Q3 2022 Funko Inc Earnings Call
To deliver strong top line performance over the long term.
Our strong results come from across the entire portfolio as we generated year over year double digit growth in all of our reported geographies and brand categories Mountain again led the way growing 57%, while core collectibles and other brands grew 34% and 25% respectively.
Direct to consumer grew 36%, while both Europe and other international exceeded 30% growth, we've managed to distinguish our brands by continually delivering products that connect fans from across all phantoms with their favorite content characters and stories and a uniquely fund co way.
This in turn has cultivated an amazingly loyal and committed fan base of collectors in pop culture enthusiasts.
Fan enthusiasm was particularly apparent with the return of in person events. We drew massive sold out crowds at San Diego, and New York comic Con as well as our own pump.
Not only are these events great parameters of our fan engagement. They also led to many of this year's top POC sales days.
The enthusiasm our fans have for funko is palpable they dress up the wait in line for hours that carry the fund co flag. They are really our greatest brand ambassadors.
Among our core collectible brands, our flagship pop vinyl continues to generate growth through innovation. Our calendar program is a great example.
We launched this line in 2018 and it has grown more than eightfold in four years.
And that's in coming months.
Finally, the most recent addition to our collectible brands as model, which we acquired last quarter.
While still early in that integration, we've already started to see synergistic benefits as we integrate mondo into the funko support functions.
We believe the Mondo acquisitions sets us up well for strong growth and music content much more to come on that.
<unk> allows fly demand across all channels, particularly our park partners has been incredibly strong lounge was 57% growth in the quarter brief their year to date growth to nearly 90%.
Importantly, loungefly direct to consumer sales jump from 10% of total sales in Q1, 16% this past quarter, reflecting the growing strength of the brand.
Believe this success as a direct result of our unique style of panic gaze, including our first brand temple somewhere of Loungefly, which strengthens the connection between our fans and the brands They love and toys and games are now up to 180 games in our catalog, which is critical to the longterm revenue central.
To the games business.
Incredible game designers continued to produce heads and both current and timeless IP within our collectible gaming business.
Our new Kitten immediate game has had an extremely strong introduction.
Was a finalist for the 2022 toy of the year and the collectibles category.
We soft launched a title at 823 this year and it's sold out every day.
On the toy spot, we recently launched the latest product and are highly successful five nights at pretty lineup featuring snap technology. We've created an interchangeable actually figure. It is true to the game's most fundamental elements. Importantly, this is the first step in building an entire ecosystem. We have plan for this property stay tuned.
For more announcements.
Finally, our digital brands continue to generate very strong growth.
Since we entered the digital collectible space a year ago, we have more than doubled our net sales versus the same quarter last year.
To sustain demand, we'd have increased drop frequency and grow the average size to well over a half a million dollars in net sales.
We've had multiple drops the top $1 million in net sales and we've announced digital collectible collaborations with some of our largest wholesale partners. Just last month, we released a Halloween drop made up entirely our own IP, it's sold out in under 30 minutes.
A two point of differentiation for Funko digital collectors has been the introduction of additional utility.
Our rarest digital collectibles are redeemable for a physical version of similar scarcity.
This feature has been a key factor in bringing physical first collectors into the digital space.
This remains a nascent market and we're very excited about its future.
Turning to channel highlights within wholesale we saw strong growth from our masks partners. Despite broadly high levels of inventory at retail.
Well wonderful products continue to be traffic drivers for our retail partners, we've seen some order delays or reductions given the broader economic climate.
Our results in direct to consumer, which I'll speak to shortly highlight the continued strength of the fund co brand. However, we do expect these wholesale order with <unk> and delays to persist in the short term given the current macro environment.
These expectations have been reflected in our full year guidance.
R D B C channel so another quarter of strong double digit growth exceeding 30% in representing when we like to call our single largest customer by net sales.
Average order value in traffic across R. E Commerce sites were both of strong double digits.
To our international Geography's Europe posted another strong quarter with growth across both established and emerging regions demand remains very strong and we continue to see excellent progress on our strategic partnership initiatives as we thoughtfully leverage the most efficient retailers in the region.
