Good afternoon, and welcome to Funko's Conference Call to discuss Financial Results for the Third Quarter of 2022. At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. Please be advised that reproduction of this call in whole or in part is not permitted without written authorization of the company. As a reminder, this call is being recorded. I will now turn the call over to Ben Avenia-Tapper, Director of Investor Relations to get started. Please proceed.

Thank you, and good afternoon. With us on the call today are Andrew Perlmutter, Chief Executive Officer; 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 in 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 Andrew.

Good afternoon, everyone, and thank you for joining us today. It was great to meet many of you at our Investor Day event in September. Funko delivered another quarter of record sales in Q3, up 37% year-over-year to $366 million. Our strong net sales performance was driven by the power of the Funko brand supported by the strength of our employees, fans, and retail and content partners across the globe. As discussed on our last earnings call, we continue to operate in an uncertain consumer market. While it is hard to pinpoint when this environment will normalize, we are confident that we are well positioned to outperform our marketplace and continue 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. Loungefly 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 managed to distinguish our brands by continually delivering products to connect fans from across all fandoms with their favorite content characters and stories in a uniquely Funko way. This in turn has cultivated an amazingly loyal and committed fan base of collectors and pop culture enthusiasts. This 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’s as well as our own FunKon. Not only are these events great parameters of our fan engagement, but they also led to many of this year's top DTC sales days. The enthusiasm our fans have for Funko is palpable. They dress up, wait in line for hours, and carry the Funko 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 eight-fold in four years. This year, we have expanded the concept to include a countdown to anything as we bring the fun of the countdown calendar to new holidays such as Halloween. Among emerging collectible brands, including Soda, Gold, and Popsies, we continue to show strong performance and see a long runway for growth. For example, our launch of Popsies at Walmart has been such a success that we'll be significantly expanding our shelf-space allocated to emerging brands in 2023. Our new installation will include Popsies as well as a number of other exciting initiatives to be announced in the coming months. Finally, the most recent addition to our collectible brands is Mondo, 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 acquisition sets us up well for strong growth in music content, much more to come on that. Turning to Loungefly, demand across all channels, particularly among our partners, has been incredibly strong. Loungefly’s 57% growth in the quarter brings their year-to-date growth to nearly 90%. Importantly, Loungefly's direct-to-consumer sales jumped from 10% of total sales in Q1 to 16% this past quarter, reflecting the growing strength of the brand. We believe this success is a direct result of our unique style of fan engagement, including our first brand tentpole event, Summer of Loungefly, which strengthens the connection between our fans and the brands they love. In toys and games, we now have 180 games in our catalog, which is critical to long-term revenue central to the games business. Our incredible game designers continue to produce hits on both current and timeless IP. Within our collectible gaming business, our new Kingdomania game has had an extremely strong introduction and was a finalist for the 2022 Toy of the Year in the collectibles category. We soft-launched the title this year and it sold out every day. On the toys front, we recently launched the latest product in our highly successful Five Nights at Freddy lineup featuring snap technology. We've created an interchangeable action figure that is true to the game's most fundamental elements. Importantly, this is the first step in building an entire ecosystem we have planned 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. Due to the sustained demand, we have increased drop frequency and grown the average size to well over $0.5 million in net sales. We've had multiple drops top over $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 of our own IP that sold out in under 30 minutes. A key 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 mass partners despite broadly high levels of inventory at retail. While Funko products continue to be traffic drivers for our retail partners, we have 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 Funko brand. However, we do expect these wholesale order reductions and delays to persist in the short term given the current macro environment. These expectations have been reflected in our full-year guidance. Our DTC channel saw another quarter of strong double-digit growth exceeding 30% and representing what we like to call our single largest customer by net sales. Average order value and traffic across our e-commerce sites were both up strong double-digits. Turning to our international geographies, 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 in LatAm and Oceania. 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. As 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 and build on that growth over the long term. In Q2, we opened our consolidated fulfillment center. Moreover, we achieved this upgraded infrastructure without the benefit of the warehouse management software it was designed to operate with. Together with our ERP implementation in 2023, these software upgrades will better position us 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 margin pressure. These actions are critical to service our near-term demand as well as support our long-term growth objectives. We are actively managing through these interim fulfillment dynamics, and we believe these investments will result in consistent margin expansion in the future. Due to the macro headwinds previously discussed, we are revising our full-year net sales target to between $1.29 billion and $1.33 billion, up approximately 27% at the midpoint year-over-year. We are also lowering our full-year EBITDA margin to high-single digits as we managed 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. We again delivered record top line results amidst 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. Our 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 remain similarly confident in our ability to achieve the five-year objectives we laid out at our recent Investor Day event both top and bottom line. We are managing through these short-term macro factors and investing in infrastructure and 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 Funko. Now Jen will provide more details on the financial results of the quarter.

