Earnings Call Transcript - FNKO Q2 2021

Operator, Operator

Good afternoon. And welcome to Funko's Conference Call to discuss Financial Results for the Second Quarter of 2021. At this time, all participants are in a 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 from 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. Ben, please proceed.

Ben Avenia-Tapper, Director of Investor Relations

Thank you, and good afternoon. With us on the call today are Brian Mariotti, Chief Executive Officer; Andrew Perlmutter, President; and Jennifer Fall Jung, Chief Financial Officer. Before we begin, I'd like to remind everyone that during the course of this conference call management will discuss forecast 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 highlighted during the call, important factors that may affect our future results are described in our most recent SEC reports and today's earnings press release. In addition, we will refer to non-GAAP financial measures during the discussion. Reconciliations to their most directly comparable U.S. GAAP financial measures and supplemental financial information can be found in the earnings press release and 8-K that we released earlier today. All of these items plus a visual presentation that investors can consult to follow along with this discussion are available on our Investor Relations website, investor.funko.com. I will now turn the call over to Brian.

Brian Mariotti, CEO

Good afternoon, everyone, and thank you for joining us today. We are pleased to deliver an exceptional second quarter highlighted by our largest top-line performance in company history. Net sales came in at $236 million, up 141% compared to last year, reflecting broad-based strength across our brands, product categories, channels, and regions. We are now above pre-pandemic levels in all our major geographies. Our ability to drive this level of performance while navigating the fluid macro environment is due to tremendous execution by our teams. I am extremely proud of what we've accomplished during the last 18 months. We have become a more resilient and dynamic organization and found new and exciting ways to delight and engage our fans. The evolution of our virtual conventions is a great example of this. I spent the earlier part of the week at our first annual FunKon event, a hybrid virtual and physical event that we think represents the future of fan engagement. We had virtual conventions in the past; in fact, there are our seventh virtual event, but we've managed to elevate the scope and success of these online and hybrid events. Hosted out of our Hollywood store, we developed a mix of live and pre-recorded content for both live bands in the store and tens of thousands of additional fans online. This week, we've featured prize giveaways, opportunities to go behind the scenes and meet Funko artists, and celebrity features among a host of other fan engagement events. What we've unlocked with virtual and hybrid conventions allows us to provide a more tailored fan experience with greater brand control and similar revenue potential when compared with our traditional convention calendar. The event is only halfway done; the initial steps have been extremely positive. We are on pace to beat our 2019 in-person sales numbers by more than 40%. That does not mean that we're abandoning in-person conventions in the future, but what it does mean is you can expect more virtual elements as we continue to elevate our fan experience. On the direct-to-consumer front, accelerating the expansion of our e-commerce platform was a key growth pillar even before the pandemic, but it became that much more important as physical retail was closed or disrupted last year. Today, we are generating sustained traffic growth. We've integrated tools and analytics to increase conversion rates and average purchase value on our sites, driving steady performance improvement. We are also leveraging our strong social media presence and broadening the SKUs available. Our Funko shop exclusives, like the Alice in Wonderland Blacklight series, continue to sell out in minutes. By expanding our catalog of pops and other categories available on our site, we're able to seamlessly provide additional item recommendations. In just the first two quarters of this year alone, average units per transaction and average orders per customer both increased by more than 35%. In a quarter that saw consumers return to brick-and-mortar retail, we maintained strong traffic and sales growth across all our sites. Turning to our evergreen collections, the past 18 months served as an important proof point of our ability to deliver compelling products irrespective of the current state of new content. With cinemas closed last spring, sports leagues