Funko Inc (FNKO) 2018 Q3 法說會逐字稿

Good afternoon, and welcome to Funko's conference call to discuss financial results for the third quarter 2018.

(Operator Instructions) As a reminder, this call is being recorded.

On the call today from management are Brian Mariotti, Chief Executive Officer; and Russell Nickel, Chief Financial Officer.

I will turn the call over to Mr. Nickel to get started.

Please go ahead, sir.

Thank you, and good afternoon.

A press release covering the company's third quarter 2018 financial results was issued this afternoon, and a copy of that press release can be found on the Investor Relations section on the company's website.

Management's remarks on this call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

These may include statements regarding our business goals, plans, abilities and opportunities, industry and customer trends, growth, momentum and investment initiatives, collaboration and licensing relationships, consumer engagement and brand awareness, acquisitions and related expenses and anticipated financial performance.

Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors, including those discussed in the Risk Factor sections of our Form 10-K for the fiscal year 2017 and our other filings with the SEC.

Any forward-looking statements made on this call represent our views only as of today, and we undertake no obligations to update them.

Please also note that we will be referring to certain non-GAAP financial measures on today's call, such as EBITDA, adjusted EBITDA, adjusted EBITDA margin, adjusted pro forma net income, adjusted pro forma earnings per diluted share, and net debt, which we believe may be important to investors to assess our operating performance.

Reconciliations of non-GAAP financial measures to the most directly comparable GAAP financial measures are included in our earnings release and in the Investor Relations sections on our website at funko.com.

We have also prepared a visual presentation that investors can consult to follow along with this discussion, and it can be accessed in the Investor Relations section of our website.

I will now turn the call over to Brian.

Thanks, and good afternoon, everyone.

Funko had another fantastic quarter.

We posted strong growth in sales, gross profit, adjusted EBITDA, adjusted pro forma EPS, as we have every quarter since we went public last year.

We were able to deliver great results.

Our sales in the quarter increased 24% over Q3 of last year to $176.9 million; adjusted EBITDA increased 26% to $34.1 million in the quarter.

Additionally, we were able to gain operating leverage, as our adjusted EBITDA margin was 19.2% versus 18.9% in Q3 of last year.

Following these results, we are raising the guidance for the year.

Our strong performance is against the backdrop of 4 straight quarters where most of the public toy companies attributed weak sales to problems associated with Toys "R" Us.

We did less than 4% of our sales with TRU in 2017, and we had said going into 2018 that we expected to see strong growth with them in the year.

When they liquidated, we did not reduce our sales guidance.

We said that we believed it would not affect our sales, and it didn't.

This is in contrast with what traditional toy companies are saying, and this underscores a big difference between our business model and theirs.

As we have said before, our products are channel agnostic, and we have a diverse set of customers, of which no retailer accounts for more than 10% of our year sales to date.

Because of this, we have been successful in regaining any sales we would have lost because of TRU with other retailers.

Another factor with -- that many companies across the industry are talking about is the tariffs imposed and threatened on products from China.

A very small amount of allowance by our products have been impacted by the tariffs, but the effect has been immaterial to date.

As we have said previously, about half our products are made outside of China, and we expect that percentage to be up to 70% by the end of 2019.

We continue to try to illustrate how our model is different from traditional toy companies.

Our disruptive model is based on the breadth and diversity of licenses, speed to market, and a wide and growing range of retailers around the world.

Because of this, we believe we will continue to perform favorably compared to the toy industry.

Increasingly, our retailers, licensers, and fans view us as the authority on pop culture.

Funko is a platform for creating a growing portfolio of products in the world we call the Funkoverse.

Our broad offering of licensed consumer products and collectibles continue to appeal to a wide array of fans across age, gender and income groups.

We are constantly adding to and leveraging our portfolio of more than 1,000 licensed properties to develop a steady stream of new products that we sell to a diverse set of retailers and directly to consumers.

Let me review the three prongs of our growth strategy.

Number one is content, where we capitalize on the ever-growing range of IP.

Number two is product, where we continually release new products and expand into new product categories.

And finally, number three, distribution, where we were adding new retailers and growing our sales within existing retailers, both domestically and internationally.

