Good afternoon, and welcome to Funko’s Conference Call to Discuss Financial Results for the Fourth Quarter 2018. 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 the 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. On the call today from management are Brian Mariotti, Chief Executive Officer, Andrew Perlmutter, President, and Russell Nickel, Chief Financial Officer. I will now turn the call over to Mr. Nickel to get things started. Please go ahead, sir.

Thank you, and good afternoon. A press release covering the company’s fourth quarter and full year 2018 financial results was issued this afternoon and a copy of that press release can be found in the investor relations section of the company’s website. Management’s remarks on this call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These may include statements regarding our business goals, plans, abilities and opportunities, industry and customer trends, growth, momentum, and investment initiatives, expectations regarding collaboration and license relationships, consumer engagement and brand awareness, acquisitions and related expenses, and anticipated financial performance. 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 third quarter 2018 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. Please note that we will be referring to certain non-GAAP financial measures on today’s call such as EBITDA, adjusted EBITDA, adjusted EBITDA margin, adjusted pro forma net income, adjusted pro forma earnings per diluted share and net debt, which we believe may be important to investors to assess our operating performance. Reconciliations of non-GAAP financial measures to the most directly comparable GAAP financial measures are included in our earnings release and in the Investors Relations section on our website at funko.com. We have also prepared a visual presentation that investors can consult to follow along with this discussion and it can be accessed in the Investor Relations section of our website. I will now turn the call over to Brian.

Good afternoon, and thank you for joining us. On the call with me are Russell Nickel, our CFO, and also Andrew Perlmutter, our President. Funko just announced another great quarter that capped a fantastic 2018. Net sales in Q4 were up 38% to $233 million and that put our full year sales at $686 million, up 33% over 2017, which greatly exceeded our expectations. Our top line growth has significantly exceeded the growth targets we set when we went public in late 2017. We are seeing stronger than expected demand for our product and the properties that they represent both domestically and internationally. In fact, our 2018 sales exceeded the 2019 sales consensus estimate established immediately after our IPO. We have beaten and/or raised guidance every quarter since we went public. And we were even more bullish for 2019, guiding to 18% to 20% top line growth year-over-year. We’re going to review many of the ways in which 2018 was a phenomenal year, but here are some highlights. We completed our first full year as a public company with the stock far outperforming the broader markets and the traditional toy companies in the year. We made sales to thousands of new stores in markets all over the world and saw our domestic business grow 30% and our international sales rise 58%. We successfully integrated three acquisitions that we made in 2017, including Loungefly, which more than doubled their sales, and we refinanced our credit facility, slashing our interest cost, producing an annualized cash savings of over $6 million per year going forward. Andrew and Russell are going to take you through more of the details of our Q4 performance and our growth expectations. But I want to start by telling you that not only did our sales exceed our own…

Thank you, Brian. As Brian said, we’re coming off a better than expected fourth quarter, which caps off a terrific year for Funko. I’m going to focus my comments on what we did last year to drive sales growth and what we’re doing this year to keep the momentum going. In 2018, our growth was balanced and came from multiple sources, including an expanded base of properties, new product categories, sales growth at existing retailers, and continued expansion and growth of our international retailer network. We had significant growth in the U.S. and internationally and all of our international markets showed growth. We expect these factors to continue to be key drivers of our growth over time. The cornerstone of our growth is the continued expansion of entertainment content across properties. In Q4, we sold against 583 active properties, which was up 34% from Q4 2017. As we said before, we expect this number to grow over time as the proliferation of content continues and we broaden our license portfolio. In the fourth quarter, not only did we increase the number of active properties 34% but we were also able to grow the sales per active property by 3%. Our business is not dependent just on newly released content. In Q4, our top 10 best-selling properties were as usual a mixture of new properties and evergreen and accounted for about 38% of sales in the quarter around the same percentage as last year. Those top 10 properties in the quarter were Fortnite, which accounted for about 12% of sales, Harry Potter, Avengers: Infinity War, Marvel Studios 10th Anniversary, Stranger Things, Overwatch, Star Wars Classic, Mickey Mouse, Dragon Ball Z, and The Nightmare Before Christmas. The fact that Fortnite, which the Washington Post called "the biggest pop culture phenomenon of 2018"…