canceled seasons, and TV shows stopped filming, we refocused even more on our evergreen properties. Our content catalog is a treasure trove of fan favorites, and it is no surprise that evergreen titles dominated throughout 2020 sales. Today, we're maintaining the ability to create products that thrill and resonate from our entire catalog. In fact, evergreen property revenue more than doubled in Q2 versus the prior year. But now we're beginning to layer on new content, including an excellent theatrical release calendar, and the results speak for themselves. This past quarter, our list of top 10 properties included new titles like Space Jam: A New Legacy as well as classics like Lilo and Stitch in Funko. Lastly, I want to call out the tremendously successful launch earlier this week of our first digital pop NSP collections with the Teenage Mutant Ninja Turtles. The first drop of 20,000 standard packs and 10,000 premium packs sold out in less than 15 minutes, with more than 45,000 fans in the queue when the drop went live. Just like with our physical product, the first launch is always a learning opportunity. We will continue to refine the size of our drops, the cadence of when our drops occur, and the overall user experience. However, the early response has been extremely encouraging and well above our expectations. I'm genuinely pleased with the team's ability to quickly execute against this initiative and deliver a product and buying experience that excited and delighted our fans. Q2 was a company-wide success, reflecting the effectiveness of our entire pop culture platform and our ability to connect with our fan bases around the world. Our Pop and Loungefly brands each grew in excess of 130% over the prior year, as the reopening of specialty retail provided a huge lift to both brands. Pop benefited from the stronger content calendar as well as our continued success with evergreen property revenues. Meanwhile, Loungefly's unique and innovative approach to collectible fashion has made it particularly attractive to specialty retail partners looking for opportunities to differentiate their experience and product. Initiatives like our exclusive program continue to be a driver for new demand for the brand. From a product category perspective, our diversification efforts were headlined by Loungefly, which grew 136% over 2020, led by bags, wallets, and accessories. We also generated strong growth in non-Loungefly items, including games, plush, and action figures. On a regional basis, both the U.S. and Europe generated triple-digit growth over Q2 2020, and both regions exceeded 2019 performance. The reopening of specialty drove significant growth in both geographies. Within Europe, we saw recovery across the region, with the areas that lagged in Q1 of this year largely coming back in line as lockdown restrictions eased. In our other international markets, results approached or exceeded pre-pandemic 2019 levels as growth returned to nearly all regions. We delivered an excellent first half of the year, and we remain focused on executing against our key initiatives to increase our broad consumer appeal and expand our total addressable market. Against the backdrop of a record quarter and a really excellent first half, we are mindful of the macro uncertainties we are facing in the second half. Most notably, trade headwinds are accelerating sharply, causing parts delays and substantial cost increases. Additionally, the rising concern around the Delta variant is beginning to weigh on our consumer sentiment. Despite these macro challenges, we now expect to achieve net sales of $900 million to $930 million, up approximately $30 million at the mid-point from our previous guidance range, reflecting our second-quarter outperformance and the exceptional demand for our products, which remains at an all-time high. Jen will share more details on our outlook when she reviews our financial results. Now, before I hand things over to Andrew, I want to express my enthusiasm for the management transition we announced this afternoon. Andrew and I have enjoyed a strong and highly productive partnership since he joined Funko in 2013. We will continue to collaborate closely through this transition process, and we are looking forward to maintaining our partnership in our new roles beginning next year. The business has never been stronger. We just reported our best sales quarter ever and have the product and talents to ensure we are well-positioned to deliver long-term growth and sustained shareholder value. We greatly appreciate the support of our partners, fans, and shareholders, and look forward to keeping you updated on our progress throughout the year. Now we'll turn the call over to Andrew to discuss our strategic initiatives.

