Funko Inc (FNKO) 2021 Q2 法說會逐字稿

Good afternoon, and welcome to Funko's conference call to discuss financial results for the second quarter of 2021. (Operator Instructions) Please be advised that the 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 will now turn over to Ben Avenia-Tapper, Director of Investor Relations, to get started. Ben, please proceed.

Thank you, and good afternoon. With us on the call today are Brian Mariotti, Chief Executive Officer; Andrew Perlmutter, President; and Jennifer Fall Jung, 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 their 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 of 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 now turn the call over to Brian.

Good afternoon, everyone, and thank you for joining us today. We are pleased to deliver an exceptional second quarter, highlighted by our largest top line performance in company history. Net sales came in at $236 million, up 141% compared to last year, reflecting broad-based strength across our brands, product categories, channels and regions. We are now above pre-pandemic sale levels in all our major geographies. Our ability to drive this level of performance while navigating the fluid macro environment speaks the tremendous execution by our teams. I am extremely proud of what we've accomplished during the last 18 months.

We have become a more resilient and dynamic organization and found new and exciting ways to delight and engage our fans. The evolution of our virtual conventions is a great example of this. I spent the earlier part of the week at our first annual FunKon event, a hybrid virtual and physical event that we think represents the future of fan engagement. We had virtual conventions in the past. In fact, it's our seventh virtual event, but we've managed to elevate the scope and the success of these online and hybrid events in a massive way.

Hosted out of our Hollywood store, we developed a mix of live and prerecorded content for both live fans in the store and tens of thousands of additional fans online. This week, we've featured prize giveaways, opportunities to go behind the scenes and meet Funko artists and celebrity features among a whole host of other fan engagement events. What we've unlocked with virtual and hybrid conventions is a format that provides a more tailored fan experience with greater brand control and similar revenue potential when compared with our traditional convention calendar.

The event is only halfway done, but the initial steps have been extremely positive. We are on pace to beat our 2019 in-person sales numbers by more than 40%. That does not mean that we're abandoning in-person conventions in the future, but what it does mean is you can expect more virtual elements as we continue to elevate our fan experience.

On the direct-to-consumer front, accelerating the expansion of our e-commerce platform with a key growth pillar even before the pandemic, but it became that much more important as physical retail was closed and/or disrupted last year. Today, we are generating sustained traffic growth, and we've integrated tools and analytics to increase conversion rates and average purchase value on our sites, driving steady performance improvement.

We are also leveraging our strong social media presence and broadening the SKUs available. Our Funko shop exclusives like Alice in the Wonderland Black Light Series continue to sell out in minutes. But by expanding our catalog of Pop! and other categories available on our sites, we're able to seamlessly provide additional item recommendations.

In just the first 2 quarters of this year alone, average units per transaction and average orders per customer both increased by more than 35%. In a quarter that saw consumers return to brick-and-mortar retail, we maintain strong traffic and sales growth across all our sites.

Turning to our evergreen collection. The past 18 months have served as an important proof point of our ability to deliver compelling products, irrespective of the current state of new content. When cinemas closed last spring, sports leagues canceled seasons and TV shows stopped filming, we refocused even more on our evergreen properties. Our content catalog is a treasure trove of fan favorites, and it is no surprise that evergreen titles dominated throughout 2020 sales.

Today, we're maintaining that the ability to create products that thrill and resonate from our entire catalog. In fact, evergreen property revenue more than doubled in Q2 versus the prior, but now we're beginning to layer on new content, including an excellent theatrical release calendar and the results speak for themselves. This past quarter, our list of top 10 properties include new titles like Space Jam: A New Legacy as well as classics like Lilo & Stitch and Seinfeld.

And the last item I want to call out is the tremendously successful launch for earlier this week of our first Digital Pop! NFT collection with the Teenage Mutant Ninja Turtles. The first drop of 20,000 standard packs and 10,000 premium packs sold out in less than 15 minutes with more than 45,000 fans in the queue when the drop went live.