I’ll now turn the call over to Russell to discuss our financial results. Thanks, Andrew. Good afternoon, everyone. As was the case throughout 2018, our strong fourth quarter results were broad-based and reflected a number of positive underlying trends. Net sales in the quarter increased 37.6% to $233.2 million and were driven by strong and balanced global demand for our products across a higher number of properties. On a geographical basis, in the fourth quarter, net sales in the United States increased 29.8% to $158.8 million and net sales internationally increased 57.8% to $74.5 million. As you recall, earlier in the year, we implemented a new ERP system in the UK and rolled out a 3PL operation in Mainland Europe to support the growth. These investments helped us achieve growth in net sales in Europe of 37% in the fourth quarter over the prior year. We believe this growth was still constrained by some system limitations and the capacity of our fulfillment network in the UK given the higher than expected demand. On a product category basis, in the fourth quarter, net sales of figures increased 37.9% to $188.3 million and net sales of other products such as bags, accessories, apparel and homewares increased 36.6% to $45 million in the quarter. As Andrew noted, sales in the quarter of Pop! Vinyl figures increased 48% on a global basis over the prior year and as a brand, Pop! was up 52% over the prior year. Gross margin, which excludes depreciation and amortization decreased 260 basis points from Q4 of last year to 36.7%. As we communicated after the third quarter, gross margins in the third and fourth quarter of 2017 were atypically high and we knew at the time that margins would get lower year-over-year in the second half of 2018,…

Thank you. At this time, we’ll be conducting a question and answer session. [Operator Instructions] Our first question comes from the line of Erinn Murphy with Piper Jaffray. Please proceed with your question.

Great. Thanks. Good afternoon, and really nice job on a solid year-to-year. My guess my first question for the team, maybe actually probably for Russell, on the guidance of 18% to 20% for the year recognized you have the comparability in Q1, but really curious more for the balance of the year, how should we think about the run rates for the U.S. and international. And then particularly on the U.S., if you could just touch upon what you saw in the fourth quarter with respect to Walmart, that was a very, very strong Q4 number for the U.S. just curious what you’re seeing with the extensions there.

Yes. In regards to the growth that we’re seeing or expecting in 2019, domestically, we’re expecting about 10% growth – 10% to 15% growth coming out of the – in the domestic markets and then really the rest of the markets coming – making up the rest with really strong growth continuing in Europe for an overall balance. And regarding to Walmart, I’d let Andrew take that question.

Yes. So the Walmart, the rollout was successful. We saw a very strong compliance within the chain with the new collectibles section. As far as setup was concerned and sell-through followed, we had several very strong programs with them in Q4. And I believe that they are seeing the opportunity and we expect that to grow in 2019.

Okay. Thank you, that’s helpful. And then just on the gross margins, going back to some of the comments that are in the prepared remarks, I guess two questions. First, is anything structurally changed outside of your doing more FOB more in Europe? And I guess some pricing changes there, but from getting back to 39% or getting there over time suggests that was obviously what we thought about the IPO time. I’m curious if you think if there’s anything that you think is truly structural. And then the second piece is in the release then I think on the transcript, you also talked about royalty, is that mix or are there any specific renegotiations that are happening with some of your key partners that would continue to hinder the gross margin rate?

No. So the – in regard to the gross margin, I’ll take that one first, it was largely mix that drove the difference between Q4 of last year and this year. There was no change in our negotiations with our licensers that should have an impact. So it’s been driven by mix. In regard to structural changes, there’s again nothing structural. The changes in pricing that we referenced really relates to what we talked about in Q3 and Q4 of last year and then on the call last year after having bought Underground Toys, we gave back some of that margin at the beginning of this year really at very end of Q4 of 2017 to more streamline and align pricing on a global basis. And then obviously there’s the shift as more retailers want our products and want our products sooner, they’re moving and shifting to an increased percentage of their buys coming directly from our factories. So coming out of FOB, which again, has no real impact or operating leverage, but it’s a shift between gross margin percentage and SG&A.