Andrew Perlmutter, President

Thanks, Brian. Let me start by saying how honored I am to assume the role of CEO next year. Brian and I have been working together for more than 10 years, and I look forward to working with him for another 10. This is a very special time for Funko. We have amazing opportunities in front of us, and I know that with Brian as our Chief Creative Officer, our future will be bright. Our record quarter was driven by success in each of our four strategic growth initiatives. Q2 was an exceptional quarter for the pop brand, which generated triple-digit growth and exceeded 2019. As Brian highlighted, our successful evergreen properties are now being complemented with a robust movie slate. Within our evergreen properties, sports, music, and anime continued to gain momentum. Three animated properties made it into our top 20 for the quarter. Our new Vinyl Figure platform targeting sports and music fans is set to hit shelves this fall, and we have more programs targeting new customers and fans on the way. Our product diversification initiatives saw similar success. Our non-figure business also generated triple-digit growth and success across all categories. Loungefly continues with the exceptional growth trajectory driven by a strong recovering specialty DUC performance and growth in Europe, a combination of exclusive programs, higher average price points, and a more focused product mix are all factors in our success. International continues to be a growth area for Loungefly. When we originally acquired the Loungefly brand, it was mostly a domestic business. Over the last few quarters, we've seen accelerated growth in Europe as we've expanded our footprint. In our youth collectibles category, we continue to make strides in new areas of the store, reaching new customers. The smash hit wave two is hitting stores soon, and we continue to see strong success with our plush and action figures, mainly driven by our five-metric business. Last but certainly not least, our continued expansion into the game aisle saw strong positive reactions to several of our new titles, including ESPN Trivia Night; Disney, It's a Small World; Goonies: Never Say Die; and our new Seinfeld game, The Game About Nothing. Within our collectible gaming systems, we are seeing success out of the gates on Battle World 2, and there's a lot more fun and games on the way. Moving to our direct consumer business, this channel accounted for 11% of net sales in the quarter. We continue to generate strong revenue and track growth by offering an increased selection of mainline items as well as limited edition exclusives. We're driving traffic and increasing cart size, and we've also increased the conversion rates on our growing traffic volume. We will continue to expand product lines and enhance customer experience. This will remain an important driver for incremental growth for Funko. Turning to international expansion, we saw growth across our geographies, particularly in Europe, which maintained strong momentum from Q1 to Q2 and exceeded 2019 results. The major contributors to this growth were specialty recovery, continued Loungefly growth, and our D2C channel Funko Europe.com. Our other international geographies also show growth, especially Oceania and LatAm. Finally, this week at Funko, we announced a brand new initiative as part of Funko Cares Program called Pops! With Purpose. At Funko, community engagement has always been at the center of our efforts. With Pops! With Purpose, we are elevating our commitment to our community with a distinctly Funko approach. We began identifying causes that are important to our fans, employees, and communities. Today, we are partnering with leading organizations to create pop collections celebrating individuals affected by or contributing to those causes. Stay tuned for our first pop collection in partnership with Make-A-Wish. We've had an excellent first half of the year, and we're excited to execute on the opportunities in front of us. We look forward to keeping you updated as we progress through the year. I will now turn the call over to Jen to take you through the financials and 2021 expectations.

Jennifer Jung, CFO

Thanks, Andrew, and good afternoon, everyone. We're pleased to report record second quarter results highlighted by net sales growth of 141% over the prior year, reflecting the very strong second quarter demand and broad-based strength across our product categories, geographies, and channels. The overperformance relative to our expectations was primarily driven by our Loungefly brand in Europe as well as strong mass market results. All comparisons are to the second quarter of 2020 unless otherwise stated. Net sales in the U.S. increased 110% to $163 million, while Europe grew 393% to $52 million, and our other international markets increased 117%, with growth in all our larger regions. Active properties in Q2 were 795, an increase of 23% from the prior year. Net sales for active properties were $297,000 in the quarter, an increase of 95%. For a list of our top-performing properties in the quarter, please see the accompanying earnings presentation. On our price category basis, Q2 net sales figures grew 142% to $187 million, with Pop branded product increasing 137%. Non-figure product sales increased 136% to $49 million, primarily driven by our Loungefly brand, which grew 132%, with strong contributions from accessories, games, plush, and action figures. Second quarter gross margin was 39.1%, an increase of 250 basis points versus Q2 of 2020. This improvement primarily reflects our healthy inventory position and lower clearance activity in the quarter. While we were able to largely offset rising shipping and freight costs in the first and second quarters, we've seen a sharp acceleration in July in shipping and freight becoming a significant headwind throughout the second half. SG&A came in at $55 million, slightly lower than anticipated due to the timing of onboarding new talent and a shift in marketing spend to the second half of 2021. Moving down the P&L, adjusted EBITDA increased substantially to $41 million, with an adjusted EBITDA margin of 17.4% and adjusted diluted earnings per share of $0.40. Turning to the balance sheet and cash flow, we ended the quarter with $95 million in cash and cash equivalents, our highest balance ever, and $75 million of availability under our revolver, representing total liquidity of $170 million. We ended the quarter with total debt of $177 million, down 26% compared to Q2 of last year. Inventory at quarter-end totaled $86 million, up 43% on sales growth of 141%. The business generated strong operating cash flow of $71 million during the quarter. As Brian mentioned, we expect container costs and availability to present a much greater headwind in the second half than we saw in Q2. Meanwhile, Delta variant concerns continue, adding additional uncertainty to the second half outlook. Offsetting these external headwinds is the record demand for our products across all our channels and our focused execution. Based on our current view, we're raising our full-year revenue guidance to reflect our strong second quarter, while adjusted EBITDA margin guidance remains unchanged. With that context for the full-year 2021, we are raising our top-line outlook at the midpoint by about $30 million, with anticipated net sales of $900 million to $930 million. We now expect gross margin for the year to be approximately at or just below 2020 levels, which implies a sequential decline from Q2 reflecting the sharply increasing shipping and freight costs expected in the second half. We expect third-quarter SG&A to increase sequentially to the mid to high single-digit millions, reflecting a catch-up in some of the marketing spend that shifted from Q2, with a more modest sequential increase in the fourth quarter. Full-year adjusted EBITDA margin is expected to be in the range of 14% to 14.5%, representing an increase of 170 to 220 basis points compared to 2020. We expect adjusted net income of $57.4 million to $64.2 million based on a blended tax rate of 25% and adjusted earnings per diluted share of $1.06 to $1.19 based on the weighted average diluted share count of 54 million. We appreciate your time this afternoon, now, Brian, Andrew, and I would be glad to take your question.