Just like with our physical product, the first launch is always a learning opportunity. We will continue to refine the size of our drops, the cadence of which our drops occur and the overall user experience, but the early response has been extremely encouraging and well above our expectations. I'm generally pleased with the team's ability to quickly execute against this initiative and deliver a product and buying experience that excited and delighted our fans.

Q2 was a company-wide success, reflecting the effectiveness of our entire pop culture platform and our ability to connect with our fan bases around the world. Our Pop! and Loungefly brands each grew in excess of 130% over the prior year as the reopening of specialty retail provided a huge lift to both brands.

Pop! benefited from the stronger content calendar as well as our continued success with evergreen property revenue. Meanwhile, Loungefly's unique and innovative approach to collectible fashion has made it particularly attractive to specialty as these retail partners look for opportunities to differentiate their experience and product.

Initiatives like our exclusive program provide additional tiers of differentiation and continue to be a driver for new demand for the brand. From a product category perspective, our diversification efforts were headlined by Loungefly, which grew 136% over 2020, led by bags, wallets and accessories.

We also generated strong growth in non-Loungefly items, including games, plush and action figures. On a regional basis, both the U.S. and Europe generated triple-digit growth over Q2 2020 and both regions exceeded 2019 performance. The reopening of specialty drove significant growth in both geographies. Within Europe, we saw recovery across the region with the areas that lagged in Q1 of this year largely coming back in line as lockdown restrictions eased.

In our Other International markets, results approached or exceeded pre-pandemic 2019 levels as growth returned to nearly all regions. We delivered an excellent first half to the year, and we remain focused on executing against our key initiatives to increase our broad consumer appeal and expand our total addressable market.

Against the backdrop of our record quarter and a really excellent first half, we are mindful of the macro uncertainties we are facing in the second half. Most notably, freight headwinds are accelerating sharply, causing product delays and substantial cost increases. Additionally, the rising concern around the Delta variant is beginning to weigh on our consumer sentiment.

Despite these macro challenges, we now expect to achieve net sales of $900 million to $930 million, up approximately $30 million at the midpoint from our previous guidance range, reflecting our second quarter outperformance and the exceptional demand for our products, which remains at an all-time high. Jen will share more details on our outlook when she reviews our financial results.

Now before I hand things over to Andrew, I want to express my enthusiasm for the management transition we announced this afternoon. Andrew and I have enjoyed a strong and highly productive partnership since he joined Funko in 2013. We will continue to collaborate closely through this transition process, and we are looking forward to maintaining our partnership in our new roles beginning next year.

The business has never been stronger. We just reported our best sales quarter ever and have had the product and talent to ensure we are well positioned to deliver long-term growth and sustained shareholder value. We greatly appreciate the support of our partners, fans and shareholders and look forward to keeping you updated on our progress throughout the year.

Now I'll turn the call over to Andrew to discuss our strategic initiatives.

Thanks, Brian. Let me start by saying how honored I am to assume the role of CEO next year. Brian and I have been working together for more than 10 years, and I look forward to working with him for another 10. This is a very special time for Funko. We have amazing opportunities in front of us, and I know that with Brian as our Chief Creative Officer, our future will be as bright as ever.

Our record quarter was driven by success in each of our 4 strategic growth initiatives. Q2 was an exceptional quarter for the Pop! brand, which generated triple-digit growth and exceeded 2019. Brian highlighted our successful evergreen properties, which are now being complemented with a robust movie slate.

Within our evergreen properties, sports, music and anime continue to gain momentum. Three anime properties made it into our top 20 for the quarter. Our new vinyl figure platform targeting sports and music fans goal is set to hit shelves this fall, and we have more programs targeting new customers and fans on the way.

Our product diversification initiatives saw similar success. Our non-figure business also generated triple-digit growth and success across all categories. Loungefly continued with their exceptional growth trajectory. This is driven by a strong recovery in specialty, D2C performance and growth in Europe. A combination of exclusive programs, higher average price points and a more focused product mix were all factors in our success.

International continues to be a growth area for Loungefly. When we originally acquired the Loungefly brand, it was mostly a domestic business. Over the last few quarters, we've seen accelerated growth in Europe as we've expanded our footprint.