Thanks, Andrew, and good afternoon, everyone. We delivered strong third-quarter net sales growth of 37% over the prior year. Our results were broad-based with strength across our geographies and channels. Once again, each of our three reported brand categories grew double digits. Multiple factors drove our top line outperformance, including another excellent quarter from Loungefly. In the U.S., net sales increased 37% to $262 million, while net sales in Europe grew 33% to $78 million and other international net sales increased 43% to $25 million. On a brand category basis, Core Collectible brands net sales grew 34% to $282 million, driven by innovation in our Pop brand and increased contributions from our emerging brands in the category. The Loungefly brand grew 57% to $62 million with particular strength in our parks business, as Andrew mentioned. Among our other brands, which includes toys and games and our digital brands, net sales grew 25% to $22 million. This quarter we saw particularly strong contributions from our digital category. Turning to margin and expenses. Third-quarter gross margin was 35%, a sequential increase of approximately 200 basis points due to a more favorable product mix than the prior quarter. Freight rates have improved significantly since their recent highs earlier this year. However, we did not realize the benefit in the third quarter due to the timing of inventory delivery. For context, had we been able to receive freight under the in-quarter rate per container, it would have contributed roughly an additional $7 million in gross profit. We expect to benefit from the rate improvements as 2023 progresses. We remain committed to gross margin improvement, which will come in three main components. First is the improvement in freight that I just described. Second is driving more efficient sourcing from more cost-effective geographies. And third is a broader application of the price increases we 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 both wholesale and our D2C 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, I'll start with a few comments on the significant upgrade to our infrastructure that we previously announced. These investments are critical to our ability to keep pace with the strong double-digit growth we've generated over the past year and a half. It's also vital to support our long-term growth plans. In the short term, these investments add additional expense as we operate out of the new distribution center without the intended software system in place. The higher expense is primarily composed of greater labor costs within the facility and additional machinery to support product movement. We've also added additional third-party logistics or CPO warehouses. Together, these initiatives will enable us to continue to support our strong demand until our software upgrades are in place next year. We believe these increased expenses will be short-term in nature, but we expect them to continue until the rollout of our new ERP next year. In the third quarter, these additional investments reduced adjusted EBITDA by approximately $5 million. As a result of these infrastructure upgrades, SG&A as a percentage of net sales increased sequentially to 27% or $98 million. For the third quarter, adjusted EBITDA was $36 million with an adjusted EBITDA margin of 10% reflecting elevated freight rates, limited 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 $0.28. Turning to the balance sheet, we ended the quarter with $150 million in total liquidity, roughly double our second-quarter position. This comprises $125 million under our revolver and $25 million in cash. We ended the quarter with total debt of $250 million, up 41% compared to Q3 of last year, as we accessed our revolver to support the near-term infrastructure investments and offset our increased working capital needs stemming from our inventory timing. Inventory at quarter-end totaled $266 million. Inventory levels remained higher than the prior year, which was a particularly tight inventory environment due to port delays and supply chain congestion. We believe that our inventory is generally high quality. We will continue to work through our inventory levels and expect to make sequential progress. Now to the guidance for 2022. We are revising our full-year net sales target to $1.29 billion to $1.33 billion or approximately 27% growth year-over-year at the midpoint. As the fourth quarter is typically our lowest gross margin quarter, we expect a Q4 gross margin to decline sequentially due to margin seasonality and ongoing inventory management. For full-year adjusted EBITDA margins, we now expect high-single digits. We expect adjusted net income of $39 million to $41 million based on a blended tax rate of 25% and adjusted earnings per diluted share of $0.70 to $0.80 based on a weighted average diluted share count of $55.2 million. As I previously mentioned, the reductions in our full-year net sales and adjusted EBITDA margin outlook is a function of a broader macro climate and our continued investment in more efficient fulfillment capabilities to support our future growth. We now expect this SG&A investment impact on our margin profile to largely persist until the completion of our software upgrade next year. With a year and a half of very strong double-digit growth behind us, we are on the right path to deliver on our five-year objectives laid out in our Investor Day, including increasing net sales to $2 billion and driving adjusted EBITDA margin to approximately 20%. We look forward to updating you on our progress. We appreciate your time this afternoon. Now Andrew and I would be glad to take your questions.

