Funko, Inc. Q1 FY2020 Earnings Call

Good afternoon. And welcome to Funko’s Conference Call to discuss Financial Results for the First Quarter of 2020. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Please be advised that reproduction of this call in whole or in part is not permitted without written authorization from the company. As a reminder, this call is being recorded. I will now turn the call over to Andrew Harless, Manager of Investor Relations to get started.

Thank you, and good afternoon. With us on the call today from management are Brian Mariotti, Chief Executive Officer; Andrew Perlmutter, President; and Jennifer Fall Jung, Chief Financial Officer. A press release covering the company’s first quarter 2020 financial results was issued this afternoon and is available on our Investor Relations website investor.funko.com. Before we begin, I need to remind you that management’s remarks on this call may contain forward-looking statements with the meaning of the Private Securities Litigation Reform Act of 1995. 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 Factors section of our Form 10-Q for the three months ended March 31, 2020, 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 obligation to update them. We will be referring to certain non-GAAP financial measures on today’s call such as EBITDA, adjusted EBITDA and adjusted EBITDA margin, which we believe may be important to investors to assess our operating performance. Reconciliation of non-GAAP financial measures to the most directly comparable GAAP financial measure is included in our earnings release. We have also prepared a visual presentation that investors can consult to follow along with this discussion and can be accessed at investor.funko.com. I will now turn the call over to Brian.