Operator, Operator

Our first question comes from Tami Zakaria from JP Morgan. Tami, your line is open now if you'd like to proceed with your question.

Tami Zakaria, Analyst

Hi. Thank you so much for taking my questions. So, my first question is regarding your comment that the Delta variant is beginning to weigh on consumer sentiment. Could you elaborate on that a little bit? Is that based on what you've seen from retailer order trends or the end consumer holding off on purchases because of the virus?

Jennifer Jung, CFO

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

Tami Zakaria, Analyst

Got it, got it. So, it's nothing specific to Funko's quarter-to-date trends, rather more of a macro sentiment. Okay. Got it. That's super helpful. And then, I think your previous full-year guidance contemplated a low-to-mid double-digit sales growth in the back half. And now, I think you're raising it to mid-teens to high-teens sort of a range. So, can you help us understand what that means for the third quarter versus fourth quarter? And then whether this increase implies any contribution from the NSP that you launched recently?

Jennifer Jung, CFO

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

Operator, Operator

Okay. Next question comes from Erinn Murphy from Piper Sandler. Erinn, your line is open now if you'd like to proceed with your question.

Erinn Murphy, Analyst

Great. Thanks. Good afternoon, and congratulations, Andrew and Brian on the announcements this afternoon. I guess my first question is on the supply chain. I believe you produce 70% out of Vietnam. Could you share a little bit more about what you're seeing in terms of factory downtime? How flexible you can be in terms of moving product out of Vietnam or into China or just elsewhere? And then you talked a little bit about freight expense in the back half; what’s embedded in the outlook right now? Are you having to tap into air freight?

Brian Mariotti, CEO

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

Jennifer Jung, CFO

Yes. As you, I'm sure you've been reading as well, it's a constantly evolving situation with the containers and freight costs. We have tried to look forward to see what we anticipate based on what we’re seeing out in the marketplace and bake that into our guidance. That's why we feel really good about our EBITDA margin guidance. But, if we were to actually exceed our sales, there will be margin pressures due to the ongoing constraints. However, we have contemplated those freight increases in our guidance.

Erinn Murphy, Analyst

Okay. And then, Brian, just a follow-up to make sure I understand. So, are you not being impacted by any of the factory downtime? I know a lot of athletic manufacturers right now are moving on to week five or six downtime in factories. So, I just wanted to share your thoughts?

Brian Mariotti, CEO

Not an issue for us at all, Erinn.

Erinn Murphy, Analyst

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

Andrew Perlmutter, President

Yes. Hi, Erinn. Yes, so we saw strong results in the mass market in Q2, as we've been building pretty significant programs in that channel for quite some time. That channel fared the best over the last year, and it continues to. While back-to-school isn't traditionally a very big event for Funko, we do benefit a little from the foot traffic going into stores for back-to-school supplies and things like that, but those are more targeted back-to-school programs. We are thrilled with where we are right now, and we think we're benefiting a little bit from foot traffic, but I wouldn't say it's anything above our normal expectations.

Erinn Murphy, Analyst

Okay. And the last question is following up on NSP, very exciting to see that it launched earlier this week. Can you share a bit more about the user experience you've created and how should we think about the frequency of launches going forward? Thank you so much.