Among the other geographies, we experienced excellent growth and last Hamm and oceana.
While we're still in the early stages of reaching our growth potential in Asia. We've recently hired leaders experienced in the region to execute on our growth strategy in this critical market.
And described in previous calls we've experienced very strong growth over the past year and a half. This success necessitates infrastructure investment to ensure we have the capacity and capability to maintain build on that growth over the long term and.
And Q2, we open our consolidated fulfillment center. Moreover, we achieve this upgraded infrastructure without the benefit of the warehouse management software. It was designed to operate with it.
Together with our European implementation in 2023, these software upgrades will better position to sustain our double digit growth and drive efficiency as we continue to scale our operations supporting the complex upgrades to our core infrastructure has resulted in higher than expected short term operating expenses and increased margie.
Pressure. These actions are critical to service, our near term demand as well as support our long term growth objectives. We.
We are actively managing through these in terms of government dynamics and we believe these investments will result in consistent margin expansion in the future.
Due to the macro headwinds previously discussed we're revising our full year net sales target between 12913 3 billion.
Approximately 27% at the midpoint year over year.
We're also lowering our full year EBIT margin to high single digits as we manage through the previously mentioned infrastructure upgrades necessary to support the sustained growth.
In closing we are pleased with our ability to continue to generate and service robust demand.
Again delivered record topline results I missed an uncertain consumer market, while we continue to manage through that uncertainty in the fourth quarter. We are still on pace to deliver high teens growth in the second half.
Are very strong results through these three quarters and our confidence in the resiliency of our business model is a testament to the power of the Funko brand and the incredible loyalty of our fans.
We remained similarly confident in our ability to achieve the five year objectives, we laid out at our recent Investor day, a bet both top and bottom line, we are managing through the short term macro factors.
And investing in infrastructure operation upgrades, when combined with our focused execution. We believe these steps will enable future growth and margin expansion over the next several years.
In closing I'd like to thank our fans partners and employees for their continued dedication and support for panko.
Now Jim will provide more details on the financial results of the court.
Good afternoon, everyone. We did that very strong third quarter net sales growth at 37% over the prior year all results from a broad base with strength across our geographies and channels. Once again each of our three button brand categories to double digits.
Multiple factors drove our top line outperformance, including another excellent quarter from that's fine.
In the U S. Net sales increased 37% to $262 million net sales and you're at 33% to $78 million and other international net sales increased 43% to $25 million.
On a brand category base, it or collectible brand net sales grew 34% to 282 million driven innovation and our brand and increase contributions are emerging brand in the category.
The last night brand with 57% to $62 million with particular strength in our practice business as Andrew mentioned.
One of our other brands, which includes toys and games and our digital brands net sales grew 25 per cent to 22 million. This quarter, we saw particularly strong contributions from our digital category.
Turning to margin and expenses third quarter gross margin with 35% a sequential increase at approximately 200 basis points due to a more favorable chronic next in the prior quarter.
<unk> have increased significantly since a recent highs earlier this year.
However, we did not really like the benefit in the third quarter due to the timing of inventory delivery.
Contact if we've been able to receive free under the enquirer rate per container. It would've contributed roughly an additional $7 million in gross profit.
We expect to benefit from the right improvements at 2023 Progressive we remain committed to gross margin improvement, which will come in three main components.
First you can prevent and pray that I kept described set.
Second is driving more efficient sourcing from more cost effective geography, and third is a broader application at the price increase Disney announced late last year.
To provide more detail on the pricing lever we were deliberately cautious when we implemented our first price increases in almost five years.
Based on our observations over the past year from the wholesale energy to see channel, we've taken steps to apply the price increase more comprehensively, which we expect to be in full effect by early to mid 2023.
Turning to SG&A, let's start with a few comments on the significant upgrade store infrastructure that we've previously announced these.
These investments are critical to our ability to keep pace with a strong double digit growth, we generated over the past year and a half.
It's also vital to support our long term plan and.
In the short term investment add additional expense as the upper right out of the new D C without the intended software system in place.