Looking at content, we continue to acquire new licenses in properties that provide us with new business opportunities and fuel our growth.

In the third quarter, we increased the number of active properties sold by 38%, from 400 to 553.

Over the last 9 months, we've increased the number of active properties 28% to 600.

This is the heart of our business model.

The top 10 performing properties in the Q3 were Harry Potter for the second consecutive quarter, Nightmare Before Christmas, Marvel Classic, Overwatch, Disney Classic, Deadpool, The Fantastic Beasts: Crimes of Grindelwald, Star Wars Classic, Five Nights at Freddy's, and finally, Stranger Things.

Notice that half of the properties in the top 10 this quarter were not in the top 10 last quarter.

That's pretty typical.

In Q3 of this year, just over 50% of our sales come from Evergreen Properties, which is back catalog content that is not tied to a current movie, video game, or TV show.

That is the highest level of contribution from Evergreen Properties in a given quarter over the last 6 years.

New entertainment content can give a boost to our Evergreen Properties, in part by introducing new audiences to the original characters.

A good case study is Marvel Classics.

We took advantage of the Marvel Venom movie by Sony and came up with a line of Marvel Classic products that were not directly tied to the movie release.

Additionally, to coincide with the 10th anniversary of the Marvel Cinematic Universe, we launched a special-edition line which was a unique form factor based on our Marvel Classic licenses.

These were the prime driver of why Marvel Classics rose to #3 in the quarter.

Another example is Deadpool, where we launched a classic Deadpool program around the release of Deadpool 2, which had great success and drove Deadpool to our sixth largest property in the third quarter.

Having such a deep roster of properties gives us the opportunity to take advantage of what consumers want at any time.

This shows, again, how we have products related to hit content, but we are not a hit-driven company.

In the third quarter of 2018, no single property accounted for more than 7% of sales, and our top 10 properties accounted for only 34% of our total sales.

On our last call, we said how excited we were about 2 of our new licenses, Fortnite and Pokemon.

Fortnite shipments began just in the final week of Q3, and while neither property was in the top 10 in Q3, we fully expect Fortnite to be one of our top performing licenses in Q4.

Fortnite is a great example of why we see Funko as an index fund of pop culture.

We don't need to be the ones coming up with the hits; we just have to act quickly to get the products out when the hits come.

Fortnite came out, and it was a global phenomenon.

We were able to jump on it, and we were the first to secure a license, and our products were the first in the toy and collectible category to get into the marketplace.

Our vast fashion approach and rapid development is why we are often the go-to partners for licensors.

We believe 2019 is looking like an exceptional year for entertainment content.

Just from the Disney family alone, there will be several major film releases, including Toy Story 4, live action remakes of Lion King, Dumbo, and Aladdin, Star Wars Episode 9, the sequel to The Avengers: Infinity War, 2 X-Men film, Dark Phoenix and the New Mutants and Captain Marvel.

And that's just the movies.

On TV we'll see new seasons of Stranger Things, Rick and Morty and the final season of Game of Thrones.

In video game, we expect to benefit from a full year of selling Fortnite, the continued strength of Overwatch and a slate of new video game titles.

We believe it's also going to be a great year for the evergreens.

There are many properties celebrating significant anniversaries, including Batman, Marvel, Alien, Ghost Busters and Dragon Ball Z. Layered between all these launches, there's always a Bob Ross or a Golden Girls out there, and we are constantly looking for those opportunities to surprise and delight our fans.

Our video shorts, produced in our Funko Animation Studios, also continue to generate tremendous interest.

Not only are our licensing partners increasingly interested in working with us by having their properties featured in our video shorts, some retailers now have our video shorts playing alongside our products.

In 2017, our video shorts generated approximately 40 million views worldwide, and in 2018, they've already generated over 150 million views, with over 60 million views alone in the third quarter.

Looking at products.

We are very pleased with our result, as we saw significant growth across our categories in the third quarter, with a 24% increase in figures and a 26% increase in apparel, bags, accessory and other.

Within the figure category, our worldwide sales of Pop!

Vinyl figures were up 26% compared to the same quarter last year.

As a reminder, our Pop!

Vinyl line is nearly 9 years old and has still growing year-over-year by more than 25% for 7 consecutive quarters.

