumer business, the channel we have most control over, we grew 37% year-over-year.

And on the wholesale side, while we don’t typically comment on point of sales trends, wholesale sell-through has been very encouraging. In Q4, we posted double-digit POS growth, well ahead of NPD estimates of flat growth for the broader industry over the same period. While demand remains strong, our fourth quarter profitability was heavily impacted by our operational challenges. Adjusted EBITDA was a loss of $6 million and adjusted EPS was a negative $0.35. It was clear on our last earnings call that the business and our operations hit an inflection point, a combination of macro factors and Funko-specific issues have disrupted our financial and operating performance to an unacceptable degree. We’ll share more details on our financial results shortly, but I want to spend this time discussing the important work that’s underway and how we’re going to get our operations back on track.

Our Board and our management team are deeply focused on execution and unlocking the potential of Funko’s unique value proposition. To begin, we have strengthened our leadership team. Steve Nave, who is with me on today’s call, joined us in early December in interim operations consulting capacity. We announced that today, Steve will serve as both the new Chief Financial Officer and Chief Operating Officer. Steve brings a wealth of expertise spanning retail, consumer and e-commerce industries. He served as CFO, COO and CEO of Walmart.com where he is responsible for all aspects of a multibillion-dollar e-commerce business. More recently, Steve was the CEO of new — brand, a multi-channel retail. We are thrilled to have Steve on board. We made good progress in aligning the finance and operations side of the business, and that’s exactly why Steve will be serving in both capacity as CFO and COO.

Allowing Steve to oversee both functions, we believe we’ll be better positioned for him to drive that alignment as we work across the organization to improve efficiencies and ultimately, our financial results. Our efficiency improvements fall into 3 categories, gross margin initiatives, fulfillment cost reductions and other SG&A savings. These actions are well underway, but 2023 is still very much a year to operationally reset. Once completed, we believe these actions will save us between $150 million and $180 million annually. Our first category of focus to improve execution is on the gross margin line. Here, we have 2 primary levers: price and product costs, which, together, we expect to contribute approximately $60 million to $70 million in annualized adjusted EBITDA.

Last quarter, we discussed extending our price increases to include our exclusive product line. The resection has been encouraging, and we believe our products remain curly at an affordable price range for our customers. We are also driving down our product costs with the introduction of a more competitive bidding process from our vendors and a more comprehensive assessment of cost throughout the product development life cycle. The second and third categories include addressing our fulfillment obstacles and reducing other SG&A spending. Since the pandemic, we’ve added approximately $85 million in annual fulfillment expenses despite similar overall throughput in our distribution center. The mix of the business has changed since 2021. But by focusing on the execution, we can replan a significant portion of that spending increase.

Combined, we expect fulfillment savings and other SG&A reductions to add $90 million to $110 million in annualized adjusted EBITDA. The first action addresses the efficiency of our distribution center. We’re implementing a warehouse management system that we believe will dramatically improve our cost to fulfill. This system is expected to be up and running this summer. The second fulfillment improvement action is addressing our elevated inventory levels. We are beyond the intended capacity of our Arizona-based distribution center. The volume is restricting our distribution centers throughput and incurring incremental container rental charges. By eliminating this inventory, which we expect to do in the first half of this year, we expect that will both reduce SG&A spending expenses and improve our gross margin by saving on incremental container rental targets.

Finally, we are taking steps to reduce operating expenses across the board, including a workforce reduction of approximately 10%, tighter marketing spend, and other cost reduction actions to ensure our spending is aligned with our top line results. These changes are on-going, and we are focused on executing on all these initiatives with a high degree of urgency. We expect the margins in the first half of the year for me under significant pressure. However, by the second half of the year, we expect the combination of gross margin initiatives, improved fulfillment and reduced SG&A spending to return for our adjusted EBITDA margins to double digits. 2023 is a year for us to focus on operations. Most of that work is already underway and will continue throughout the first half of the year.