Good afternoon, everyone, and thank you for being on the call today. We hope you are all staying safe and healthy during this unprecedented time. Since our last call, only nine weeks ago, we have all had to adapt to a new way of life and Funko has pivoted accordingly. We are remaining nimble and acting swiftly to navigate the dynamic environment and best position Funko for both the remainder of 2020 and the long-term. Amongst our foremost priorities is the well-being of our employees, partners, and communities across the globe. We have implemented measures to safeguard the health of our employees, made strategic moves to mitigate business disruption and taken steps to strengthen our financial position. Let me provide a brief summary of the actions we have taken to date. We have closed all corporate offices, as well as our two flagship retail stores. We have implemented practices to safeguard workers at our distribution centers, including reduced staffing, staggered work schedules, heightened cleaning procedures and temperature screenings. We have intensified our focus on our e-commerce initiatives and increased the number of SKUs on our website. We have lowered expenses by implementing executive and senior level management salary reductions, furloughing a significant portion of our employees globally and cutting other areas of SG&A. We have reduced non-product development-related capital expenditures. We are proactively reducing incoming inventory to better align with the current demand we are seeing in the market, and most recently, we have secured an amendment to our credit facility, which provides us with covenant relief over the coming quarters. Equally important, we are actively exploring opportunities to further increase our flexibility and liquidity. Like many organizations out there, we have had to make some tough decisions in recent weeks. As a company, we are learning to do more with less and evaluating opportunities to eliminate redundancies and shift resources toward key growth priorities. We believe Funko will emerge from this crisis as a leaner and more efficient organization. Also, we believe we will be better positioned to reach our highly engaged and growing fan base with our broad array of product categories in a more cohesive way as we further align our operations and go-to-market strategy. Now I’d like to turn to the first quarter and how our business trends evolved as stay-at-home orders, business closures and social distancing guidelines took effect. Up until mid-March, we were tracking to meet our revenue expectations for the quarter and we were seeing solid consumer demand at retail. Additionally, we were optimistic about how our second quarter order book was filling up. However, in the final weeks of the quarter as non-essential retailers across the globe began to close their doors and consumer demand shifted toward household essentials, orders started to get deferred and canceled, and this has persisted into the second quarter. Additionally, some of our customers that remained open began to prioritize restocking essential goods and slowed replenishment orders. These trends developed more quickly in regions outside the U.S., especially Europe, which drove a significant decrease in our international business in March. Despite the topline pressures, we delivered strong gross margins and carefully managed operating expenses, which enabled us to preserve profitability in the quarter. Currently, we anticipate that Q2 is likely to be our most challenging quarter this year as we face the continued effects of COVID-19 around the world. Looking at our U.S. distribution channels, in the mass channel, we are seeing durable consumer demand and we anticipate we will see somewhat softer order volumes while customer capacity limits remain in place. We are continuing to gain traction in this important channel and expect to expand our shelf space by over 20% with one of our key mass market partners later this year. This will include an expanded product offering of accessories and soft line goods. In our specialty channel, most of our retailer doors remain closed. However, some are offering curbside pickup and continue to serve customers via their e-commerce sites. Until stores reopen, we expect that shipments of our specialty customers will be limited. In our third-party e-commerce channel, we are seeing customers begin to restock non-essential items, resulting in improvements in order trends. In Europe, many of our key accounts remain closed or are operating at significantly reduced volumes. As a result, we have made the strategic decision in Europe to shift any new products that were planned to hit shelves in the second quarter into the third quarter to preserve demand for these new items. Therefore, we expect shipments in the region during Q2 will be minimal. Given all these puts and takes across the global retail landscape, we are anticipating a Q2 net sales decline of about 60% versus a year ago. That said, our relationships with our retail partners remained strong and we believe Funko will continue to be an important traffic driver in stores and online as the world emerges from the present situation. At the same time, Funko’s relationship with our consumers and fans continues to deepen as we add new categories, products and properties that they want to connect with. In the face of today’s challenging environment, we are focused on initiatives that will further strengthen our brand equity. We are encouraged to see some states beginning to ease stay-at-home restrictions and reopen stores this week. Recognizing this will be a gradual process, which we will likely see be somewhat uneven, we are optimistic that COVID impacts may begin to lessen in the second half of this year. Importantly, as retail customer and supply chain dynamics continue to evolve, we have begun acting quickly to mitigate inventory risk by working closely with our factories to reduce future purchase orders to align with demand trends. We have also shifted exclusive and mainline products to our retail customers that remain open and have decreased those offerings on Funko’s website. As we look at the new content slate for 2020, many studios have shifted movie release dates through the latter half of 2020 and into 2021. As a result, we have adjusted our manufacturing timeline to match the new release schedules and for items that were already in production, we will be holding them at our factories and in our warehouses. While we do expect these movements to impact the timing of revenue, one of Funko’s key strengths is its ability to produce against evergreen properties, which we will continue to lean on. While we are confronting the challenges and mitigating the impacts of COVID, we remain committed to our key growth strategies which we believe are critical to our long-term health and value