FNKO - NASDAQ

Good afternoon and welcome to Funko's 2023 Third Quarter Financial Results Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at the 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'll now turn the call over to Funko's Director of Investor Relations, Rob Cassidy. Please proceed.

Hello, everyone, and thank you for joining us today to discuss Funko's 2023 third quarter financial results. On the call are Mike Lunsford, our Interim Chief Executive Officer, and Steve Nave, the Company's Chief Financial Officer and Chief Operating 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 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 recent 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 2023 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 company's earnings press release issued earlier today. I will now turn the call over to Mike Lunsford. Mike?

Thanks, Rob, and good afternoon, everyone. We're pleased to report better than expected financial results for the third quarter. Net sales were $313 million, adjusted net income was $2 million and adjusted EBITDA was $25 million, all of which were above the high end of our guidance range. These results were primarily driven by strong direct-to-consumer sales, improved sales to several of our larger wholesale customers both in the U.S. and in Europe, and the cost reductions and operational improvements we've implemented over the course of this year. On the last call, we outlined a path to achieve long-term profitable growth. We said that this strategy and approach will inform everything we do going forward. By focusing on the fans and our unmatched brand, by running the business with financial discipline, rejecting complexity, and focusing on fewer products done extremely well. By investing in areas we can control, measure and grow profitably and by keeping the flywheel turning where each action we take builds on the previous one, propelling positive momentum. I'd like to call out a couple of highlights from the quarter that demonstrate the progress we've made executing that plan. I'll start with the first element of the plan, though some of the highlights relate to multiple elements of the plan. We believe our fans and customers are excited and engaged that our brand is strong. So how do we quantify this? First, we grew direct-to-consumer sales 32% year-over-year, with D2C sales in Q3, representing 17% of our sales mix versus 11% in the third quarter of last year. Second, across our website, the average order value grew 8% year-over-year to $60. Third, the successful online launch of Pop Yourself in August contributed to the strong D2C sales in Q3, and we expect sales to continue to ramp for the upcoming holidays. Pop Yourself is attracting new customers to our brand and to our D2C channel, with over 50% of customers purchasing Pop Yourself being new to our website. Fourth, Mondo sold more than 3,500 units at a $500 price point of a Masters of the Universe Battlecat figure in an exclusive Timed Edition sale, our largest revenue drop ever. And finally, our Fans Reward Loyalty program, which we just launched in May, has already surpassed 100,000 new members. In the third quarter, we also made progress focusing on fewer products done extremely well. On the fewer product side, we have stopped development of lower value product lines and SKUs. We believe this will ultimately help us expand gross margin and improve inventory management. On the done extremely well side, Loungefly won the Innovation Award at The Licensing Awards in September for its McDonald's French Fries Crossbody Bag and Loungefly’s Disney Nightmare Before Christmas toy, Undead Duck Crossbody Bag, one of the fastest selling lines of Q3 saw 100% sell through within the first week of sales. Bitty Pop!, our line of miniature collectibles launched earlier this year, was a key contributor to wholesale sales in both the U.S. and Europe, making up nearly 5% of total sales. Aside from the tremendous growth potential, we are excited about this product line for a couple of reasons. First, we're not reliant on new content, and we're able to leverage the strength of evergreen properties. The top selling Bitty Pop! in Q3 were the original Star Wars and Harry Potter characters. And second, we're able to secure incremental shelf space and reach new customers in different aisles and specialty mass and value retailers. Turning to the company's leadership, I'll share a brief update on the CEO search. The search process is underway and we're delighted with the quality and caliber of the candidates expressing interest in the position. I remain very excited about the opportunity ahead, and the candidates I have spoken with share my enthusiasm. We also announced today a change to our Board of Directors. Mike Kerns has been named to the Board, replacing Rich Paul. Mike is a Co-Founder and Managing Partner at The Chernin Group and has deep experience starting, managing and investing in digital media and consumer technology companies. We welcome Mike and look forward to his counsel and insights. At the same time, we thank Rich for his contributions as a director. While he has resigned from the Board, we are pleased that he will continue to serve in a new role as a Strategic Advisor to the company. And finally, as we previously announced, Brian Mariotti, who resigned from the Board in September also continues to serve as a Strategic Advisor to the company. With that, I'll turn the call over to Steve to cover our detailed financial results and guidance.