Many of our retail partners have been very tentative in their post-holiday restocking, and we expect that to weigh in on first half However, as already noted, demand and sell-through remain strong. We expect a robust second half rebound in the content calendar. These factors give us confidence in top line performance in the second half. That sales trend, coupled with the bulk of our operational improvements coming in the first half, we expect our results to improve in the second half of the year. I look forward to updating you on the progress along the way. While we are heavily focused on execution, we have not lost sight of opportunities to grow our core business through new collaborations, adjacent product categories, new direct-to-consumer experiences and new geographies.

These opportunities are exciting and expected to help grow our bets. Today, however, operational improvements are the most important. Our execution here will help us to ensure we’re well positioned to win in these new growth opportunities in the future. We know that 2023 will be a year to reset, but I’m confident we will come out of this a stronger Funko from top to bottom. These steps will allow us to regain our operating leverage as we accelerate growth in the near future and deliver long-term value creation for the company and our shareholders. Now let’s turn it over to Steve to provide more details on the financial results of the quarter.

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Steve Nave: Thanks, Brian. Hey, everyone. It’s nice to meet you. I look forward to future conversations with each of you. I’m super excited about this business and helping to unlock Funko’s potential. I look forward to getting to know you all over the coming quarters as we continue on the operational and financial initiatives we have underway. Now jumping into the results. In the fourth quarter, we delivered net sales of $333 million, down 1% over the prior year. Our direct-to-consumer channel grew 37% to $49 million driven by very well-received events, including Black Friday and Cyber Monday. The strong performance in our direct-to-consumer business was offset by slower sell-in on the wholesale side. Wholesale declined 6% to $284 million as we manage through a period of muted destocking across most of our retail partners.

In the U.S., net sales declined 5% to $241 million, while net sales in Europe were relatively flat at $64 million. Other international net sales increased 45% from $28 million with double-digit growth in all of our emerging geographies. On a brand category basis, net sales in our core collectible brands declined 7% to $244 million, on lower evergreen content, as we prioritize more time-sensitive current content in light of our constrained logistics. The Loungefly brand grew 31% to $71 million, bringing the full year growth to 68% year-over-year as the brand saw strong demand. Among our other brands, which include poise and gains in our digital products, net sales declined 13% to $18 million as the on-going strength of our digital collectibles was offset by fulfillment challenges in our games business.

Turning to margin and expenses. Fourth quarter gross margin was 28%, well below our expectations due to multiple factors, including container rental charges and, to a lesser extent, chargebacks. These 2 factors reduced gross profit by approximately $15 million. While freights do continue to improve, this was offset by container rental charges incurred when capacity constraints within our distribution center prevented us from unloading containers. As Brian discussed, we believe that our on-going inventory management practices, combined with our lower product costs and increased pricing will allow us to get back to our historical margin range in the second half of this year. Moving on to operating expenses. We experienced significant headwinds due to constrained logistics.

SG&A was $139 million, which includes a onetime $33 million non-cash charge for the write-down of capitalized costs related to a pivot in our ERP deployment strategy. In addition, there was approximately $3 million in incremental labor and third-party fulfillment expenses. For the fourth quarter, adjusted EBITDA was negative $6 million, due to container rental charges, chargebacks and additional fulfillment expenses, all of which we are addressing in the first half of this year. Finally, adjusted diluted loss per share was $0.35. Turning to the balance sheet. We ended the quarter with $19 million of cash on hand. We ended the quarter with total debt of $246 million. Today, we announced an amended credit agreement which provides us with additional room under our financial covenants as we implement this year’s cost savings initiatives.