of our business. On our year-end conference call in March, we outlined four key strategies for 2020. Let me provide you with a brief update on each of these priorities: Our first strategy is continuing to expand our pop culture business. This includes building fun and nostalgic evergreen programs at retail, as well as expanding within the unpenetrated genres. In the first quarter, our evergreen properties made up 58% of our total sales compared to 45% in the same period last year. This was driven by solid execution against some of our mainstay properties such as Star Wars Classic, Harry Potter, DC Comics, and Marvel. We also saw positive initial response to both new and expanded lines. Our new Marvel Venomized line propelled Maximum Venom in the number eight spot on our top 10 property list for Q1. Our expanded offering of Pokemon performed extremely well, making it our second largest property in the quarter and The Mandalorian was our third largest property driven by shipments of our first products of the child. We saw tremendous demand for these items, which included Pop!, Vinyl, t-shirts, and accessories and we will be building on this in the coming quarters. Our second area of focus in 2020 is driving continued product diversification. We are launching new products and building on current platforms to create new revenue streams and expand our consumer base. In the first quarter, we saw positive initial response from both retailers and fans to our launch of Vinyl Soda!, which was our fourth largest figure line in the quarter. Also, our Loungefly brand continued to perform well, growing 4% compared to last year. As consumers shifted their purchases towards stay-at-home activities, we also saw a seasonally strong pickup in consumer demand for our Funkoverse board games. While the board game business is still nascent for Funko, we are excited about the opportunity in front of us. We are moving aggressively to launch our new games and toys into the market during the latter part of this year. We will be releasing dozens of new offerings from Funko Games, including new Funkoverse titles, as well as licensed and non-licensed board games. Late in the second quarter, we will be launching our first-ever battle-inspired game that will be targeting a younger demographic and mixes cooperative gameplay in micro collectibles. Additionally, our new licensed toy offerings, Snapsies, Boogey Monsters, and Gashouse Gang are all expected to hit toy aisles in the second half of 2020. Our third area of strategic focus is international expansion. Most of our overseas markets have been hit hard by COVID and we expect to see greater impact on our business internationally than domestically. As I noted earlier, we are limiting the shipments of the new items in Europe in Q2 to preserve demand while our stores remain closed. However, we are encouraged to see that countries such as Spain and Germany are beginning to relax guidelines. We continue to believe that there is significant opportunity to expand internationally and as the global economy begins to reopen and recover, we will be focused on capturing more international business across Europe, Latin America, and APAC. Our fourth area of focus, which we view as an increasing priority, is expanding our e-commerce business. We are accelerating our plans and investment to build a robust online platform and enhance our digital capabilities. The size and scope of our e-commerce business is evolving as we focus on transitioning to a more powerful selling model and ensuring that we have the operational infrastructure to build scale as demand grows. In the first quarter, our e-commerce business grew more than 50% but represented only a small percentage of the overall business, reflecting the significant opportunity in front of us. In early summer, we plan to re-launch funko.com to provide our fans with a more expansive e-commerce experience. The refreshed site will allow consumers to shop across new fandom categories such as movies, anime, sports, and music, as well as a broader site catalog, which has grown significantly since January. Additionally, the site will feature a recommendation engine that showcases related products to increase depth of purchase. To help drive traffic, we will be offering special promotions to our fan club and app users and collaborating with our studio partners and influencer communities through social media and other digital campaigns. To ensure we have sufficient resources and capabilities to meet demand, we are converting existing warehouse space in the U.S., which will be dedicated to our direct-to-consumer business. Additionally, we are planning to accelerate the expansion of our e-commerce capabilities in Europe later this year. As we focus on leveraging the significant D2C opportunity in front of us, I am particularly excited to tell you about our new Chief Marketing Officer, Ginny McCormick. Ginny comes to Funko with 15-plus years of toy industry experience, substantial expertise as a global brand leader and two decades of digital transformation work. Ginny was most recently Head of Global Media for Hasbro and joined us in late March. We couldn’t be more thrilled to have Ginny onboard as we continue to strengthen the Funko brand, expand our reach of consumers, and broaden our product offerings, while ensuring we are surprising and delighting our fans. We believe our initiatives to diversify Funko’s revenue streams, coupled with the strategic acquisitions we have made over the past three years will pay dividends over the long-term. We believe Funko’s competitive advantages will provide resiliency in a challenging macro environment, diversity of products, licenses, consumers, and channels, as well as low price points, speed to market in connection to key secular trends. We believe in the rise in pop culture and fandom will endure as entertainment and content continues to become ingrained in everyday life and Funko will continue to create products that connect fans to the content they love. We are operating and planning our business conservatively, but we are remaining nimble and acting decisively to ensure that when the economy begins to reopen we are prepared to ramp up as quickly as needed. Before I turn the call over to Jen, I would like to offer a huge thanks to the entire Funko team as they have taken every challenge head on and adapted quickly over the past couple of months. We would not be in the position we are today without the tireless efforts of everyone in our organization. Also, we are grateful for the continued support of our partners and our shareholders as we navigate these dynamic times. And finally, a big shout out to our fans who continue to be the lifeblood of Funko. We will always be committed to our fans and connecting them to the properties they love. I will now turn the call over to Jen.