The entire expensive consistent primarily a greater labor costs within the facility and additional machinery to support product movement.
We've also added additional third party logistics or <unk> warehouses.
These initiatives will enable us to continue to support our strong demand until our software upgrades are in place next year.
We believe these increasing expenses will be short term in nature, but expect them to continue until the rollout of our new ERP next year.
And a third quarter. These additional investments reduced adjusted EBITDA by approximately 5 million as.
As a result of these infrastructure upgrades SG&A as a percentage of net sales increase sequentially to 27% or 98 million.
For the third quarter, adjusted EBITDA was $36 million with an adjusted EBITDA margin of 10%, reflecting elevated frightening.
<unk> application of our pricing increases and the investments we are making to serve a strong current demand and support future growth.
Finally, adjusted diluted earnings per share were 28 cents.
Turning to the balance sheet, we ended the quarter with $150 million in total liquidity roughly double our second quarter physician.
This comprises $125 million <unk> and $25 million cash.
We ended the quarter with total debt at $250 million at 41% compared to Q3 of last year as the access a revolver to support the near term infrastructure investment and upset or increased working capital needs stemming from our inventory tiny.
Inventory at quarter end totaled 266 million inventory levels remain higher than the prior year, which was particularly tight inventory environment port delays and supply chain congestion.
We believe that our inventory it generally high quality, we will continue to work through our inventory levels and expect to make sequential progress.
To the guidance for 2022.
Revising our full year net sales target to 1.29% to 1.33 billion or approximately 27% growth year over year at the midpoint at.
The fourth quarter is typically our lowest gross margin quarter, we expect a Q for gross margin. She declined sequentially due to margins seasonality, an ongoing inventory management or full year adjusted EBITDA margins, we now expect high single digits.
We expect adjusted net income of 39% to $41 million based on a blended tax rate of 25 per cent and adjusted earnings per diluted share at 70 to 80 cents based on a weighted average diluted share count at $55.2 million is.
As I previously mentioned the reduction in our full year net sales and adjusted EBITDA margin outlet is a function of the broader micro climates, and our continued investment and more efficient appellant capabilities to support our future growth.
We now expect that's S. You need investment impact on our margin profile to largely persist until the completion of our software upgrade next year.
With a year and a half a very strong double digit growth behind us we are on the right path to deliver on our five year objectively out in our Investor day, including increasing net sales to $2 billion in driving adjusted EBITDA margin to approximately 20%. We look forward to taking you on our progress.
We appreciate your time this afternoon, now Andrew and I would be glad to take your questions.
To ask a question. Please dial star followed by one now we're preparing to ask a question. Please ensure that you are muted locally.
And our first question of the day. It comes from the line of Megan Megan Alexander from J P. Morgan checks. Please go ahead.
Hi, Thanks for taking my question I guess, you know maybe starting on the top line three killed with strong I think at the mid point you know the Guy <unk> down you know call at 5% given where you know is that is that related to destocking and the macro and I guess, you know given where inventory levels are.
Are you anticipating Destocking continues into 23 and you know are are you do you think you're gonna have to take any action on any of your own inventory.
And how does that change how you're thinking about or does it change that you're thinking about calling this hotline double.
Double digit.
Yeah. So thank you for the question good to speak with you I'll I'll take them off and then I can hand, it over to Jen Yeah. We are.
I'm very happy with our top line growth in Q3, you know, we definitely feel that we've outperformed the market and.
And that has been pushing hard and what's been uncertain consumer market I would say that our largest hurdle in the back half was really well a wholesale partners what they're doing at retail <unk> I just need to learn from the broader marketplace get.
<unk> retail partners were pulling back they're tightening up their inventory, which is which kind of which was reflected in the apartment. So you know the signs we're seeing on the phone to a brand now and then the second and the bad.
Okay are are awesome right cause <unk>.
<unk> dot com direct to consumer size and people are spending more money and put in a bind more items than ever before so that's a really positive silent machines. Yes. There are there are outside pressures that we're dealing with it that have had.
An effect on inventory and we all are always looking at the health of our inventory and silence, we need to ask you that.