Okay. And then I guess for the year, then as you think about 2019, I mean, should we just kind of be modeling this kind of a march forward from where you ended Q4 or is there any other kind of thoughts about how we should be thinking about even just first half, second half for the GM?

No. I’m saying – we’re not again with the opportunities and growth opportunities we see in front of us, the fact that retailers frequently want us to air-freight in product on their behalf. Those dollars flow through, we charge -- we flow those through, and so those are negative from a gross margin percentage, but they don’t impact our gross profit. We’re not guiding to a specific. If you have to have, I’d probably hold it around the same lines of what we saw this year, knowing there are opportunities that might impact that over the course of the year. Again we’re focused on the long-term growth and healthy growth of the business.

Okay. And then maybe just last question, big picture for Brian. When you said out at the IPO, this was kind of the longer- term aspirations were $1 billion in sales, and next billion in sales, and next year is starting off not too far from that. I’m curious how you’re thinking about bigger opportunities longer term to drive above that and you’ve reference for in music in some of these categories you’re just starting to see some great traction, kind of what gets you beyond the $1 billion? Thank you.

Yes. No, I think, Andrew’s experience and work in helping us acquire Forrest-Pruzan is certainly our first take in the ground of a category that’s much larger in the action figure category and has significant growth above what the toy sector is doing right now. We think that’s a new stream of revenue we think our war chest of licenses, our industry expertise, our global distribution in a partner with almost 20 years experience dealing with the Asmodees and the Hasbros and the Mattels and the Spin Masters on game creation, we think that’s one of the revenue stakes, that we’re going to be able to grow and get push pass that $1 billion. We made some comments that we are working on some of our own IP and how that’s going to go into the toy aisle. And we think that there’s definitely an opportunity to scale down with our own IP and our creative team of 150 world class artist to recognize some revenue in categories that are much younger than what we traditionally play and much like the Five Nights at Freddy’s licenses and the demographic that reaches. So that’s another – we think another avenue that’s going to help us push fast $1 billion in our future. So those are the couple of things we’re working on that I’m not really yet prepare to talk about, but those are two big ones be alike are going to overtime get us to the next level as the company.

Thank you guys. And all the best.

Thank you.

Our next question comes from the line of Stephanie Wissink with Jefferies. Please proceed with your question.

Thanks. Good afternoon everyone. Just a follow-up on one of Erinn’s questions, I’m curious if you can talk about the new retailers you’re seeing coming off the tradeshows, also in the sports category. And then Brian, one for you, just the more mechanics, as we think about 2019 and the content, should we think about the number of new properties slowing a bit and the dollars per property going up? Just again mechanically how should be think about property growth versus dollar for property in 2019? Thank you.

Thanks, Stephanie. I’ll take the second question first. Yes. I think there’s – it is an interesting year for us because the content is so good. And so yes, you could potentially see us not leverage as many unique properties because of how we’re dealing with A+ content. And we say, we’re not hit driven. If we had something that was a big movie that we can’t anniversary in a quarter, we’ll make it up with two, three, four, 10 properties. So I think there could be – it will be interesting to see how the year shakes out, but there could be a potential to actually make less and lever against less properties this year because of the strong content. Repeat the first question though. I’m not sure, I exactly understood that one.

Erinn had asked about music and sports. And I think you’re opening some new retail channels with some of those.