Thanks, Brian, and good afternoon, everyone. Before I review the first quarter financials, I will begin by outlining the steps we are taking to manage expense and preserve cash in response to the COVID crisis. In recent weeks, we have made a number of strategic decisions that enable us to increase flexibility, reduce costs, strengthen our financial position, and improve overall liquidity. Most recently, we successfully amended our credit facilities to provide greater near-term flexibility, which most notably includes the financial covenant waiver for Q2 and Q3 of this year. In recent weeks, we implemented cost-cutting initiatives across the business. We furloughed roughly 40% of our global workforce, executed 20% salary reductions for the executive team and other members of upper-level management, reduced Board of Directors’ compensation by 20%, implemented a hiring freeze, and deferred merit increases. Additionally, we significantly reduced expenses across several other buckets, including marketing, travel, professional fees, and contract labor. As a result of these initiatives, we expect to capture approximately $15 million of SG&A savings in the second quarter of 2020. For perspective, Q2 SG&A dollars are now expected to be down moderately on a sequential basis from Q1. As we look at the second half of 2020, we are planning our business against multiple recovery scenarios and we will be managing our expense base with the goal of maintaining our new minimum liquidity covenant of $30 million. In addition to cost reductions, we have also taken several actions to preserve cash and increase liquidity. First, we drew down approximately $29 million under our revolver in late March to increase our cash on hand. At quarter end, we had approximately $46 million of availability under the revolver. Second, we reduced non-product development capital expenditures, cutting total CapEx spend by approximately one-third for the year. And third, we have been proactively managing working capital by reducing incoming inventory to align with anticipated demand. At the end of April, we had over $60 million of cash on hand and $46 million of availability under our revolver, resulting in over $106 million of liquidity. We believe the underlying strength of the business and our financial flexibility will enable us to navigate the impacts of COVID. That said, we believe it is prudent to explore opportunities to secure additional liquidity and we are continuing to evaluate options. Now turning to our first quarter financials, our topline results reflect a combination of tough comparisons to last year, as well as various impacts of COVID during the quarter, particularly the past two to three weeks of March. As we previewed on our year-end earnings call, we experienced manufacturing disruptions and delayed shipments throughout the period. Additionally, we saw incremental pressure on our business in the final weeks of the quarter as retail store closures and social distancing measures took effect. First quarter net sales came in at $137 million, down 18%. As a reminder, we are comping against a number of high-performing properties in Q1 of 2019 including Fortnite, Avengers: Endgame, Captain Marvel, the final season of Game of Thrones, and Toy Story 4. The number of active properties in Q1 increased 11% to 681 and the net sales per active property were $201,000, down 27% year-over-year. In the quarter, our top 10 performing properties were Star Wars Classic, Pokemon, Mandalorian, Avengers: Endgame, Harry Potter, Naruto, DC Comics, Maximum Venom, Dragon Ball Z, and Fortnite. We continue to see underlying strength in the evergreen category, including diversity of products and number of properties. As a percentage of our total mix, evergreen properties accounted for 58% of net sales, which increased 13% compared to last year. Some of our stronger-performing evergreen programs in the quarter included Harry Potter, Star Wars Classic, Pokemon, Maximum Venom, and DC Comics. In the first quarter, net sales in the U.S. decreased 10%, while international sales decreased 34%, reflecting the negative effect of COVID on overseas markets, particularly Europe within the quarter. On a product category basis, Q1 net sales of figures were down 18% to $111 million, while other sales decreased 18% to $25 million. Sales of our Pop! branded products were down 16% in the quarter and Loungefly was up 4%. The first quarter gross margin came in at over 40%, up 240 basis points versus a year ago. The increase in gross margin is a result of improved product margins and enhanced inventory management processes implemented in the latter half of 2019. The strength of product margins in the quarter was driven by higher average selling prices, driven by a mix shift towards D2C sales, as well as higher margins on our Loungefly products and sales to our European customers. We expect gross margins to remain strong in 2020, but also anticipate there will be puts and takes throughout the year due to a variety of factors, such as lower sales and volumes, changes in purchase orders, the focus on our e-commerce business and our launch of higher margin games and non-licensed toys later this year. Selling, general and administrative expenses increased to $47 million, primarily reflecting an increase in headcount, rent, and facility costs, as well as professional fees. We anticipated SG&A deleverage as a percentage of sales coming in at 34.6% versus 24.2% a year ago. From an earnings perspective, adjusted EBITDA came in at $11 million, and adjusted EBITDA margin was 8%. While net sales were pressured by tough comparisons to last year and the impact of COVID, gross margins remained strong and we carefully managed expenses throughout the quarter. Turning now to the balance sheet and cash flow, we ended the first quarter with cash and cash equivalents of $55 million and total debt of $243 million. Inventory totaled $53 million, down 30% versus a year ago and 14% from year-end. We generated cash flow from operations of $37 million and capital expenditures totaled approximately $5 million. As I mentioned earlier, our liquidity as of April 30 was over $106 million. As Brian discussed, we currently expect the second quarter will be our most challenging quarter in 2020, as many of our retailer stores remain closed, and consumers adhere to stay-at-home orders and social distancing guidelines. We also anticipate there will continue to be heightened pressure within international markets. While we are beginning to see some states reopen this week, in light of ongoing uncertainty both here and abroad, we are not providing a full-year outlook at this time. We appreciate your time this afternoon. Now Brian, Andrew and I will be glad to take your questions.