Please refer to our 10-K filing for additional details. Inventory at quarter end totaled $246 million, up 48% year-over-year. As Brian previously mentioned, we’ve conducted an exhaustive analysis of our fulfillment network and have decided to reduce our inventory levels to improve our overall cost to fulfill by managing our inventory to the proper efficient operating capacity of our U.S. distribution center. We expect this action to result in an inventory write-down in the first half of between $30 million and $36 million. Before I move on to our guidance, I’ll note that we’ve all been incredibly focused on identifying and addressing opportunities for improvement. We believe that executing on our initiatives will position us to drive sustained long-term shareholder value.

However, these initiatives will take time and in some cases, several quarters. As a result, we don’t expect adjusted EBITDA to be positive until the second half of 2023, but to improve sequentially throughout the year as these initiatives take hold. For the first quarter, we expect revenue of between $225 million and $255 million, excluding our anticipated inventory write-down, we expect gross margin to be slightly below this past quarter and improved sequentially throughout the year as our inventory actions, pricing and product costing efforts take hold. We expect SG&A to be sequentially lower by approximately $25 million. Adjusted EBITDA for the quarter is expected to be between negative $50 million and negative $45 million, returning to positive territory in the second half of 2023.

We expect adjusted net loss of negative $53 million to negative $48 million based on a blended tax rate of 25%. And adjusted loss per diluted share of negative $1 to negative $0.90 based on a weighted average diluted share count of 52.3 million. For the full year, as gross and operating margins improved, we expect year-over-year revenue growth between 0% and 5%. We expect adjusted EBITDA for the year to be between $50 million and $75 million with effectively all of that coming in the second half of the year. We’ve made steady progress, and there’s still much more to do. We’ve identified initiatives to capture between $150 million and $180 million in annualized adjusted EBITDA. The next two quarters will see us rebuild a stronger foundation for Funko, and we are confident it will produce meaningful benefit in the second half and into 2024 and beyond.

We appreciate your time this afternoon. Now I’ll turn it back over to Brian.

Brian Mariotti: Thank you, Steve. In closing, we remain very encouraged by the strong support and demand we continue to see from our devoted advance. As I’ve said, we recognize our results are not where we want them to be, and we are working with urgency to take operational steps we need to deliver margin improvement and drive a long-term shareholder value. We are confident in our ability to execute. Thank you for the time today, and I will now turn it over to the operator for Q&A.

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Q&A Session

Operator: Thank you. The first question on the line comes from Alexander Perry from Bank of America Merrill Lynch. Please go ahead. Your line is open.

Alexander Perry: Hi, thanks for taking my question. I guess just first, sort of is there any indication on when the operational headwinds from the lack of the warehouse management software at the new DC will be behind us? And then I guess the obvious question is, how much of a drag on sales, gross margin, SG&A, is that this year? So like if we sort of exclude the operational headwinds, what would the guidance have been? You mentioned some pretty positive color about wholesale POS being up double-digit percent in the quarter. Is that the type of growth rate that 2023 sort of would be if it weren’t for the operational issues you guys are facing? Thanks.

Steve Nave: Sure. Hey, this is Steve. I’ll take the first cut at this. On your first set of questions around the operational efficiency initiatives that we have underway, it’s going to kind of come in kind of phased throughout the year. For example, we’re already taking action on the inventory, and we’re already seeing some efficiency gains from that, although we’re not done with that work yet. We are starting to see some benefit there. We’ve already started to see these container rental charges that we’ve been incurring as we basically cut those in half as of a couple of days ago. So we’re seeing that benefit already. And that benefit is going to continue to get bigger and bigger as we work through the inventory. On the systems side, which is really the biggest hamstring in our U.S. distribution, we expect to have a warehouse management system in place this summer.

And normally in a systems implementation like that, it takes 45, 60 days to fully burn in and work out the kinks. But we’re confident that after that burn-in period, we’ll see some really nice efficiency, especially on the variable labor side of fulfillment.

Alexander Perry: Great. That’s really helpful. And then I guess just on the sort of 2 follow-up questions. Can you give us a little more color on the anticipated inventory write-down? Was this due to sort of lower wholesale reorders? Or is it primarily just the logistics issue, which didn’t allow you to unload the containers? And then my last question is what sort of led to the decision to not go through with the ERP implementation and take the charge in the quarter? Thanks.