Yes. I think that Footlocker and Fanatics are two great examples of retail partners that desperately wanted to get into the business of pop culture. Obviously, Fanatics being an e-tailer, geographical concerns traditionally with the sports goes away on an e-commerce platform so that’s been something we’ve seen. And we’ve seen some amazing success, I think both Pop Footlocker and Fanatics websites crashed on LeBron and Michael Jordan exclusives we gave them. Pop Footlocker is really happy with their basic two quarters worth of sales in our category and how they’re leveraging our everyday pop culture content to align with – sometimes Nike activations or Adidas activations, and we’re seeing a parallel consumer that’s a sneakerhead that is crossing over into our pop culture world. They already have that collecting bug in their DNA. So, two great retailers, two new retailers for us that we’re continuing to expand with both music and sports.

Final one for us, just on the acquisition of Forrest-Pruzan. Does that come with any owned IP that you’re looking to exploit down the road or is it more of a platform acquisition around the gaming and gaming development?

It’s a great question. They actually have over 500 pieces of IP or what you’ll hear me refer to as game engines in their catalog. These are games they’ve created, had in the market at the time and brought back. It’s not necessarily the game. It’s the engine that drives the game, the mechanics of it. And they’ve brought it back or there’s an equally large catalog of games that they’ve created that they haven’t found the right home for yet. And so these are all opportunities for us to explore as we move forward. That said, we are developing new game engines with them out of the gates. So, we’re excited about both of those avenues.

I think the library helps us with a fast turnaround when it comes to something that is pop culture we need to get in the marketplace immediately. But there is definitely a strategy of using that library plus creating our own.

Thank you.

Our next question comes from the line of Michael Swartz with SunTrust Robinson Humphrey. Please proceed with your question.

Hey guys. Good evening, guys. Russell, maybe, starting with you, you outlined a number of items in the quarter that can avoid on gross margins. I was just trying to get a sense of the magnitude of some of those, whether it was the chargebacks or some of the elevated costs related to expedited shipping.

Yes. Again, I want to highlight most of these were driven by demand or related to demand exceeding expectations, including the elevated shipping, which again, was largely at the request of retailers that wanted us to airship in. Again, zero impact from a gross profit percentage, but negative to gross margin. I won’t get into the detail in terms of the overall impact of each one. But in total, if you kind of pro formed it and you backed those out, then frankly, our gross margins really would have been in line with where they were in the fourth quarter.

Okay, great. That’s helpful. A lot of the investments that you outlined for the year ahead seem to be more on kind of the distribution or retail side of things. I guess it brings to question as far as just manufacturing capacity and ability to meet the demand from that standpoint. Are there any limitations or capacity constraints in terms of the manufacturing?

Absolutely not, we have 11 unique factories. We are making a shift into a greater percentage each and every year into Vietnam versus China. But we both have – we represent a good 80% to 100% of those factories’ capacities, but we are probably only at about 50% to 60% of what we’re able to produce on a month-to-month basis within those factories. There is a ton of bandwidth for us to continue to grow. There is no shortage of factories that we are now digging into that are coming to us with a slowdown of toys and asking if they can be a part of our manufacturing team. So that will not be any kind of issue at all.

Okay, great. Thanks a lot. Appreciate it.

Our next question comes from the line of Michael Ng with Goldman Sachs. Please proceed with your question.

Great. Thanks for the time. I have two. Can you just talk about your optimism about the boardgame category and the acquisition of Forrest-Pruzan? Is this a category, where you see a lot of potential underlying growth or do you think there’s a lack of compelling innovation creating some opportunities for market share gains or both? And then do you see this as a marketing tool for the Funko brand or will boardgames be profitable in and of its own right. Thanks.

I can take that one. It’s Andrew. Yes, I would say that it is definitely going to be profitable for Funko to get into this space. That being said, I will say that there is a tremendous amount of opportunity in both the innovation side, which we believe we’re going to bring to the game aisle. But as importantly as the innovation side, we believe we’re going to disrupt this category by approaching it in a very non-traditional way similar to how we’ve approached the figure business. That’s one of the reasons why we’re most excited about getting into this category and we think that there is a tremendous opportunity ahead.