Brian Mariotti, CEO

Yes, great question. I would say that we didn't create a user experience; we definitely piggybacked on WAX's marketplace and worked closely with them to enhance previous releases on that platform to make it more enjoyable. As for cadence, we won't be as aggressive as we originally thought with once-a-week releases. We've learned that the licensing space has complexities and legalities that require attention and take time. While we had an amazing initial launch, we want to improve the overall experience. My guess is you'll see things on an every three-week cadence with some tighter releases throughout the year as we ramp up; however, so far we're really optimistic about the initial response.

Operator, Operator

Our next question comes from Steph Wissink from Jefferies. Steph, your line is open now if you'd like to proceed with your question.

Steph Wissink, Analyst

Thank you. Good afternoon, everyone. And I’ll echo Erinn's sentiment and congrats to the team on the transition. My question is actually on Loungefly. If we could just unpack that a little bit over 100% of the quarter, has that been some incremental distributions? It sounds like Europe was part of that. What are you seeing about that customer relative to your core business? Is it bringing a new customer into the Funko family? Are you seeing that as an overlapping customer that's already buying some of your figures as well?

Brian Mariotti, CEO

Yes, I'll start off and let the others chime in. We're seeing that the thriving of mom-and-pop specialty retailers are driving a significant amount of growth. They're able to order more and carry exclusive content that aligns with the parks returning like Disneyland, Disney World, and the resorts, and Universal Studios as well. The D2C Channel continues to thrive, and we're dedicating more resources to create interesting online exclusive content. Part of what Andrew and I promised Loungefly when we acquired the brand is more licenses and better distribution. All of this has contributed phenomenally to the growth story, and we believe we're just scratching the surface with that brand.

Andrew Perlmutter, President

I would say that we're seeing sales from both existing Funko fans but are also bringing new people into the Funko ecosystem. This further establishes us as a pop culture lifestyle brand, reaching new customers we weren't talking to before, so there are Funko fans that are Loungefly fans, but we are indeed welcoming new customers.

Brian Mariotti, CEO

Yes, Steph, one key metric: We brought our key person from Disney to lead Loungefly marketing; we've never had dedicated resources before. She’s nearly doubled our Instagram followers, and now we’re at over 700,000 followers. The leading competitor has just 24,000 fans on Instagram. Loungefly is a high-end pop culture brand, and we have a phenomenal global appetite; we're excited about properly marketing the brand for the first time.

Steph Wissink, Analyst

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

Jennifer Jung, CFO

Yes, that's absolutely correct. We did have some of our marketing that we anticipated spending in this quarter that have shifted to the back half of the year to align with product launches. Secondly, from an SG&A perspective, we had a slower ramp of our hiring than we anticipated, but we are still on track to continue adding talent. So, we are reiterating our adjusted EBITDA margin guidance, but overall, the adjusted EBITDA will rise with increased sales.

Operator, Operator

Our next question comes from Linda Weiser from D.A. Davidson. Linda, your line is open. Please go ahead.

Linda Weiser, Analyst

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

Jennifer Jung, CFO

Hi, Linda, this is Jen. Yes, as we come off our Q4 call, we'll give a little bit more guidance to what we're seeing in 2022 and beyond. For now, I will say that we're currently investing in infrastructure. We have our ERP project in process aimed for implementation next year. While we will continue to invest in infrastructure, most of our capital will focus on tools and molding which should remain relatively consistent going forward.

Linda Weiser, Analyst

Great. You mentioned that the situation with the containers could lead to some shifting more towards the mix of FOB sales. Can you remind us generally what would be your percentage of sales on FOB? Do you think that shift sales into the third quarter from the fourth quarter?

Andrew Perlmutter, President

When we're talking about that, we are having conversations with our customers about container availability. We're trying to find more containers, but even large retailers like Walmart are having trouble. Most of those are already doing some FOB with us, so we are utilizing that as much as we can to move products. As for what percentage of our business is FOB, I think it's around 25% to 35% when you look at both the U.S. and Europe combined. But I will need to double-check that.

Operator, Operator

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

Brian Mariotti, CEO

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

Operator, Operator

This concludes today's call, and you may now disconnect your lines.