Steve Nave: Sure. On the inventory, it’s purely an operating thing. The products are good, but the facility was running at over 100% capacity when it needs to run around 80% capacity to be as efficient as we’d like it to be. And we were incurring all these kind of storage costs, both in terms of the container rentals as well as some off-site storage that we had to procure in the fall of last year and then another temporary one that we’ve had to put in place a few weeks ago. So the inventory reduction is purely in order to be able to operate more efficiently and save a lot of money on storage costs. We work that trade-off through pretty tightly to understand that takes a hit to get rid of that inventory, but we’re very confident of the payback that we’re going to get as a result of being — just being more efficient and saving on storage costs.

On the ERP question, so it’s a little bit of an involved answer. We figured out in early part of this year, let’s call it, January, that we were not going to be on time with the launch of the ERP that was scheduled to happen this summer. And unfortunately, the warehouse management system for the Buckeye facility would have been tied to the launch of the ERP. So we took a look at the landscape, other system solutions that were out there that maybe we could implement much more quickly, including the ERP that we run very successfully in our EMEA business. And basically made the decision that we could move forward, invest less money in a pivot in the strategy than it would have cost to complete the original strategy. And the side benefit is it gives us the ability to actually launch a warehouse management system in advance this summer.

So full-blown ERP Phase 1 will not be completed until sometime in 2024, but we’re able to separate warehouse management from that now and go down that path separately.

Alexander Perry: Perfect. That’s really helpful. Best of luck going forward.

Steve Nave: Thank you. Appreciate the questions.

Operator: The next question on the line comes from Linda Bolton-Weiser of D.A. Davidson & Co. Please go ahead.

Linda Bolton-Weiser: Yes, hi. I’m sorry if you answered this because I missed the very beginning of your commentary, but like my understanding was that this distribution center was like almost inaccessible, like it was just so many problems and that therefore, you had to have duplicative storage and inventory in third-party locations. So are you saying now that you are accessing the DC? Or like — I’m just not — I’m trying to figure out like what has happened since the last time you spoke about all this.

Steve Nave: Yes, sure. So I mean, we’ve been operating that distribution center since, I believe, June or July of last summer when it went live. The problem with the inventory is it just became too cumbersome to operate in any sort of efficient manner. So the notion that we’ve not been able to access it, I would say, is not quite accurate. We’ve been using it. It’s been incredibly inefficient both because of the system issue as well as the inventory starting to pile up. And so yes, I mean, like I answered from the last call, we’re already seeing some of the benefits of the changes that were taking place. Does that cover everything you asked?

Linda Bolton-Weiser: Yes. Yes, that’s fine. And previously, I know you were just giving very rough guidance before because you didn’t quite know probably, but I know you were talking about an SG&A — adjusted SG&A level of $100 million per quarter thereabouts. Is that still the case? Or I know you said it like it’s going to be that high in first quarter, then it’s going to come down? Or what’s the color on that?

Steve Nave: Yes. So the — our SG&A expenses this year, we’ve got some headwinds there the annualization of some expenses and payroll that we — new payroll that we incurred last year. We are working very aggressively to bring that down. Inside SG&A is the variable labor. Well, it’s more than just the variable labor, but mostly variable labor of our distribution centers. So you’re going to see improvements there. Again, back to my previous answers, probably not until — I mean we’re seeing some benefit now, but real benefit not until later this year. And then we’ve got a number of cost takeout initiatives that Brian alluded to that are underway that are going to bring it down even more.

Linda Bolton-Weiser: So — sorry, I didn’t glance at your SG&A in the fourth quarter yet, but what was that number? And then how much of that in the fourth quarter SG&A is unusual type expenses that will eventually go away?