Great. And then my second question is just about the U.S. sell-through. And I think you said it was up 10% in the quarter, selling was up 30%. Could you just help reconcile some of the gap there? Was it just a function of Walmart stocking up and expanding shelf space? And I guess do you expect sell-through to accelerate in 2019? Thanks.

So, it’s a great question. I’ll remind you – we get sell-through data from about 15 of our top customers in the U.S. So, it’s not all of our top customers. We did have a couple of customers that one, like Walmart, that stocked up as they moved into a new retail store. We also saw some e-commerce platforms that changed their buy-in habits. Also in order to – because they just were beginning – they’re beginning to understand what Pop! culture and what our products specifically can mean to them. And so they started to increase their overall buy. I will say for the retailers that report to us. It’s important to note that the sell-through, which was up about 10%, but their channel inventory was up only 8%. We’re seeing a very strong correlation between the sell-through and the levels of inventory that they’re carrying, which is why we’re seeing a healthy level of – we feel good about the channel inventory as a whole going into 2019.

Okay, great. And maybe, one last one for Brian, if I could – Brian, could you just comment on what you’re seeing in terms of Fortnite demand as we start off 2019, particularly with Apex Legends kind of creeping up and any comments about a potential license there? Thanks.

I just won a lot of money in Vegas knowing there would be an Apex Legend question would come up. Daddy’s got himself some money.

Brian, I want half of that.

So, any ways, look Fortnite continues to be strong. We’re monitoring the sell-through. It is doing extremely well at the bigger retailers. And that’s interesting for us, where we kind of thought that was going to be. We think a full year and continued trust in partnership with Epic; it’s going to be a meaningful license for us. With that said, obviously, Apex is on a run rate that is on par with what Fortnite did last year as far as interest and adoption. And like anything else, we’ll give you the party line, anything that’s moving the needle on Pop! culture we’re on top of, we’re having dialogues with. And this is just part of our business model. Certainly, aware of that property.

Okay. Great. Thank you guys.

Our next question comes from the line of Gerrick Johnson with BMO Capital Markets. Please proceed with your question.

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Yes. I would say that we have had conversations with a large number of our current licenses. So far, every license that we have talked to has been very enthusiastic about this new avenue of product diversification. And so to give you a specific percentage, probably wouldn’t be fair at this juncture. I can just tell you that the adoption rate has been extremely high and as we expected.

Okay. A couple of housekeeping questions – perhaps CapEx in the quarter and your expectations for the year and then also your expectation for equity compensation for the year. Thank you.

Yes. So, CapEx was in line with what we’re expecting for the fourth quarter and you’ll see that as it comes out. Next, when we file our K as it relates to CapEx next year with the addition of the Hollywood Store, we will see a little bump increase in CapEx spend next year as we continue to invest. And then also, you’ll see as the stock continues with the full year of the stock grants and things in line, we are expected to see approximately about $10 million in stock compensation expense recognized from a GAAP perspective next year.

Okay, great. And maybe one last question – I thought I heard you say that increased FOB sales lowered your margin in the quarter. Wouldn’t that help your gross margin? Help me understand how that would lower your gross margin.

We give – typically, when we sell to retailers from an FOB, we’re given a discount of its top line. So, because we’re not – they’re covering the freight costs. So, there’s that element. But there is typically an increase in the royalty costs related to it. So, it’s decreasing given the – it’s decrease in our gross margin given the discount that we give.

All right. Okay. Got you. Thank you.

Thanks, Gerrick.

Our next question comes from the line of Christopher Horvers with JPMorgan. Please proceed with your question.

Thanks. Good evening guys. So, it seems like the product category expansion has really accelerated here with Loungefly and now with the boardgame company. So, as you go back to the original plan around the IPO, there was the expansion within existing retailers, new categories, there was international – obviously, Europe is growing like a weed as well, but does the success of the new categories and particularly, the recent acquisition of Forrest-Pruzan, does it change your sort of thought process on how hard you need to push outside of the Europe and the United States?