Thanks Mike. Hey everybody, thanks for joining us today. I'm going to dive right in on the financial results. For the third quarter, net sales were $312.9 million which included wholesale channel sales of $258.3 million and direct-to-consumer sales of $54.7 million. Q3 wholesale and D2C sales increased 29% and 38% respectively, compared with the second quarter. Gross profit for the quarter was $104 million and gross margin was 33.2%, which, as expected, was well above our Q2 gross margin of 29.2%. The increase in gross margin was primarily driven by price increases fully in effect for the quarter, lower inbound freight costs, partially offset by increased levels of discount sales and inventory reserves. Included in the Q3 gross margin was $6.4 million of non-recurring charges related to factory purchase order cancellation. If not for the one-time charges, gross margin would have been higher at approximately 35%. SG&A expenses were $94 million and as a percentage of net sales improved considerably to 30% in the third quarter versus 36% in the second quarter. Some additional color on SG&A. First, SG&A in Q3 included $9.9 million of one-time expenses, which included $6.2 million related primarily to the termination of a lease agreement and $3.7 million for severance and related charges. Second, excluding the one-time expenses, SG&A in dollars remained essentially flat in Q3 from Q2, which is quite an achievement considering net sales in Q3 were $73 million higher than Q2. It also gives you a sense of the progress we’ve made carrying out our cost reduction plan. And then third, the workforce reduction announced in August generated a partial cost savings benefit in the third quarter. We expect to see the full benefit beginning in our current fourth quarter. Adjusted net income was $1.7 million equal to $0.03 per diluted share, which exceeded our guidance range for the quarter. And finally, adjusted EBITDA was $25.4 million, which as Mike mentioned earlier, was much better than we anticipated. Turning to our balance sheet. At the end of the third quarter we had cash and cash equivalents of $31.9 million. Our total debt was approximately $299.5 million, which includes the amount outstanding under the company’s term loan facility net of unamortized discount, the balance on our revolving line of credit at our equipment finance loan. Inventory was $162.1 million, which was $84 million lower than the December 31, 2022 balance and $25 million lower than our Q2 ending balance. To be clear, a portion of the lower inventory was due to a higher than average obsolescence reserve recorded during the third quarter. This was expected and included in the guidance we provided last quarter. A comment about our inventory. Right sizing our inventory remains a key objective. We have completed the bulk of our product purchases for the year, and as a result, we are on track to end 2023 with the lowest inventory levels of the year. As a result, we expect working capital to be a tailwind in the fourth quarter, and we should see a meaningful rise in our liquidity in the quarter. Now, turning to our outlook. For the full year, we have narrowed our range for net sales and maintained the midpoint. Our range for adjusted EBITDA is unchanged. We now expect net sales of between $1.065 billion and $1.105 billion, and adjusted EBITDA of between $20 million and $30 million. For the fourth quarter, our guidance is as follows: net sales of between $260 million and $300 million; gross margin increasing sequentially from the third quarter; SG&A expenses in dollars decreasing from the third quarter; adjusted net loss of $4.2 million or $0.08 a share to adjusted net income of $2.8 million or $0.05 per diluted share. Finally, we expect adjusted EBITDA of between $16 million and $26 million. Mike, that’s it for the financial results, so I’m going to kick it back to you to close this out.

Thanks, Steve. I’ll close with some high level thoughts about 2024. We’re currently developing our outlook for next year, which we expect to provide in our next earnings report. This involves weaving together the elements of our plan, focusing on our brands and fans, running the business with financial discipline and selectively investing in areas we can grow profitably given our opportunities and challenges. Our Q3 performance is a good starting place that reflects the strength and resilience of our brand, the cost reductions and operational improvements we implemented this past year, as well as a reenergized attitude within the company to build a solid foundation for a more profitable future. I will now turn it over to the operator for Q&A.

Thank you. [Operator Instructions] Our first question today comes from Linda Bolton Weiser of D.A. Davidson. Your line is open.

Hi. This is Christina Xue on for Linda. So I want to ask, what are the factors would result in the high end of the EBITDA guidance range for the fourth quarter versus the low end?

Hey there. It’s Steve. I’m sorry, I didn’t follow that question. Could you repeat that for me?

Yeah. So I was wondering what are the factors that would possibly result in the high end of the EBITDA guidance range for the fourth quarter versus the low end?

Sure. So, I mean, it’s going to come down to sales, and probably most specifically to the D2C sales, because a lot of the retailers for holiday, they’ve done their stocking up, et cetera. So I think it’s going to come down to how well we do with our e-commerce business right up until ground cut off, as well as our couple of retail stores.

Okay. Thank you. Maybe a follow-up. So can you give us like a general idea to the trend of your retail POS growth?

Our own internal – our retail store POS.

Yeah.

I don’t know that at the top of my head.

No, I mean, external – okay.

External POS growth?

Yes. Sure. I’ll jump in. Hi. This is Yves LePendeven, I’m Deputy CFO. Sure. Yeah. We don’t have specific stats on our retail POS, but for those retailers in the mass channel that report the data to us, we’re still down year-over-year in POS sales. But we have seen an improving trend over the past six months. We’ve commented on this before I think the most encouraging thing that we’re seeing is that our sell-in continues to be lower than our sell-through. And we’re just seeing improved levels of inventory in the channel as we head into the holiday sales period. So I think that the trend is encouraging from what we’re seeing.

Okay. Thank you. I’ll pass it along.

Tell Linda we miss her.

Yes.

Thank you. There are no further questions in the queue, so I’ll turn the call back over to management for any closing remarks.

Okay. Thank you, everyone, for joining us on the call today. As always, thanks to our fans, employees, and our partners for their support. And thank you to our investors and analysts for joining the call and listening in. We look forward to sharing our progress on our next call, and we’ll talk to many of you in the next 48 hours as we do follow-up calls. Thank you.