In our youth collectibles category, we continue to make strides in new areas of the store, reaching new customers. Snapsies Wave 2 is hitting stores soon and we continue to see strong success with our plush and action figures, mainly driven by our Five Nights at Freddy business.

Last, but certainly not least, is our continued expansion into the game aisle. We saw a strong positive reaction to several of our new titles, including ESPN Trivia Night, Disney It's a Small World, Goonies: Never Say Die, and our new Seinfeld game, the Game About Nothing. Within our collectible gaming systems, we are seeing success out of the gates on Battleworld 2, and there's a lot more fun and games on the way.

Moving to our direct-to-consumer business. The channel accounted for 11% of net sales in the quarter as we continue to generate strong revenue and traffic growth. By offering an increased selection of mainline items as well as limited edition exclusives, we are both driving traffic and increasing cart size. We've also increased the conversion rates on our growing traffic volume. We will continue to expand product lines and enhance customer experience. This is and will remain an important driver for incremental growth for Funko.

Turning to international expansion. We saw growth across our geographies, particularly in Europe, which maintained its strong momentum from Q1 to Q2 and exceeded 2019's results. The major contributors to this growth were specialty recovery, continued Loungefly growth and our D2C channel, funkoeurope.com. Our Other International geographies also showed growth, especially Oceana and LatAm.

Finally, this week at FunKon, we announced a brand-new initiative as part of Funko Cares program called Pops! With Purpose. At Funko, community engagement has always been at the center of our efforts. With Pops! With Purpose, we are elevating our commitment to our community with a distinctly Funko approach. We began identifying causes that are important to our fans, employees and communities.

Today, we are partnering with leading organizations to create Pop! collection, celebrating the individuals affected by or contributing to those causes. Stay tuned for our first Pop! collection in partnership with Make-A-Wish.

We've had an excellent first half of the year, and we're excited to execute on the opportunities in front of us. We look forward to keeping you updated as we progress through the year.

I will now turn the call over to Jen to take you through the financials and 2021 expectations.

Thanks, Andrew, and good afternoon, everyone. We're pleased to report record second quarter results, highlighted by net sales growth of 141% over the prior year, reflecting the very strong second quarter demand and broad-based strength across our product categories, geographies and channels.

The overperformance relative to our expectations was primarily driven by our Loungefly brand in Europe as well as strong mass market results. All comparisons are to the second quarter of 2020, unless otherwise stated. Net sales in the U.S. increased 110% to $163 million, while Europe grew 393% to $52 million, and our Other International markets increased 117%, with growth in all of our larger regions.

The demographic properties in Q2 was 795, an increase of 23% from prior year. Net sales per active property were $297,000 in the quarter, an increase of 95%. For a list of our top performing properties in the quarter, please see the accompanying earnings presentation.

On a product category basis, Q2 net sales of Figures grew 142% to $187 million with Pop! branded products increasing 137%. Non-figure product sales increased 136% to $49 million, primarily driven by our Loungefly brand, which grew 132%, but with strong contributions from accessories, games, plush and action figures. Second quarter gross margin was 39.1%, an increase of 250 basis points versus Q2 of 2020. This improvement primarily reflects our healthy inventory position and lower clearance activity in the quarter.

While we were able to largely offset the rising shipping of freight costs in the first and second quarters, we've seen a sharp acceleration in July and expect shipping and freight to remain a significant headwind throughout the second half. SG&A came in at $55 million, slightly lower than anticipated due to the timing of onboarding new talent and a shift in marketing spend to the second half of 2021.

Moving down the P&L, adjusted EBITDA increased substantially to $41 million with adjusted EBITDA margin of 17.4% and adjusted diluted earnings per share of $0.40.

Turning to the balance sheet and cash flow, we ended the quarter with $95 million of cash and cash equivalents, our highest balance ever, and $75 million of availability under our revolver, representing total liquidity of $170 million. We ended the quarter with total debt of $177 million, down 26% compared to Q2 of last year.