And our first question of the day comes from Meghan Alexander from JPMorgan Chase. Please go ahead.

Hi, everyone. Thank you for taking my question. It seems that Q3 was strong at the midpoint, but the guidance suggests a decline of about 5% in Q4. Is this decrease related to destocking and the broader economic situation? Considering the current inventory levels, do you think destocking will continue into 2023? Will you need to take any actions regarding your owned inventory? How does this affect your outlook on achieving double-digit growth in net sales?

Yeah. So thank you for the question. Good to speak with you. I'll kick it off and then I can hand it over to Jen. Yeah. We are very happy with our top line growth in Q3. We definitely feel that we've outperformed the market and then have been pushing hard in what's been an uncertain consumer market. I would say our largest hurdle in the back half is really about our wholesale partners. What they're doing at retail, I think we've heard from the broader marketplace that some of our retail buyers are pulling back. They're tightening up their inventory, which was reflected in our portfolio value. So the signs that we're seeing on the Funko brand now and in the second half are positive. If we look at our direct-to-consumer side, when people are spending more money and buying more items than ever before, that’s a really positive sign that we're seeing. Yes, there are outside pressures that we're dealing with that have had an effect on inventory. We are always looking at the health of our inventories and deciding whether to adjust or not. I'll let Jen comment on that if she's got anything to add.

Yeah. Thanks, Megan. Nice to 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 the supply chain challenges. So there is a little bit of nuance 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. In the event we have seen a pullback a little bit in Q4, we have been making the right edits to our inventory, whether it be cutting receipts or pushing receipts out to manage towards the end of the year. Definitely an area of focus.

Thank you. Jen, can you help us understand the components of the margin in Q4? Specifically, can you provide a full-year gross margin range? I'm also interested in knowing how much of the additional pressure is from gross margin versus SG&A, and how much of it might be transitory related to inventory actions that could improve next year?

Yeah. So in general, what we typically see in a normal year is that our Q4 gross margin does come down a little bit from Q3 simply because that is when all of our retailers will take advantage of their contractual discounts with us. So that's a normal trend that we see underneath the covers. We have accounted for the possibility that we might have to do a little bit of discounting because we know that 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, we'll see a slight uptick in Q4 from Q3 on a total dollar basis, but that's really related to some of the infrastructure that we had to put in place to make sure that we can maintain and continue to grow the business. So, we'll see a little bit of dollar uptick in SG&A in Q4, not significant, but that's where you see the pressure points.

When do you expect the ERP software system to be rolled out? If it's in the middle of next year, should we anticipate a recovery in the second half of next year?

So I think that the way that we're looking at next year is, there are three main areas of gross margin that we're looking to action to help us improve that in the near term. We talked about price increases, aggressive sourcing out of Asia to leverage price cost decreases when our factories, and then lower shipping container rates, which we're seeing come down significantly. As we flow in that new inventory at lower container rates, we should start to get some of the upside benefit of that. On the SG&A and additional costs with the growth and the infrastructure that we're investing in to support the growth. We would expect that these upgrades will continue primarily until the middle of next year. We are pushing hard to get that ERP up and running, which also, by the way, brings the software to optimize our warehouse. Unfortunately, we’re having to find a lot of manual workarounds. Last quarter, we experienced record product sales growth, and we will continue to do so until we get this up and running, which we anticipate will be in the middle of next year.

Okay. Thank you. I'll pass it on.

Thank you.

Our next question comes from the line of Linda Bolton Weiser of D.A. Davidson. Linda, 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%, 30%, 20%. I'm just trying to, like, figure out the math here. There's a lot of moving pieces, but EBITDA in dollar terms will be down significantly in the fourth quarter, correct?

Pardon me, down compared to…

So down, will EBITDA in dollars be down significantly year-over-year in the fourth quarter?

Well, what we guided to was high-single digit EBITDA percentage on the year. So I'll let you guys kind of work out how you want it, given we only have one quarter left, let you guys work on your models there. But we are seeing pressure on the margin front as we mentioned, and we do have some additional investments for future growth that we're maintaining.