The Loungefly acquisition provided us with the opportunity to expand into adjacent categories such as apparel and accessories, including handbags and backpacks.

By leveraging the new categories that Loungefly gives us as well as our own distribution network and portfolio of licenses, we were able to grow Q3 sales of Loungefly products by over 80% compared to Q3 of last year, which was the first full quarter we owned Loungefly.

We also continue to roll out launches of innovative products, including our Funko’s cereal and Pop!

PEZ.

These lines are selling in specialty stores as well as Target, Walmart, and online, and they're off to a great start, with retailers reporting very strong sales and exceptional customer demand.

Let's look at a quick study of Golden Girls.

In the days surrounding the launch of Golden Girls Funko cereal, new stories about the launch generated hundreds of articles, nearly 0.5 million Facebook shares, and over 8 million television views, providing tremendous free exposure not only for the product but for Funko as a whole.

I will finish the product discussion with the mention of a small example that has exceeded our expectations and allows us to gain additional shelf space within our retailers, and that's the Harry Potter Advent Calendar.

This line was launched based on success we've had launching Freddy Funko advent calendar last year on our website.

It's a great example of how we can leverage our property rights across many product categories and form factors.

We believe this success has resulted in a strong appetite on the part of our licensing and retail partners to work with us on more products like this in the future.

On the distribution side, U.S. and international retailers continue to look to us to offer a growing assortment of curated products that resonate with their consumers.

In Q3, our U.S. sales increased 16%, as we continued to benefit from expanded shelf space with many of our existing retailers.

In the wake of TRU's liquidation, we are seeing other retailers trying to grab TRU's market share.

In addition to the retailers that already have a high percentage of the market, such as Walmart, Amazon and Target, several of our specialty retailers are trying to grab market share as well, and we are seeing strong growth within this channel.

Excluding Loungefly, our sales to domestic specialty customers during the first 9 months of the year were up more than 30% year-over-year.

This growth is not being driven by new doors.

It is being driven by increased shelf space and stronger sell-through in existing retailers.

Although mass retailers account for only 10% of our sales, we are continuing to grow within this channel.

As we had mentioned before, Walmart has been transitioning most of our products from the toy department to the DVD and entertainment section of their stores in order to grow their market share.

Walmart has activated this new section, and they have given us dedicated shelf space that ranges from 4 to 20 feet.

You can see example of a 20-foot section in the earnings presentation.

The space expansion at Walmart was not complete until the beginning of fourth quarter, and almost none of the products you see in those sections shipped in Q3.

In fact, our sales from Walmart were down in Q3 as they transitioned most of our products to this new section.

With this transition behind us, we expect our sales with Walmart to be up sharply in the fourth quarter and going forward into 2019.

Sell-through at the major U.S. retailers that provide us with POS data was up high teens in Q3 compared to Q3 last year.

But again, that's with Walmart declining, given their transition.

Also, at the end of Q3, inventory at retail continued to be down low double digits compared to Q3 last year, and we feel good about the channel inventory as we enter into Q4.

Our sales through online retailers also continued to see strong growth.

Year-to-date, our sales through third-party e-commerce sites were up over 55% and accounted for 14% of total sales, up from 12% a year ago.

This speaks to the fact that our products resonate online as well as in-store, and are seen by retailers as traffic drivers no matter where they are sold.

As we continue to be a definitive pop culture company, more and more retailers are coming to us for our expertise across a range of products.

A great recent example of a retailer that wanted to get into pop culture is FootLocker, who recently opened a store within a store concept for pop culture merchandise at a few locations.

FootLocker partnered with us to help legitimize their entry into the pop culture market with our products, and are pleased with the early results from the stores where they have set up this concept.

From our discussion, we understand that FootLocker expects to expand the number of stores within this concept.

We aren't just seeing success in the U.S. Internationally, sales increased 44%, driven by growing demand for our products, combined with the continued globalization of content.

Additionally, our European sales were up 49% in Q3, which puts our European sales up 73% year-to-date.

In Q3, we activated over 1,600 new doors across EMEA and 1,100 new doors in Latin and South America.

One of the retailers we recently partnered with in the U.K. is The Entertainer.