Inventory at quarter end totaled $86 million, up 43% on sales growth of 141%. The business generated strong operating cash flow of $71 million during the quarter. As Brian mentioned, we expect container cost and availability to present a much greater headwind in the second half than we saw in Q2.

Meanwhile, Delta variant concerns continue, adding additional uncertainty to the second half outlook. Offsetting these external headwinds is the record demand for our products across all our channels and our focused execution.

Based on our current view, we're raising our full year revenue guidance to reflect our strong second quarter, while adjusted EBITDA margin guidance remains unchanged.

With that context, for the full year 2021, we are raising our top line outlook at the midpoint by about $30 million with anticipated net sales of $900 million to $930 million. We now expect gross margin for the year to be approximately at or just below 2020 levels, which implies a sequential decline from Q2, reflecting the sharply increasing shipping and freight costs expected in the second half. We expect third quarter SG&A on a dollar basis to increase sequentially to the mid- to high single-digit millions, reflecting a catch-up in some of the marketing spend that shifted from Q2 with a more modest sequential increase in the fourth quarter.

Full year adjusted EBITDA margin is expected to be in the range of 14% to 14.5%, representing an increase of 170 to 220 basis points compared to 2020. We expected adjusted net income of $57.4 million to $64.2 million based on a blended tax rate of 25% and adjusted earnings per diluted share of $1.06 to $1.19 based on a weighted average diluted share count of 54 million.

We appreciate your time this afternoon. Now Brian, Andrew and I would be glad to take your questions.

(Operator Instructions) And our first question comes from Tami Zakaria from JPMorgan.

So my first question is regarding your comment that the Delta variant is beginning to weigh on consumer sentiment. Could you elaborate on that a little bit? Is that based on what you're seeing from retailer order trends or the end consumer holding off on purchases because of the virus?

I would -- hi, Tami. How are you? This is Jen. Thanks for the question. What we're really describing there is what we're hearing externally. Our demand has never been stronger. We feel really good about our Q2 sales and about our outlook. It was more just to acknowledge that this pandemic continues to weigh on consumer sentiment. So we'd be remiss not to mention that.

Got it. Got it. So it's nothing specific to Funko's quarter-to-date trends, rather more of a macro sentiment.

Correct.

Okay. Got it. Got it. That's super helpful. And then I think your previous full year guidance contemplated like a low to mid-double-digit sales growth in the back half. And now I think you're raising it to like mid-teens to high teens sort of range. So can you help us understand what that means for the third quarter versus fourth quarter? And then whether this increase implies any contribution from the NFTs that you launched recently.

Yes. So the way I would think about our quarters, we have a fairly stable normal quarterly basis. And I think looking at just some of the history, if you remove 2020, of course, would be helpful. As we talked about in our last call, we feel really good about the NFTs. We just launched our first one officially on Tuesday, which was exciting. At this point, it's an evolving industry and we're new to it. So we have not baked that into our numbers at this time.

Our next question comes from Erinn Murphy from Piper Sandler.

Great. Congratulations, Andrew and Brian, to the announcement this afternoon. I guess my first question is on supply chain. 70%, I believe, you produce out of Vietnam. Could you share a little bit more about what you're seeing in terms of factory downtime, how flexible you can be in terms of moving product out of Vietnam or into China or just elsewhere?

And then you talked a little bit about freight expense in the back half really starting to pick back up. What's embedded in the outlook right now? And are you having to tap into air freight?

Erinn, I'll take the first part of that. As far as bandwidth in terms of capacity for our factories, we're in great shape. We still have, like I said, 70%, 75% is still in Vietnam, but our ability to keep up with demand is not a problem in factory capacity. It's more about container space. That's where the bottleneck is for us and just about everybody else. We continue to work with either some of our biggest retailers in the world about moving FOB product to them. They're having the same constraints that we are, but I'll let Jen answer the second question.

Yes. We've -- as you I'm sure have been reading as well, it's constantly evolving, the situation with the containers and the freight cost. We have tried to look forward to see what we anticipate based on what we're seeing out in the marketplace and bake that into our guidance. That's why we feel really good about our adjusted EBITDA margin guidance. But if we were to actually exceed our sales, it would put margin pressure on just based on what we're seeing out there. But we have contemplated those freight increases in our guidance.