Your first question comes from the line of Erinn Murphy with Piper Sandler. Erinn, your line is open.

Hey. My first question is really just to dig into the international business a little bit more, could you just maybe share how it progressed throughout the quarter, so starting in January, February, March? And then as you think about Q2, you obviously referenced Europe you are going to have minimal shipping, but curious on if you could just share what you are seeing in APAC, Canada, any other big regions for you?

Yeah. Erinn, I can start…

Yeah. Hey, Erinn.

Yeah. Go ahead.

Go ahead, Brian.

I can go and start. Erinn, I think that, obviously, like we said, at the beginning of the call, we were doing really good globally first and second quarter or the first and second month of the quarter and then halfway obviously through March when COVID really hit. So I would tell you that strategically everything was going as planned. Our initiatives were making sense on a global basis and then, obviously, the rug came right out from everybody’s feet. So I think what we are seeing now in international is just the beginnings of some of these countries beginning to open up doors. They were down considerably. Almost everybody in Europe was shuttered, but we are seeing, over the last two weeks, three weeks, the beginnings of people getting back on track, but we are taking definitely a conservative approach on the rest of the world. I think EMEA is very similar to Southeast Asia and Latin America in the same regard as the way we are viewing our international business. I mean, we are going to be very conservative coming out of this. But we also believe that the demand for our products is higher than ever, I mean, the fact that we are up at one of our biggest retail partners in the mass channel year-over-year is staggering, considering what the world is going through right now. So we believe when the world returns to some semblance of normality, we are going to pick up right where we left off but we will come out of it a leaner organization, and hopefully, a more profitable organization.

That's helpful. Please continue.

I was just going to say, you could think about really LatAm and Canada operating more like the U.S. where you saw Europe and Australia …

Okay.

have and Asia have directionally the same growth over the quarter.

Okay. Brian, this question is for you regarding your factory partners. You mentioned that you had to cancel some orders, which is understandable. Since you are a significant part of many factories you collaborate with, I am curious about how your partners are responding and how you are working together during this undoubtedly challenging time.

That's a great question. It's challenging. We don't want to focus solely on ourselves. Our priority is ensuring our employees are healthy, which is always our main concern, and the same goes for our manufacturing partners. I've known some of these factory owners for about 16 years. It's been difficult for them, especially when they were trying to recover in China before COVID hit the U.S. They faced challenges getting people back, and we aimed to support them. Once they resumed operations, the situation hit us here. Fortunately, moving to Vietnam has helped with capacity, cost stability, and faster manufacturing. We're working hard to be mindful of their businesses during this unprecedented time. Flexibility has become essential, and communication has been ongoing. They've shown understanding regarding our reduced order quantities and delays, recognizing that they need to be adaptable to help us navigate this situation. If they support us, we will support them in return. It's impressive how our teams have built strong relationships with these factories, which contributes to our success. No one is pleased with the current circumstances, but it could have been much worse for us. We’re managing to come through this well, and when things return to normal, we'll be the great company we were before.

Okay. And then just last question, maybe for Jen. Inventory, can you just talk about how you see the cadence of it throughout the year, when do you expect it to peak, and yeah, I guess, I will pause there. Thank you.

Yes, that's a great question. As we began to see the effects of some of our specialty retailers closing their doors, we quickly focused on our inventory to ensure it matched our expectations for the upcoming year. Throughout the second quarter, we adjusted our June receipts by significantly reducing replenishment orders. We also evaluated the content set for the following year and ensured our inventory and production were aligned with the release dates of that content. We have taken two key approaches: first, ensuring our inventory aligns with sales, and second, synchronizing our content launch with inventory availability. So far, we have reduced our June receipts and adopted more aggressive strategies for the third and fourth quarters to avoid overextending ourselves. If we start to see a rebound, we are confident in our ability to quickly replenish inventory.

Yeah. Erinn, I think, Jen brings up a great point. Our ability to chase and that goes to relationships with the factory. We are going to make mistakes underproducing and chasing than we will overproducing and I think that is where our relationships over the years are going to allow us to quickly replenish if we have to and not lose that overall revenue uplift without the risk of having the inventory in hand.

Great. Thank you, and all the best.

Your next question comes from the line of Stephanie Wissink with Jefferies. Stephanie, your line is open.

Thank you. Good afternoon, everyone. Just a quick follow-up on Erinn’s question on inventory. I am wondering if you can talk a little bit more about the flow of goods to your retailers and how the inventory position is at retail. How should we think about any sort of order risk as we move through the next couple of quarters based on the inventory already in the channel?

Yeah. Andrew, why don’t you start with that, the first part of that?