We have entered into all of their stores with a strategic digital marketing initiative, by merchandising our products next to the TVs that are playing our animated video shorts.

Additionally, we recent launched at TOP-TOY in Denmark.

TOP-TOY recognized the importance of attracting a new demographic and driving foot traffic, so they launched a new section called Awesome Stuff, a large part of which is dedicated to Funko products.

Both of these retailers have seen great initial success, and they have indicated that they plan to expand the Funko space that we currently occupy.

Increasingly, in stores around the world, our products are a part of bold and attention-getting displays.

Retailers know consumers everywhere are fans of something, whether it is a TV show, movie, or a sports team.

These retailers are turning to Funko because have the diverse set of products, breadth of licenses, and speed to market to connect a wide range of consumers with the content that they love.

You can find large dedicated sections for Funko products in retailers all over the world, including music stores, hypermarkets, bookstores, and toy stores in countries ranging from Germany to Kuwait to South Africa.

You can see examples of these retailers in the Q3 presentation.

We believe Funko is rapidly becoming just as globally recognizable as the entertainment content we work with.

Let me shift gears here to talk about what we're doing with consumer experiences.

Our main consumer event is San Diego Comic-Con, which was in July, where we were dubbed "king of pop culture" by CNET.

Funko will do over 50 events across the globe this year from New York to London to Dubai to South Africa, which continues to solidify and expand the global recognition of the Funko platform.

We continue to look for new and innovative ways to engage with consumers, promote our brand, and show not only our fans but our retail partners the full range of the Funkoverse and how it can be merchandised.

One of the ways we do this is in our retail store in Everett, Washington, in our headquarters building where we have created a fully interactive and immersive experience.

We also use the store to introduce new product lines as well as showcase our own IP, such as Wetmore Forest.

So in summary, we had another great quarter, and we are pleased with our momentum, the underlying trends in our business, and the progress we continue to make against each of our growth strategies.

Based on the continued strength of the first 9 months of the year, we are raising guidance for fiscal 2018, which Russell will discuss in more detail.

Looking beyond Q4, we are not only working on all the new licenses and product launches that we expect to drive growth in 2019, but we are also excited about a couple new categories we're looking to enter with both licensing partners and with our own IP.

As we look around the pop culture landscape, we are convinced we can have a bigger impact outside of our existing categories.

So stay tuned; we will have much more to discuss next year.

Before I end, I want to thank our entire team, our licensers, retail partners for their continued support that has contributed to our success to date and will drive our success going forward.

As always, a special thanks to our amazing engaging fan base, whose passion and excitement is what motivates us every day.

I will now turn the call over to Russell to take you through the third quarter financial highlights in more detail.

Thanks, Brian, and good afternoon, everyone.

Our strong third quarter results were broad-based and continued positive underlying trends.

Net sales in the quarter increased 24% to $176.9 million and were driven primarily by the continued expansion of products and properties in our portfolio.

In the quarter, the number of active properties increased 38% to 553, and net sales per active property were $320,000, which was down 10% year-over-year.

We often see net sales per active property dip in a period when the growth in the number of properties accelerates.

We see this as a good thing, and we believe this highlights the value and importance of our diverse and growing portfolio of licenses.

On a geographical basis, in the third quarter, net sales in the United States increased 16% to $121.3 million, and net sales internationally increased 44% to $55.6 million.

With our new ERP system implemented in the U.K. and a 3PL operation in Europe rolled out to support growth, we were able to get sales in Europe back up to strong levels.

Net sales in Europe were up 49% in the third quarter over the prior year.

On a product category basis, in the third quarter, net sales of figures increased 24% to $141.8 million, and net sales of other products, such as bags, accessories, apparel and homewares, increased 26% to $35.2 million.

We saw continued strength with our Pop!

brand, with sales of Pop!

Vinyl figures increasing 26% on a global basis over the prior year.

As Brian noted, Pop!

Vinyl is nearly 9 years old and is still putting up big growth rates.

This also contributes to the strength of the Pop!

brand and underscores that Pop!

has become a platform that transcends multiple product categories, with the Pop!

brand being up over 30% over the prior year.