No. I don’t think so. I think we’ve looked at the rest of the world really strategically. I think we just added two people in Latin America. From 2017 to 2018, I think we grew that about 700%, we just keep people on a focus. it doesn’t change the philosophy that we believe that content resonates on a global basis. I think what the expanded category success has allowed us to do is continue to create wonderful whimsical programs for our key retail partners and be able to garner all of the categories within that space instead of having to farm some of that stuff out to other manufacturers. So, that’s been really the key that we can basically carry a section, whatever the section would be, if it’s an 80’s retro TV section, if it’s a section all about ad figures, we have all the categories necessary to carry that section and just getting that expertise in these adjacent categories has really helped us with our retail partners understand that we truly are a one-stop shop for anything and everything that is Pop! culture. So, it’s really paid off. Even thing is whimsical as the serial on the Pop! Has just having some consumables and they are allowing us to delight surprise when the consumer coming to this section.

And then as you – I know you were going to work a lot on the direct side, funko.com. But obviously, that’s branded under Funko. Do you think there’s just philosophically a lack of what a singular destination on the web for fandom-type products? Obviously, you still have Amazon, Walmart, Target, but do you think there needs to exist something that’s not called Funko.com that you could participate in and you could perhaps, have ownership and that can be the web destination for this type of product?

I think we’ve focused so much time and energy in the last year and a half in helping Target, to build up target.com and Walmart build up Walmart.com and seeing a great success with Amazon growing their business as we’ve grown our own B2C. So, I don’t think we’re ever going to see any one retailer definitively own Pop! culture, because it is so vast and is so diverse and when you go back to see a Pop! Footlocker, who’s really putting a foothold into music and sports and fanatics, who’s putting a foothold into sports. I think you’re going to see multiple players there. We have to get better with our search engine capabilities and our marketing, and making sure that we continue to garner more and more of that direct to consumer sales. But no, I don’t see, unless Andrew has a differing opinion, I don’t see any way that anybody can definitively own this. It’s too broad of a category and now it’s too mainstream.

Yes. I would just say – I would just add on to that that we have talked to websites and their whole business is around fandom. What we have found is with as little of a focus as funkoshop.com has been for us, the traffic that we generate dwarfs a lot of the other companies out there. So, we would – I think what we’re saying is we would rather focus on our third-party partners as well as building funko.com.

Yes. Got it. And just some further model questions for Russell – any other cadence commentary around the top-line growth? Obviously, you’re not going to lap Fortnite. You’re not going to lap Walmart until the end of the year. How does sort of that interact with the overall content calendar you mentioned a number of the movie franchises coming out? Any variation in terms of top-line growth year-over-year besides that shift from 1Q and 2Q – 2Q to 1Q?

Yes. I think the other aspect of it is right now given Fortnite and the strong demand and also a little bit of the FOB sales that came in the fourth quarter. I think you may also see Q4 being a little just below our annual top-line guidance for the full year. Other than that, I think it’s a pretty normal cadence in terms of overall growth.

And then last one from me – any expectation around the level of debt on the balance sheet? Do you anticipate paying any of that down or not that you need to – are you going to keep that level of leverage?

I think we’re going to keep and maintain – I don’t think we’re going to accelerate any paydown of the debt. We are getting to a comfortable leverage ratio with our performance. We’re able to manage and refinance, manage our interest cost. We’ll continue to evaluate obviously, but our focus right now, is continue to invest in the business, see the opportunities and be in a position when presented with opportunities such as Forrest-Pruzan to take advantage of the position in the market that we’ve created.

Understood. Thanks, guys. Have a great year.

Thank you.

Yes. Thank you for your interest.

Yes. Go ahead.

I just want to say thank you for your interest and the support of Funko, and we look forward to speaking to you guys again, on the first quarter of 2019 earnings if not sooner. So, thank you very much.

This concludes today’s conference. You may disconnect your lines at this time. Thank you for your participation.