So it feels to me a little bit like a bomb has dropped on my head. You know, like, you 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 analyst meeting where you stood up in front of everybody in September, and you talked about, really kind of aggressive margin goals going forward. So I guess I'm having trouble marrying, like, the two ideas here. I mean, when you have the analyst meeting, did you know that you had these operational issues?

So on the Investor Day, if that is what you referred to, I just want to take an annual reminder that that is a long-term view of our business. So we're still very bullish on, and we absolutely believe in the long-term vision of this. I think what we're experiencing right now is contraction of the retail marketplace, which we're seeing across the entire industry and we're executing against two major infrastructure projects to deliver that due to revenue. It just so happened to fall in the year where there was this broader economic pressure. And again, if that's what you're saying, which is why we're confident this is a short-term situation we have to overcome. We are rolling out multiple large infrastructure projects in a tough year, and that's what we're seeing happening.

Right. So if we think about the long term, I'm going back and looking at your EBITDA margin and since 2016, it has declined in every single year except for 2021. So you had an EBITDA margin of 22% in 2016, and now here we are at high-single digit EBITDA margin. So you've been investing all along because that's been impacting your margin all these years, all the infrastructure investments. And so I guess, I'm just not seeing with 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 in the Investor Day, we see a path to 20% over the longer term. As Andrew mentioned earlier, there are several factors that we're already putting into place that are going to help that. We have already negotiated some pricing with our factories. We are rolling out starting in next year, it will take place mainly in Q2, broader price increases across the board. We will also see the benefit of the reduced shipping rate. What you're seeing this year is that we didn't quite get all the pricing that we had anticipated, and our shipping expense, we are still amortizing those higher shipping costs that we've brought in with our inventory. So we are feeling very good about being able to achieve that, absolutely a priority of ours, and that's why we did want to share that number at the Investor Day.

So can I just ask, like, how is the consumption, the demand for your products? Is it strong or has it weakened?

Yeah. I mean, I think if we took a look at the Q3 versus the market and other people in our sector, that tells you everything you need to know, right? The demand is there. We are seeing record numbers of consumers come to funko.com. They're 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 something that's not really 100% within our control. If a retailer has the mandate to lower their inventory, we are going to be caught up in that. Even keeping key programs exclusive to direct-to-consumer driving foot traffic to those retailers, there is a broader effort by our wholesale retail partners to end the year with lower inventory. I think that's what you're saying.

So it sort of implies that you've been selling into the channel and a pace that exceeds your POS growth. I mean, is that the case?

I'm sorry. Say that again?

It sort of implies that in the last two, three quarters, four quarters, you've been selling into the channels into Walmart and Target at a pace that exceeds your POS growth. Do you have a sense as if that has been happening? You've been shipping more in at a rate that is higher than what it's been selling through at?

Yes. It’s a broader context, Linda. As you've heard across the board, retailers are bringing down their inventories. It's not a direct reflection of our sell-in versus our sell-through. It's really the macroeconomic 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's what you're seeing. If you look at the back half, we are still up in the low teens on the back half of the year, and overall approaching high-20s growth on the year. So we're still feeling there is demand out there for our products. Our online channel has demonstrated that. And we feel good about working through this near term as retailers want to get clean for their inventory by the end of the year. So those are the challenges we're working through, but we think it's prudent just to make sure that we align our inventory with our sales, and that’s what we’re doing, and that’s what's reflected in our guidance.

Can you tell me the incremental investment by having duplicative 3PLs 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 given 2023 guidance as you said, and we would like to give a more holistic picture on that. We disclosed that it's about a $5 million hit in terms of warehouse labor in Q3 just as we had to put more bodies to get the goods out the door versus having the systems in place to do so. It's definitely been a headwind for us in the quarter and will be in Q4.

But those expenses of whatever magnitude it's going to be in the first quarter and the second quarter of 2023. Is that what you're thinking for the elevated expenses?

We'll continue to have the 3PL expense as we work through, but we are actively working on getting more equipment into our distribution center to streamline our fulfillment and get some of those costs down. We've also opened an additional 3PL in Arizona to help some of our throughput. So we are addressing some additional expenses, but we should be able to mitigate those as we kind of move forward.

Thank you. It seems there are no additional questions at this time. I will now turn it back to Andrew for any closing remarks.

All right. 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. This concludes the call, and you may now disconnect your lines.