Jen comments automatic she's got over that yeah. Thanks, Megan Uhm speak with you as we think about our inventory yes. It is up year over year remember last year was a pretty tight inventory environment, because we were dealing with a supply chain challenges uhm. So there is a little bit of new once in the number underneath the covers that being said we are constantly.
Looking at the quality of our inventory and we think it generally is very healthy right now and in the event, where we have seen.
Pull back a little bit in queue for we have been making the right added to our inventory whether it be cutting receipts are pushing receipts out to make sure that we are managing this and managing it down towards the end of the year.
Definitely an area okay.
Okay. Thank you and then maybe a follow up for your tennis all can you just help us maybe better understand the components of the margin and <unk> you know maybe how much of the can you give us like a full year.
Gross margin range, just to try and understand how much of the additional pressure. It's gross margin burst SG&A and then you know just trying to understand within that how much of that is transitory and may be related to inventory action that that you can get back next year.
Yeah. So you know in general what we typically see in normal years that our queue for gross margin does come down a little bit from Q3 simply because that is when all of our retailers will take advantage up there and contractual mm discounts with that so that that's a normal trend that we see underneath the covers we have accounted for it.
In the event, we might have to do a little bit discounting because we know the inventory is tight across our retailers in the back half of the year. So we've taken that into consideration from an SG&A perspective, you know it's.
I'll, let you guys need to work on your models, but yeah, we will see a slight uptick in queue for from Q3 until one dollar basis, but yeah, that's really related to some of the infrastructure that we've had to put in place to make sure that we can maintain and continue to go to the business. So.
You'll see a little bit of dollar uptick in SG&A in queue for not significant but that's where do you see the pressure point.
And then when did you expect the European software system to be rolled out and should the.
You know if it's in the middle of next year. So the pressure should you get this pressure back in the second half of next year.
So.
We're looking at next year is there.
There are three main areas of gross margin that we're looking at the afternoon to help us improve that in the near term yeah, we talked about price increases aggressive sourcing out of Asia.
<unk> <unk> Ah cost decreases walk backwards, and then lower shipping containers, which we're seeing come down between eight 6000, perfect <unk> ourselves with low on that new inventory lower container raged, we should start to get somebody to upsize benefit.
All of that yesterday, and additional costs with the growth and the other.
Structure, what happened to invest in.
Well.
That to be the middle of next year, we are pushing hard to get that European <unk>, which also by the way brings that the the the software.
A warehouse, which we.
We built the warehouse too long W bus because of the ER pita like that's pushing back us up in your lap. So we've obviously found a lot of manual work Ross for sure you'll get this you know the record services 7%.
<unk> last four available to continue to do so it's only get the shot which is like I said, a little a mixture of what we're looking at.
Okay. Thank you I'll I'll pass on.
[laughter].
Our next question comes from the <unk> the <unk>.
Please go ahead.
Yes. Thank you so I'm trying to figure out the math here just for the fourth quarter I mean are we talking EBITDA down.
50 per cent have 30 per cent, 20th and I'm, just trying to like figure out the map here, there's a lot of moving pieces, but even Ah in dollar terms will be down significantly in the fourth quarter correct.
Pardon me.
Down to compare it to you so.
Down we'll EBITDA in dollar you down significantly year over year in the fourth quarter.
Well you know what we got into was high single digit EBITDA percentage on the year. So yeah I'll, let you guys kind of work out how you want to give them. We only have one quarter left [laughter]. Let you guys work on your models there, but we are seeing you know pressure on the margin front as I mentioned that we do have some additional investments for.
Or future growth that we're meeting.
So it it it feels to me a little bit like a bomb had dropped on my head you know like like you you've really up until the second quarter. When you did have an EBITDA decline you've had pretty strong EBITDA growth.
In the last five quarters.
And you just had a big analysts meeting where you stood up in front of everybody in September and you talked about you know really kind of aggressive margin.
Goals going forward, so I guess, what I'm, having trouble marrying like the two ideas here I mean, when you have analysts meeting did you know that you have these operational issues.