Steve Nave: I might need to follow up with you on that question just to make sure that I’m capturing it correctly. Our fourth quarter SG&A was about — was $139 million, that included — that includes a $32 million charge for the ERP write-down that I just discussed. And then small single-digit millions of other non-recurring onetime expenses.

Linda Bolton-Weiser: Right. So even excluding the charge, that’s like whatever, $100 million. That’s a very large number for a company of your size. So I’m trying to figure out like what’s normal if you’ve got all these things going on because just a few quarters ago, your SG&A was like, I don’t know, it was like below $70 million or something. So how much of it is like unusual like that’s nonrecurring sort of once you fix all your problems?

Steve Nave: Well, I mean, the things that I just mentioned, that’s about — that’s going to total about $40 million of nonrecurring expense that we got hit with in the fourth quarter that we’re not going to see going forward into 2024. There are some other headwinds in the number for this year, the annualization of any new hires that took place last year is the best example of that. But again, the cost takeout initiatives that Brian mentioned and that I’ve mentioned as well, are going to — you’re going to see a pretty dramatic reduction in our SG&A expenses over time.

Linda Bolton-Weiser: And will that be noticeable in third quarter 2023 or not until fourth quarter?

Steve Nave: It will be noticeable in third quarter.

Linda Bolton-Weiser: Okay. Got you. Thank you. And then one more thing on just the retail situation, I have a lot of my other companies talk about how specialty retailers didn’t stock up as much inventory, so they’re not reducing inventory because they never had it, but it’s the bigger big-box retailers that are more problematic. And I think you talked about that. However, Walmart said, their inventory was flat year-over-year in the last quarter. It seems like the problem is like fixed almost pretty much. So is that the case? And like why wouldn’t your sales growth then kind of snap back a little bit more quickly?

Brian Mariotti: Yes, Linda, this is Brian. Yes, I would say that you’re accurate on the first part. Definitely, specialty has not had the dip that some of our bigger partners did when they had some over inventory positions and they began basically canceling orders in late third quarter and also fourth quarter. We are seeing some rebound, but we’re also still seeing a little bit of conservative nature in terms of ordering with some of the bigger accounts. I mean the one thing that is in our favor and as has been is lack of concentration, right? I mean, no one retailer is more than 8% of our overall business. And then obviously, our number one customers ourselves at close to 15% for the quarter percent, which is our direct-to-consumer channels. But yes, I mean, it’s been a slow but starting to show take on our bigger retailers in terms of increasing their orders with exclusive content in the everyday items.

Linda Bolton-Weiser: Okay, allright. Thank you very much. I really appreciate it.

Brian Mariotti: Thank you Linda.

Operator: The next question on the line comes from Megan Alexander of JPMorgan. Please go ahead. Your line is open.

Megan Alexander: Hi, thanks for taking my question. I guess maybe to follow up on that. Is there any way within the guide of the first quarter, at the midpoint, maybe down 25% that you could unpack the impact from maybe some normalizing seasonality, the impact of destocking. Just help us understand what the actual core underlying demand that you’re projecting there is and maybe what you’re expecting for POS. And are you seeing more destocking than your POS might suggest, given your inability to fulfill product? And when would you expect that dynamic to reverse?

Steve Nave: Yes, I think — so I think there’s a lot to unpack there, and it’s going to take a little bit of time to unpack that for you. But I mean great questions. Also, you’ve got to keep in mind that we are trying to comp an artificially high quarter in the first quarter of last year. So when we look at our sales guide for the first quarter, it’s taking into consideration that especially January and February of last year, had really sales, as a lot — supply chain challenges caused orders and replenishment orders specifically to move into — from like a November, December time line into January and February. So a big part of the basically flat to 5% growth, which is pretty muted, obviously, for the first quarter of this year as a result of that.