As the COVID effects impacted retail, we proactively engaged with our retail partners to understand their needs and the timeline for when they would require products. We discussed potential store closures and operational changes due to e-commerce-only sales. As store closures increased, we took decisive actions to halt production or redirect products to other retailers that remained open. Many of our retailers successfully continued shipping online orders, which benefitted our mid-tier specialty customers more than we anticipated. They managed to sell a substantial amount of incoming inventory. We have been asked whether the inventory will become stale once the stores reopen in a few months, and we believe the answer is no. Firstly, 58% of the inventory we shipped in Q1 consists of evergreen products, which are not tied to specific releases and sell year-round. Secondly, we don't think the store closures were prolonged enough to render our products stale. If stores were to remain closed until August, it might prompt a different outlook, but we expect most stores to open soon, with the majority by June.

Okay. Great. And then one for you, Jen, really quickly, just on your comments on SG&A. I think you mentioned $15 million of savings down quarter-on-quarter. How should we think about the permanence of some of those savings versus just the transitory nature of the situation we are in and investing back into some of those areas in the back half or in the following year once the business starts to recover?

Yeah. Thanks. So in terms of SG&A, how we are really thinking about it is, we are managing to multiple scenarios, of course, we think we have a good forecast in terms of how we are going to project the year. But that being said, we all know there are many different permutations that can come from what we are currently experiencing. I would say one thing we have learned from this is our ability to do more with less and so as we continue to progress through the year, we will definitely become a more efficient and slimmer organization per Brian’s comments. Some of the other areas in terms of investment, whether it be marketing or other areas of SG&A, those will all be determined upon how fastly or how quickly the business ramps back up. Right now we are just making sure that we are being as responsible as possible given the fluidity of the situation. So we have great plans to currently come out the other side of this for 2020, but obviously, as the scenarios change we will adjust accordingly.

Thank you.

Your next question comes from the line of Michael Ng with Goldman Sachs. Michael, your line is open.

Great. Thank you very much for the question. I just had a follow-up on the second quarter sales outlook, was the shifting of products from 2Q to 3Q just for Europe or is that something you are doing globally? And could you just help us think about what the geographic breakdown of that 60% decline could look like, is it largely concentrated in international and less so domestically or will both geographies see similar declines? Thanks.

Jen, do you want to start with the first part?

As we consider the second quarter and noting that it is now May with most of Europe closed for the quarter, we made the decision to move some of the goods to the third quarter. We expect significant challenges for our European business in the upcoming quarter. Additionally, our specialty retailers in the U.S. have also been closed for about two months this quarter. Both markets are facing difficulties in terms of revenue, but we anticipate that the challenges will be more pronounced in Europe.

Great. And just as a quick follow-up, could you provide any help around how we should think about operating cash flows for the year or maybe the quarter? Thank you.

Yeah. We feel really confident about where we are from a liquidity standpoint. We don’t typically give out what our cash flow forecast is on a quarterly basis. But we are managing to multiple scenarios. As I mentioned earlier, if we see continued pressure versus where we are today, I would say, at this point, it looks as though retailer stores are starting to open back up. If we see a relapse or something else happens within the economy, we are prepared to take additional adjustments to continue to preserve cash and maintain our liquidity.

Great. Thank you so much.

Your next question comes from the line of Alex Perry with Bank of America. Alex, your line is open.

Thanks for taking my question and I hope everyone is doing well. I guess, first, maybe for Brian, a little higher level. Can you talk about how you would expect the business to perform in a more recessionary consumer environment and any historical perspective you could provide?

Sure. I appreciate the question, Alex. I've been with Funko for 16 years, and we have managed to grow consistently every year. It took a global pandemic for us to see our first year of stagnation. Our company has performed well even during difficult economic periods, including those in 2008, 2009, and 2010. We consider our products as impulse buys, with an average price of around $8, which are connected to meaningful aspects of people's lives. While some may hesitate to return to movie theaters due to various concerns, they continue to engage with content on platforms like Netflix. Our offerings tap into significant pop culture moments, sports, music, and video games without breaking the bank, and our long history of consistent growth demonstrates our resilience during challenging economic times. The pandemic did interrupt our growth streak this year, but we are confident in our current position. We have a diverse range of products that cater to a wide audience globally at an accessible price point, bringing happiness even during tough times. The ongoing demand for our products and the engagement from our fan base highlight that people's love for pop culture remains strong, especially as they binge-watch shows and download movies. We believe there will be significant demand for our products as we move beyond this period.