Okay. And then, Brian, just a follow-up, just to make sure I understand. So are you not being impacted by any of other factory downtime? I know a lot of athletic manufacturers right now are kind of moving on to week 5 or 6 of downtime in factories. So I just wanted to clarify...

Yes. Not an issue for us at all, Erinn.

Okay. Great. And then a couple of follow-ups. Maybe Andrew, for you, I'd love to hear how your view is of back-to-school thus far and what you're seeing in terms of your kind of core channels. It sounds like mass was part of the outperformance in Q2. Is that continuing into third quarter? And maybe what you're seeing in digital versus specialty as well.

Yes. Hey, Erinn. Yes, so we are seeing -- we saw strong results in the mass market in Q2. As you know, we've been building pretty significant programs in that channel for quite some time. And that channel fared the best over the last year and so -- and it continues to.

So although back-to-school isn't traditionally a very big event for Funko, we do obviously get a little bit of the foot traffic that's going into the stores for back-to-school supplies and things like that, backpacks, things like that, that are more of the target of back-to-school. So yes, I mean, we're thrilled with where we are right now. And we think that we're benefiting maybe a little bit from the foot traffic. But I wouldn't say it's anything over and above what we see normally.

Okay. And then last question, just following up on NFTs. Very exciting to see that, that came out earlier this week. Can you share a bit more about the user experience you've created? And how should we think about frequency of launches going forward?

Yes. Great question. I would tell you that we certainly didn't create a user experience, we definitely piggybacked on WAX's marketplace. And we certainly work with them hand-in-hand to try to enhance maybe previous releases on that platform to try to make it more of what a Funko fan would expect. And I think they did a really good job.

With that being said, it is in our plan, and WAX is aware that we are building our own marketplace, and we will end up controlling the front end of that fairly quickly. As far as cadence is concerned, I think we're not going to be as aggressive as we originally thought with the once-a-week releases. We talked earlier, when Andrew and Jen did a road show, about the difficulties in the licensing space with the legalities of the boilerplate contracts because it's just new. And there's a lot of outside counsel on us and outside counsel on them trying to come up with that.

I also think that there is a lot of learnings. Despite an amazing initial launch, there are things that we want to do to better the overall experience. But my guess is you're going to see things on about an every 3-week cadence with a couple of ones that will be a little bit shorter than that throughout the end of the year. And I think as we continue to ramp up, contracts are taking a little bit longer than we anticipated. I think you'll see a more robust release schedule in '22. But so far, we're really, really optimistic and thrilled with the initial release.

Our next question comes from Steph Wissink from Jefferies.

I'll echo Erinn's sentiment. Congrats to the team on the transition. My question is actually on Loungefly, if we could just unpack that a little bit up over 100% in the quarter. Has that been from incremental distribution? It sounds like Europe was part of that. What are you seeing about that customer relative to your core business? Is it bringing a new customer into the Funko family? Or are you seeing that as an overlapping customer that's already buying some of your figures as well?

Yes, Steph, I'll start and I'll let the guys chime in, too. I mean, we're obviously seeing -- we'd like to say the thriving of the mom-and-pop or the specialty retailers are really driving a significant amount of growth. They're being able to order more. They're able to carry their own exclusive content. That married with, obviously, the parks going back into play with Disneyland, Disney World and the resorts, Universal Studios as well. The D2C channel continues to just thrive. And again, more dedicated resources to creating more interesting online exclusive content for the D2C is also thriving.

And then part of what Andrew and I have promised Loungefly when we acquired them, which is more licenses and more help with distribution. I think all of that is really just -- it's just been phenomenal, the growth story there. But we just think we're just honestly scratching the surface with that brand. We think that we're capable of so much more. And we've really been able to put some talent around that team and it keeps -- we keep investing in Loungefly and it's obviously paying off, but I'll let Andrew and Jen add anything to that.