Brian Mariotti: Yes. We’re still definitely seeing great trends on the sell-through on POS. So we’re definitely — the brand continues to do extremely well. It’s just a slower amount of orders coming in from some of the bigger customers. But that, again, like I said on the last question by Linda, starting to thaw a little bit, and it’s looking a lot better for us, but we’re very encouraged by the strong POS.

Megan Alexander: Okay. And then maybe a separate question. Are there more investments in capacity needed after this? I think you mentioned you were running additional 3PLs and last I heard you hadn’t moved Lounge lie into the new DC. So if that warehouse is kind of already at 100% capacity. How should we be thinking about additional investments beyond this needed to achieve the growth you expect? And related to that, how much of the $180 million of savings actually flows through to the bottom line?

Steve Nave: Sure. So the first thing that I’ll say is we’re leaving no stone unturned on the supply chain side. So we’re looking at every possible option to enhance the network in a way that’s more financially efficient than what we’re delivering today. Specifically on things like Loungefly, we’ve moved the Loungefly direct-to-consumer business into Buckeye that hasn’t happened already. It’s like happening this week or next. So we’re going to start fulfilling that product out of the Buckeye, Arizona facility here very soon. We are looking at all of the third-party logistics partners that we have, not just the Loungefly partners, but all of them to understand if there are some synergies we can get by collapsing those into one or two larger facilities, etcetera.

As it relates to Buckeye specifically, the inventory reduction initiative is going to allow that building to handle the capacity that we needed to handle for the next couple of years for sure. But we are also still looking at potential long-term 3PL solutions as we grow into more and more volume.

Brian Mariotti: Yes. I’ll add just one more thing on to what Steve said, which is a real hyperfocus on FOB pickups from some of our bigger customers that we finally had a chance to set up direct ship. So we’re also pushing a lot more volume out of Asia in 2023 than we ever have before. So another encouraging trend for us as we put in the WMS for mid-summer and really think that the efficiencies in the warehouse in terms of just getting product out the door and cost to fulfill will be on their way down starting to third quarter.

Megan Alexander: Okay. That’s helpful. Maybe if I could sneak in one more, just as a follow-up to the previous question. Is there any way you can share what DDC looks like through the first two months of the year relative to the 37% you talked about in the fourth quarter?

Brian Mariotti: Yes. I mean, look, it just continues to grow for us. I mean it is our strongest growth category is the fact that we have control of the iterative on that. It makes it a little bit easier with some of the difficulties in the last 1 quarter, 1.5 quarters of some of the bigger retail partners. We continue to just broaden the ability to fulfill quicker out of those direct-to-consumer orders. And we have great content coming out of the D2C channel. So we do expect again, significant growth for direct-to-consumer throughout the entire year. Obviously, the content slate gets a little bit better toward the middle and end of the year as compared to the content slate in 2022, which was about as poor as I’ve seen it in years.

So again, Loungefly and Funko continue to do really great things in direct-to-consumer and Mondo’s business, which is going to grow significantly this year since we acquired it, is pretty much all direct-to-consumer. So we will continue to see a lot of heat on that channel for us, and we’re really happy about that.

Megan Alexander: Okay, thank you very much.

Brian Mariotti: Thanks Megan.

Operator: The next question on the line comes from Gerrick Johnson of BMO. Please go ahead. Your line is open.

Gerrick Johnson: Hi, good afternoon. Thank you very much. Steve, can you talk about the inventory that you are liquidating, what type of product that is? I think it’s important given that a lot of your customers are collectors. And where is that product being liquidating? And how is that being done?

Steve Nave: Sure. So obviously, we went after the oldest inventory first. Again, inventory that we felt like we could sell over time, but due to the operational constraints, it’s just better to get out of it. So we’ve looked at all the inventory that’s been the oldest as our first bucket. And then we’re looking at anything where we feel like sure, we’re selling quite a bit of it, but we might have more weeks of supply than we need, right, to manage the business efficiently. I mean there are about 8 different lenses that we’re using to look at all of our inventory to determine which units are going to get destroyed. Speaking to how and where that’s happening, we’re using a third party and they’re not far from our distribution center in Buckeye, Arizona, so we’re not going to incur too much transportation expense to do that, but we’re using a facility that can certify the destruction for us so that we can provide certificates of destruction to our licensors.