That’s really helpful. And I guess just my second one, can you talk a little more about how the content slate for 2020 has evolved versus your original expectations maybe nine weeks ago when we heard from you last? Thanks.

The situation has changed, and I'm grateful that some studios made quick decisions regarding titles like Black Widow, Wonder Woman 1984, and several Minions movies by shifting some of our bigger initiatives to the second half of this year. We hope the world will be a bit more normal by then, carrying into 2021. Every week, we see glimmers of hope as volume increases and businesses reopen. We expect a stronger content slate in the second half of the year than what was anticipated pre-COVID. The delays from 2020 to 2021 will add to what is already an outstanding content year, and as we look ahead to 2022, that year was also promising, but the postponed releases from 2021 will enhance it further. We feel confident about our position as we emerge from this situation. Once this pandemic subsides, we firmly believe that the business will return to thriving, and people's passion for pop culture and entertainment will only grow after having so much time to engage with it. The content lineup now looks even better for the second half of this year and for 2021 and 2022 than we initially thought.

Thank you. That’s very helpful. Best of luck going forward.

Thank you.

Thanks.

Your next question comes from Tami Zakaria with JP Morgan. Tami, you can go ahead.

Hi. Thanks for taking my question. So I wanted to understand the gross margin performance in the quarter better. Did the inventory write-down you took in the fourth quarter benefit you in the first quarter and how are you thinking about gross margin in the second quarter and should we expect it to leverage similarly versus the first quarter?

Great. Thanks, Tami. So essentially what you saw in the first quarter was two things come to light. As we shifted our channel mix to be more heavily D2C-oriented, as well as we did see strong growth in some of our higher margin categories like games, we did see a benefit from the sales mix shift in the quarter. So that accounted for roughly about half of the improvement. And I would say the other half is really through a lot of our inventory management practices that we have been putting into place at the end of last year to where we have just been a little bit tighter on inventory as we move through the course of the year and so that’s what you are really seeing there. As we look forward to gross margin, we do think we will have a strong gross margin throughout the year. That being said, there will be puts and takes in each of the quarters as different things impact the business, whether it be a sales mix shift from one product category to the next or whether there’s unforeseen circumstances accompanying the COVID crisis that we have to take other actions. So that’s currently how we are thinking about gross margin on the year.

Got it. That’s really helpful. And very quickly, can you comment on the margin difference between your D2C sales versus retail partner sales?

We don’t usually separate those figures. However, when considering our own e-commerce website, we receive the full retail price for those products, while we sell them at wholesale to our retail partners who then sell them at retail prices. There is an evident difference, but we do not typically disclose that information. It's also important to note that although our direct-to-consumer e-commerce is growing rapidly, it still represents a small portion of our overall business.

Got it. Thank you so much.

Absolutely.

Your final question comes from the line of Gerrick Johnson with BMO Capital Markets. Gerrick, your line is open.

Hi. Good afternoon. So a lot of your customers, I don’t know if it’s a lot, I really don’t know how many of your customers are small business owners, but I am assuming there are quite a few hobby shops, local toy stores, and so forth. Maybe you could tell us how big of a percent of your total sales that might be and I assume some of these guys are under some stress, so just curious as to your exposure to that channel? Thank you.

Thank you for the question, Gerrick. What sets us apart is our extensive reach on a global scale, particularly among smaller customers, many of whom have websites and engage in online sales. Some are even starting to offer curbside drop-off services. While we recognize that not every small customer will survive this period, we average 13% to 15% of our total business in the mass channel, which helps us offset those losses. There is significant opportunity for growth with major retailers like Walmart, Target, and Amazon, where we have intentionally maintained a lower presence. It’s evident that not all of our customers will endure this pandemic, but we believe there is ample potential to recover and even expand our business by focusing more on these larger channels. It is encouraging to see growth in our business despite having less content compared to previous years, especially when we consider the challenges faced during the pandemic.

Okay. Great. And all the new products that you wanted to ship for the fall, particularly in your games segment, everything there is on track?

Yeah. Absolutely. All the game and toy initiatives will still be executed in the second half of the year, but, yes, absolutely.

Okay. Great. Thank you.

Thanks, Gerrick.

Ladies and gentlemen, this concludes today’s conference call. On behalf of Funko, thank you for participating. You may now disconnect.