Gross margin, which excludes depreciation and amortization, decreased 250 basis points from Q3 of last year to 38.4%, but it was up 20 basis points compared to 38.2% in the second quarter of 2018, continuing our positive trend over the course of the year, and we continue to make progress towards our long-term goal of 39% on a full year basis.

The reduction in gross margin this quarter from the prior year was driven primarily by a decrease in the average sales price to our European customers, due in part to an increase in shipments that went direct from our factories, for which we generally provide sales discounts.

The increase in these FOB shipments is a testament to the high demand we continue to see across Europe.

Additionally, we made selective price reductions in Europe to better align global product pricing, following the 2017 acquisition of our European distributor, Underground Toys.

Please note that our discounts and promotional allowances during the quarter were about 5% of gross sales.

That is well within our normal range of 4% to 5%.

In the quarter, selling, general and administrative expenses increased 27% to $41.3 million from the prior year.

The majority of the increase was driven by the growth in the business as well as incremental investments associated with strategic initiatives, including our direct distribution model in Europe and other international markets as well as Loungefly and Funko Animation Studios.

Looking at the company as a whole, the biggest areas of increase were personnel and commission expenses, which increased $3.9 million, driven by the build-out of our sales, operating and administrative teams worldwide and includes $1 million of severance cost to senior management; equity-based compensation expense, which increased $3 million; and facilities and rent, which increased $1.9 million, primarily from new facilities in Europe.

Additionally, we incurred $2.7 million of transaction costs and other nonrecurring expenses in the quarter, of which the majority was for a onetime consent fee related to certain existing licensing agreements.

Depreciation and amortization expense in Q3 increased 18% from the prior year to $10 million.

The majority of the $1.5 million increase was from higher depreciation on mold and tooling costs as we continue to expand our product offerings as well as our leasehold improvements at our corporate offices and warehouse facilities.

Net interest expense decreased 37% to $5.8 million from $9.1 million in the third quarter of 2017.

This was due to a reduced debt levels and lowered interest rates obtained from our lenders in the first quarter of 2018.

We will talk in a moment about the benefits of our recent debt financing.

As a result of these factors, adjusted pro forma net income more than doubled to $13.8 million, compared to $6.1 million in Q3 of 2017.

Adjusted pro forma earnings per diluted share was $0.27, and adjusted EBITDA increased 26% to $34.1 million.

This represents a 19.2% adjusted EBITDA margin, which increased 30 basis points over Q3 2017.

Touching on a few balance sheet highlights.

We ended the third quarter with net debt of $248.5 million, compared to $226.2 million at the end of 2017 and $340.7 million at the end of Q3 2017.

Inventory remained relatively flat at $81.2 million versus $79.1 million at year-end 2017 and $78.8 million at the end of Q3 2017.

This is despite sales being up 24% in Q3 and up 31% year-to-date.

We said on our second quarter conference call that we would improve our inventory turns over time, and we did that in the third quarter.

Turning to our 2018 outlook.

We are raising our guidance, given our strong performance over the first 9 months of 2018.

We now expect net sales of $645 million to $650 million compared to prior guidance of $620 million to $630 million.

This new outlook would represent a year-over-year growth rate of 25% to 26%, adjusted EBITDA of $108 million to $112 million compared to prior guidance of $104 million to $112 million, and adjusted pro forma earnings per diluted share of $0.68 to $0.73, which assumes a blended corporate tax rate of 25% and a weighted average diluted share count of 51.5 million shares.

This compares to our prior guidance of adjusted pro forma earnings per diluted share of $0.60 to $0.70.

I will finish with some comments about the benefits of the recent refinancing, which we announced back in September and which we closed just 3 weeks ago.

The key feature of this refinancing is that the interest rate on our $235 million term loan is expected to be approximately 300 basis points lower, resulting in significant interest savings.

We estimate savings in the fourth quarter to be approximately $1 million.

The savings in 2019 are expected to be about $7.8 million, and the average over the next 5 years is expected to be about $6.8 million per year, with roughly $6 million of that in cash savings every year.

Because there were still some unamortized capitalized financing fees on the old facilities, we anticipating taking a onetime noncash charge of approximately $4.5 million in the fourth quarter.

Our adjusted pro forma earnings per diluted share guidance excludes this charge, as does our adjusted EBITDA guidance.