So could you hold on the on the Investor Day, if that's what you refer to if if that's what you're referring to I I just want I just wanted to take advantage of reminded that is in long term.
We're still very bullish on and when we absolutely believe in the long term vision numbness, I think what you're experiencing right now is a <unk> a contraction of the retail marketplace, which we're seeing across the entire industry and you're seeing.
Awesome executing against two major infrastructure projects in order to deliver that future revenue. It just so happened to fall in a year, where there was this broader economic pressure and again I think the best what your savings why would you want with confidence in a short time.
Situations vehicle to talk we are rolling out multiple large infrastructure projects and a chap here and that's what you're seeing in the backyard.
So right. So if we think about the long term you know I'm going back and looking at your EBITDA margin and Smith, 20th 16 and has declined in every single year, except for 2021. So you've had an EBITDA margin of 22 per cent and 2016.
And now here, we are at high single digit EBITDA margin. So yeah that is asking all along because that's been impacting your margin all these years and all the infrastructure investment.
And so.
I guess I'm, just not seeing what was relatively strong top line growth most of the time why your margin has declined so much over the last five six years.
Can you just help me understand and then how do I get confidence that all of a sudden you're going to have a big period of margin expansion, even though you've had five six years of margin decline.
We are absolutely focused on improving our overall margin as we noted a named Mr de weird, we see a past 20% of the longer term as Andrew mentioned earlier. There are several factors that we're already putting in place that are going to help that we have already negotiated some better pricing with our factories, we're rolling out.
Starting in the next year it will take place mainly in Q2 more broad based price increases across the board.
And we will also see the benefit of the redo shipping rate what you're seeing this year is that we didn't quite get all the pricing than we had anticipated and our shipping expense. We are still amortizing those higher shipping cost that we brought them with our inventory. So we are feeling very good about being able to achieve that is absolutely a priority of ours and that's why we didn't want to share.
<unk> number at the best of it.
So can I just ask.
What is the.
The <unk> the demand for your product is it strong or had the weekend.
Yeah, I mean, I think that it took a look at the two three.
First the market, but other people you know it is.
And our service sector that tells you everything you need to know the demand is there life. We are seeing record numbers of consumers <unk> Dot com is spending more dollars per transaction to buy more items that tells us everything we need to know what you're seeing from a broader perspective is largely shopping.
Not really within 100 per cent within our control.
Retailer.
It has the advantage of what was your inventory we are going to be hot.
Even keeping T programs.
<unk> there is a broader you get <unk> for our wholesale retail partners to end the year.
With water inventory and I think that that's what you're.
Definitely the shake.
But it sort of implies that you've been selling into the channel at a pace and <unk>.
I mean is that okay.
I'm sorry extend area.
It it sort of implies that in the last two or three quarters for quarter, if you've been selling into the channels into Walmart and target at a pace that exceed your P. O S growth.
Do you have a sense that has been happening you've been shipping more in at a rate that's higher than what it's been selling through at.
Yeah, it's it's a broader context, Linda you've heard across the board retailers across the border, bringing down their their inventory if it's not a direct reflection of our stolen versus our cell thrill is really the macroeconomic economic environment as well as our own internal operational issues that we're currently working through to make sure that we can deliver goods on time so that.
That's what you're saying it if you look at the back half Yeah. We are still up in the low teens on the back half of the year and overall you know approaching with a high twenties Grove on the years. So we're still feeling there is demand out there are products are online channel uhm is demonstrated over that and we feel good about working through the near term.
As retailers Wanna get clean for their inventory by end of year. So that those are the challenges that we're working through but we think you know it.
Prudent just to make sure that we align our inventory with our sales and that's that's what we're doing and that's with Reflexogenic items.
Can you tell me the incremental investment by having to play could have three P out or whatever you were talking about in dollar figures, how much will that increase SG&A in the first half of 2023.
Yeah, we've been given 2023, guys Mister said, we'd like to give a more holistic picture on that we did a five.
5 million dollar hit in terms of warehouse labor.
Mm in Q3, just as we've had to put in more bodies to get some good out the door versus having the systems in place to do so it's it's definitely been it hasn't been forced the court and will be with you for.