Gerrick Johnson: Okay. So it’s being destroyed, clear. And the product, I guess, would be a whole range of products from pop on to other product that you sell, I don’t know.

Brian Mariotti: Yes, absolutely. Yes.

Gerrick Johnson: Okay. Okay. And Steve, can you talk about the inventory at Hobby and specialty a little bit more? Do you — and more importantly, I’m wondering, now that you’ve stepped into this role and you had a look under the hood, do you have confidence in Funko’s systems and the ability to track that inventory?

Steve Nave: Well, that’s a 2-part question for sure. My confidence level, yes, we don’t have the best systems right now, which is why we talk about things like an ERP and a warehouse management system. So I have confidence that we’re going to get to a place where our systems infrastructure supports the business the way it’s to. In the meantime, a lot of this stuff is done semi-manually. And we’ve especially on initiatives like this inventory effort, we’ve put in so many redundant controls in the generation of the products that we have flagged to get rid of as well as kind of the execution of getting the files passed back and forth between our planning group and the distribution center that I’m confident that we’ll do this without messing it up.

Very confident. One thing that I wanted to go back and just emphasize for you though, Garrett, is yes, we are destroying this product, but we’re doing it through a very green third-party firm that’s going to recycle everything, to the extent it can be recycled. So I just wanted to make sure that everybody knew that we’re trying to do this the most responsible way we possibly can.

Gerrick Johnson: Okay. Thank you very much.

Steve Nave: Yes, thank you Gerrick.

Operator: The next question on the line comes from Stephen Laszczyk of Goldman Sachs. Please go ahead.

Stephen Laszczyk: Hi, thanks for taking the question. Maybe just one more on the new distribution system. I was wondering if you could talk a little bit more about what the biggest differences will be between the new system compared to the one proposed last year? And do you anticipate that the new system once implemented will have a opportunity for efficiency over the long term as the plan you laid out at Investor Day last year?

Steve Nave: Yes, Steve. So that’s a good question, and to clarify something for everybody. So the new warehouse management system that we’re talking about deploying this summer is what I would call a warehouse management system light. It’s not necessarily the permanent solution, but it’s something that we know we can deploy very quickly with very little incremental cost, relatively speaking. It may be that as we complete our analysis around what the right permanent solution is that would be tied to a full ERP launch, it may be that we go in a different direction again. Although I expect what we’re going to find with the lighter system that I just mentioned is we’re going to end up with about 70% to 80% of the feature and functionality that we would have gotten with a full-blown top shelf warehouse management system.

It’s such a leap forward for our business to have the 70% to 80% that it’s going to produce amazing benefits in terms of our ability to operate efficiently, but it may not be the full term solution going forward. Now the one benefit that I will say of taking this bifurcated approach to the deployments is we won’t be dependent on the actual ERP to get the systems implemented. And that also means that when we implement the new ERP, we don’t, at the same time, have to implement a new top shelf warehouse management system if we decide to go down that path. We can still keep it bifurcated through the ERP, let that burn in, figure out the tweaks and the issues that every system implementation has and then go back and upgrade our warehouse management system if we decide that that’s worth the juice is worth the squeeze.

Stephen Laszczyk: Thanks, that’s helpful. And then maybe separately, could you talk some more about the assumptions behind your 2023 outlook, maybe just in terms of your outlook for the economy, the health in pacing of the consumer and what you’re hearing out of the retail channels in terms of the back half orders picking up, that would be helpful.