With that, I would now like to turn the call back over to the operator to start the Q&A session.

(Operator Instructions) Our first question is from the line of Steph Wissink with Jefferies.

Brian, a question for you.

You talked a lot about Funko animation, and I'm wondering if you can share with us a little bit about your initiatives around shoppable content, so making that content dynamic and converting that into direct access to your website.

Yes, it's a great question, Steph.

Obviously, as we get more and more in-depth in that transition from us owning Funko Animation Studio, one of the things we did is look at all of 2019 and the initiatives of the big product initiatives we have.

I think we identified 42 different initiatives in 2019, and we're basing all of our animation around those big initiatives.

And as we continue to get a little bit more sophisticated and having our new chief marketing officer, Molly, on our team, the ability to click through and hit directly to retailers is certainly an important part.

We're getting better at it.

I think by the time we hit 2019, we're going to continue to see better sales and the ability for our fans to find our content easier and easier.

So we're excited about using the animation format to drive awareness and to educate people on what we're making, but more importantly, to be able to deep link into our retailers, including ourselves, that are carrying our products.

And if I could, just 2 quick follow-ups, Russell.

On the Walmart initiative, so it sounds like that will be an incremental step function up in the fourth quarter.

Can you give us a sense just how big Walmart was as a customer, typically as a customer, so we can try to scope out what that decline to increase will be, kind of as a sequential?

And then, also wanted just clarification on the EU pricing reset.

Should we consider that onetime?

So post the acquisition of Underground Toys, realigning that pricing, is that a onetime event, or is that something that continues over the course of the next couple of quarters?

Okay, yes, great questions, Steph, so I'll take the last question first.

So that was a onetime adjustment.

It was part of -- frankly, it was one of the main reasons why our gross margin was higher than normal in Q3 of last year is, as we digested and invested after the acquisition of Underground Toys, looking at that -- basically that margin, we gave back some of that margin to more align globally, strategically align our global pricing.

So that was largely a onetime initiative.

We are seeing strong demand in Europe, so we have moved more of our shipments this year in Europe to FOB, which does have some sort of impact on our gross margin.

That would absolutely likely maintain as we continue because obviously the growth -- the contribution margin is actually about the same.

As it relates to Walmart, Walmart I think in last year accounted for 5% to 6% of our overall revenue.

We are continuing -- we did ship a little bit in Q2 and Q3, as we are still maintaining some placement in the toy aisle and some other seasonal opportunities.

But it's typically about 5% to 6%.

I think in the third quarter, they were down roughly about 40% as they moved the transition over in getting ready for the new placement in the DVD and entertainment section.

Our next question is from the line of Michael Ng with Goldman Sachs.

I just have one for Brian and one for Russell.

Brian, I was wondering if you could talk a little bit about the FootLocker initiative.

How far are you along with that today?

And are you curating your Pop!

specifically for FootLocker, perhaps trying to send them more sports-oriented products?

And then I have one…

Yes, those are great questions.

Yes, absolutely.

Look, obviously we were excited that they came to us early on when they had the concept in mind and how they wanted to come up with the stores and the store concept that felt very pop culture and very different than what they traditionally do, obviously, i.e., no shoes.

So yes, our sales team started curating what would differentiate them between the marketplace, and there was, there was absolutely a heavy emphasis put on sports.

The sell-through, the exposure, the -- I guess the expectations have all exceeded what they originally thought.

I think we're going to be up to about 60 stores in November with this concept.

So yes, we're really excited.

I think it goes to what we've said over and over and over again.

When retailers want to be in the business of pop culture, they turn to Funko because of the breadth of licenses, the array of products, the fact that we can ship on a weekly basis and keep that content fresh and unique.

But it's certainly excited with the licenses we have with WWE, UFC, NBA, NFL, English Premier Soccer League, Major League Baseball and NHL.

We certainly see growth in the overall sports category for us.

This is just awesome that FootLocker has come up with this concept.

Great.

And then for Russell, this is more a margin question.

I think on the call you said you feel comfortable about the long-term margin, and I apologize if I misheard.

I think you said 38% or 39%.

39%

39%?

And I think earlier in the year, you said that 39% would be a good assumption for 2018, so I just wanted to understand what were some of the changing dynamics there that made you take a more conservative outlook on margin.