Yes, I'll just chime in quickly on the customer mix. I would say that it's -- we're seeing sales from both existing Funko fans, but we're definitely bringing new people into the Funko ecosystem. It's part of furthering becoming a pop culture lifestyle brand. And that's just one more category where we can talk to people that we weren't talking to before. So I would say there's obviously Funko fans that are Loungefly fans, but we are bringing new people into the funnel.

Yes. Steph, just to give you one -- just one key metric. We brought a key person on over from Disney to run Loungefly marketing. We've never had a dedicated resource before. And she's nearly doubled the Instagram followers. I think we're now over 700,000 Instagram followers.

The leading -- I guess, the leading competition in the space, which is a much larger company than we are, has 24,000 fans on Instagram. So they're more commodity-based and Loungefly is more high-end brand pop culture base. And I think that as we continue to build out that brand, the appetite we're seeing globally is just phenomenal for the brand. And we're excited that we're actually starting to properly market the brand in new ways we've never done before. So again, this kind of leads us all to just kind of scratching the surface comment. We really are excited about what that future is for them.

That's great. And then one for you, Jen, really quickly. I wanted to just reconcile the EBITDA being unchanged. You mentioned gross margins coming in a little bit lower. But then I think you also said something around shifting in marketing to the second half, so there might have also been a timing factor. Can you just give us a little bit more color there, please?

Yes. That's absolutely correct. We did have some of our marketing that we anticipated originally spending in this quarter that will shift to the back half of the year to align when the product launches. And then secondly, from an SG&A perspective, we did have a slower ramp-up of our talent than we anticipated, but we're still on track to continue to add the talent that we've been talking about on these calls. So adjusted EBITDA margin, we're reiterating our guidance there. But overall, the adjusted EBITDA, obviously, with the increased sales will go up.

(Operator Instructions) Our next question comes from Linda Bolton-Weiser from D.A. Davidson.

So I was wondering if you could just talk about things a little bit longer term kind of even beyond this year in a general way. As our business continues to grow rapidly and ramp up, what are the next big sort of infrastructure-type investments or initiatives that you need to undertake in order to ensure continued health and growth of your business? And in general, like what would be the CapEx requirements over the next few years? Would the ratio as a percentage of sales stay constant? Or are you expecting some big investments in the coming years?

Hey, Linda, this is Jen. Yes. So I think as we come off of our Q4 call, we'll give a little bit more guidance to what we're seeing in 2022 and beyond. What I'll say is that as we talked about in our previous call, we're in the middle of investing in infrastructure right now. We do have our ERP project that's in the midst that we are looking to implement next year. So that's really one of our main focuses right now.

And from -- we will have -- continue to have some infrastructure to invest in, but really, the majority of our capital is our tools and molding, and that should remain relatively consistent go forward.

Great. And then you mentioned that with the situation with the containers, that there could be some shifting more towards the mix of FOB sales. Can you remind us generally, normally, what would be your percentage of sales as FOB? And do you think that that's going to shift some sales like into third quarter from fourth quarter?

Yes, I was going to say -- hey, it's Andrew. So when we're talking about that, we are having conversations with our customers right now, Linda, about container availability, right, whether it's -- we're working our resources to find more containers and our retailers are as well.

As you probably know, right, even companies like Walmart, the world's largest retailer, having trouble finding containers. So those are the conversations that we're referencing around trying to find ways to move products that are -- might not have a home on a container yet. And so we are in dialogues with our customers. Most of those were already doing some FOB with. So we're utilizing that as much as we can, to move as many products as we can.

As far as what percentage of our business is FOB, I think it's around the 25%, 35% when you look at both the U.S. and Europe combined. But I kind of have to go back and really look at that to confirm.

We have no further questions. So I can hand back to Ben, Brian, Andrew and Jen to conclude.

Hey, guys, I want to thank you, everybody and our investors, our shareholders and the Funko team for supporting another great quarter for Funko, and we're looking obviously forward to the rest of the year.

Thank you to everyone who has joined us. This concludes today's call, and you may now disconnect your lines.