But that was expenses of whatever magnitude of it's gonna be in like the first quarter and the second quarter of 2023 is that what you're thinking for the elevated expenses.
We will we will continue to have the three P. L expense as we work through but we are actually currently working on getting more equipment into our distribution center two more streamlined are fulfilling and get some of those costs down you would also opens an additional three P. L in Arizona to help some of our troops. It. So we are there are some additional expenses.
They should be with the help confused <unk> and we're looking to get those damning as we kind of mood board.
Thank goodness a reminder, if you would like to ask a question. Please spell staffer over one no notes on if I can keep that now.
Next question is from the lineup Gareth jumps <unk>. Please go ahead.
Sure I'd actually rather, giving my turn it back to Linda if she wants to keep going mmm seriously performance Frederick <unk> current events wondering how those events New York in the San Diego I've gone for you guys know that everything's.
Back in person and how it how are those events comparing to pre pandemic and then related to this infrastructure thing how how did it become a surprise you know how how do they cut you off guard that you'd be.
It was at the <unk> in the operating.
System or what.
What is it that comes with surprise.
So let me let me check it out new <unk> essentially budget. So let's talk with you in person events will will start their San Diego Comicon was strong double digits visual comecon was up triple digits as far as our.
<unk> most insurance, we could not even handled the demand and we have <unk> that was the biggest complaint was yeah. How do you guys. <unk>. She was you can satisfy more of the consumer so.
It's like drinking out of a fire.
Put it down so we could not maybe when I when I talk about my problems that I have on brands.
Compiled with what or combined with what we're seeing on <unk> Dot com is exactly what I'm talking to so.
Does that does that gives you a good idea.
That's great yeah. Thank you.
Right. So I'll need why was it a surprise so I think it's a combination of magenta chop trying in here as well.
You know it was a.
We launched the new warehouse we.
Decision to move to new warehouse with a delayed E. R. P M.
Part of that <unk> was called <unk> warehouse.
Management software.
And basically that how can optimize the layout of that so.
So when you're when it.
It came with the you know extra work around having to create manual processes to optimize that warehouse, which would normally have been done.
In an operating system, but unfortunately, we didn't app so that was it a surprise.
I would say it caused us more manual processes and we expect so yes, I think I think that that was something that you know call us a little bit off guard, but obviously, we're pushing June were cleaning.
<unk> then we'll work around to continue to get that revenue obligate.
And and I would go ahead and add to that given that <unk> is launching in Q2. We did expect you in any new D C.
No hiccup around the launch of it what I think is the bigger you know unfortunate part is that they continued on whereas we've added him in the first and Q2, so you're seeing a little bit of that as well, but we are again investing in growth and the best thing is <unk>, we specifically left for lunch by business and a three P. M <unk>.
Continue to support it <unk>. So we wanted to check that as as as well. So we are doing everything we can to fix our operational hiccups.
Okay great.
It's difficult given the nature of your distribution to to give us a <unk> number for.
For the quarter, but how 'bout to Peel his performance that you're major mass market accounts.
Yeah. We we were we were happy with what we're seeing.
Sure obviously, you Ryan R. Pof's is a lot different than some other some of the other people who are closed because of our distribution is so much more specialty oriented but yeah.
Was there to happy we continue to see you know not only gives you Netflix Charlotte shelter, but also I rasps. So.
It's March.
I will say, it's obviously there is a bit of forward inventory situations retailers are dealing with across the board and maybe it's not over inventory, but they're trying to cut back inventory until you've heard that from other people where they are Ah entered your clean inventory show up at that time.
So I'm sorry, what was that type of music.
Okay. Thank.
<unk> you too thank you.
Yeah, maybe.
I have a phone reminder, if you would like to ask a question. Please <unk> one on your telephone keypad.
Because we have no further questions being registered at this time, so how back to Andrew for any <unk>.
Alright. Thank you very much we appreciate everybody's questions today and look forward to talking to you again soon.
Thank you.
Thank you to everyone, who has joined US today <unk> and you may not disconnect your lines.
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