Or, said differently, the revenue guide was raised by $20 million to $25 million, but the top end of the EBITDA guide was the same.

So any clarification you could provide there would be very helpful.

Yes, I think part of it is on the -- in regards to the gross margin, part of that is, as we're seeing stronger demand, in particular in Europe, as I mentioned on this call, with the FOB shipments shipping direct, that's having an impact in terms of our near-term gross margin for the year, so that's flowing through.

And then, on the SG&A, we are still, as I've said, we are growing, continuing to grow.

We are continuing to invest in the business, but we're also in a position to start to regain that operating leverage like we have been discussing and sort of suggested and commented that we would be in Q3 and the later half of the year.

And so we're seeing that in Q3; we expect to see that in Q4 as well.

(Operator Instructions) Our next question is from the line of Erinn Murphy with Piper Jaffray.

Just a couple for me, first for Russell.

On the guidance, you raised your full year sales guidance, but it implies the fourth quarter decelerates to high teens.

I'm just trying to reconcile that, given how sharp you expect the -- or the acceleration in Walmart to be.

I'm just curious is you're anticipating something else to fall off, or is there any other shift in timing some other accounts in the fourth quarter?

No, it's -- we've always anticipated a deceleration and we've commented that we were anticipating a deceleration in the later half of the year, in part in Q4, because we're comping strong sales in Europe as we had some channel fill in Europe.

We also had some growth last year as we took on the Loungefly acquisition.

So as a reminder, no one customer typically accounts for more than 10%.

Walmart accounted for about 5% to 6%.

We'll see that initial set revenue in the third quarter -- or in the fourth quarter, excuse me, and it will begin to see some replenishment.

So we're not anticipating any fall-off; we're actually seeing strong growth across all of our channels, in particular the specialty channel.

I just think it's a little bit more of a normalization and pointing to strong results for the year overall.

Okay, that's helpful.

And then, I know tariffs have not been significant to date, but can you just speak out over the next 2 to 3 years how you see yourself [find] your manufacturing base?

I know you've got strongholds in China and Vietnam today.

Yes, I think we're not making any decisions based on something that Trump may or may not do.

We're using logic, and we're finding that manufacturing outside of China provides some competitive advantages: one, a much shorter lunar holiday break; two, the idea that they lose very few of their workers coming back off of lunar holiday.

Right now, we're above 50% in manufacturing outside China.

We think as we near the end of 2019, it's going to be closer to 70%.

So I don't think all these moves are being made in theory for potentially a tariff that would affect us.

But if something were to come down the pipeline, we're very well positioned.

I just think these are really smart decisions to find the best manufacturers with the highest quality, with the best cost of goods, and the most stable environments for us to produce against, and we found a lot of that success outside of China.

Got it.

That's helpful.

And then, just last question for me, just as you go into the holiday season, can you just talk about how you feel you're positioned, how the retailers are thinking about you guys?

Do you have incremental opportunity for end caps or anything kind of special?

And then, last year in holiday, I believe you tested working with Cosco.

Curious if that's going to be a test that you repeat.

Yes, look, I think we're really well positioned.

Again, key metrics that maybe we didn't have 18 months ago, sell-through and inventory in all of our top accounts are much better than they were a year ago, so we feel really good about that.

There obviously are some incremental opportunities and some amplified gifting opportunities in Target, for example.

So we feel really strong about what our Q4 is going to be.

I think we're off to a phenomenal start, and I think that I don't see anything that's going to derail the continued growth for us as a company, so we're certainly excited.

As far as Cosco is concerned, it was a great test.

We are looking at some programs for them in 2019, but we didn't find anything that really interested us for fourth quarter in 2018.

But I do see a potential program or 2 for them in 2019.

It appears there are no further questions.

I'd now like to turn the call back over to Mr. Mariotti for any additional concluding comments.

Thank you and for your interest and support in Funko, and we look forward to seeing some of you at New York Toy Fair and speaking to you again on our fourth quarter earnings call, if not sooner.

Thank you very much.

Ladies and gentlemen, this does conclude today's teleconference.

Again, we thank you for your participation, and you may disconnect your lines at this time.