Brian Mariotti: Yes, I’ll take that one. Yes, look, I — yes, absolutely. So look, we have obviously, visibility to our order book through all the way through Q3. And we also know there’s a lot of great content in 2023 compared to 2022. We’re seeing, say, like I said earlier, falling if some of the bigger customers in terms of liking back to their normal levels or bring on a week-to-week basis for us. So between the combination of all 3, I mean, we think we’re in a really good position to start building momentum towards the second half of the year. And then as we do that, obviously, the implementation of the Parachute and the FOB fulfillment increasing dramatically in Asia and just better systems in places like Steve said, every angle that we’re looking at in terms of getting better and fulfilling, getting faster, fulfilling and reducing our cost to fulfill should all be taking place and hold in the Q3 and Q4.

So ultimately based on the super positive POS for the brand and specialty always been a big part of our overall business with the lack of concentration we have. We see this thing continuing to build back to what we think are really good levels in the second half of the year.

Stephen Laszczyk: Great. Thank you.

Brian Mariotti: Thank you Steve.

Operator: The final question on the line comes from Andrew Uerkwitz of Jefferies. Please go ahead. Your line is open.

Andrew Uerkwitz: Great. Thank you. I appreciate the time. Just two quick ones. The first one is with all these moving pieces and kind of a stronger back half, could you share with us kind of a little bit of color around what you think like exit rate gross margins or exit rate operating margins would be as we exit this year and get a lot of these issues behind us?

Steve Nave: I’m not sure if we’re sharing that level of detail yet about the exit rate on the year, but you’ll certainly — we’ll certainly bring you along for the ride throughout the year, and you can see those — the see for yourself as those trends improve.

Andrew Uerkwitz: Got it. And then.go ahead.

Brian Mariotti: I think as we get towards the very end of Q3 and Q4, we’re going to start seeing our EBITDA in the double digits in the positive. So we are getting back to historical numbers that Funko has operated for years and years. Again, like Steve said, it’s going to take us a little while to get there. But as we end the year, we’re going to feel like we’re in a really, really good place going into Q1 of 2024. So with numbers that are much more in line with how we’ve we operated the business for the last couple of years.

Andrew Uerkwitz: Got it. That’s helpful. I appreciate it. And then last question, I guess, how is this affecting — now that you kind of come back in the seat and you’ve always been a creative guy. Dealing with all these issues, is it holding back R&D projects or growth initiatives or anything along those lines?

Brian Mariotti: No, look, we made some conscious decisions on some of our initiatives to push into 2024 so that the entire company was focused on one thing, which is to be operationally a heck of a lot better than we have been and to cut SG&A. And so I think, yes, we’ve made a couple of sacrifices for the very short term. It will not affect the promising nature of some of those investments 2024, but we wanted the entire company pulling in the same direction in terms of fixing our ales as fast as we possibly can. Look, we had a fairly watched ERP process. And unfortunately, a really nice warehouse that was configured for an ERP and WMS that never arrived on time. But I think it is important for us to continue all of the company falling in the same direction on fixing these two problems.

The meanwhile, that we have three new product lines that are all launching middle of this year or later that have had a phenomenal response from our retail partners on a global basis, one of which is the pop that we’re just insanely excited about, which is a micro pop collectible. So we feel like a much better content slate, three great new products dropping, planned to more than double Mondo since we’ve acquired it. Loungefly seems to be on fire. And we just have to fix our fulfillment issues and some of our operational issues while we reduce SG&A. And so the focus has been on Napa. I think you’re still going to see some new disruptive products in the market, and then we’ll pick up with some of the other new initiatives we have in 2024 as we get that — the business back in order as fast as we possibly can.

Andrew Uerkwitz: Got it. Really appreciate to counter on that. Appreciate guys. Thank you.

Brian Mariotti: Thank you Andrew.

Operator: We currently have no further questions, so I’ll hand back to the management team for any closing remarks.

Brian Mariotti: Yes. I would appreciate everybody’s questions and their lines. So thank you very much.

Operator: This concludes today’s conference call. Thank you all for joining. You may now disconnect from the call.