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 this 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, they also led to many of this year's top DTC (ph) sales days. The enthusiasm our fans have for Funko is palpable. They dress up. They wait in line for hours. They carry the Funko flag.…

Thanks, Andrew, and good afternoon, everyone. We delivered strong third quarter net sales growth 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 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 timing of inventory delivery. For context, if we've 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…

[Operator Instructions] And our first question of the day comes from the line of Meghan Alexander from JPMorgan Chase. Please go ahead.

Hi, guys. Thanks for taking my question. I guess maybe starting on the top line, 3Q was strong. I think at the midpoint, the guide implies 4Q down, call it, 5% given where -- is that related to destocking and the macro? And I guess given where inventory levels are? Are you anticipating destocking continues into ‘23? And are you -- do you think you're going to have to take any actions on any of your owned inventory? And how does that change how you're thinking about -- or does it change how you're thinking about growing the top line double-digit?

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 sort of 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 is -- which kind of -- which was reflected in our portfolio value (ph). So the signs that we're seeing on the Funko brand now and in the second -- in the back half, are positive, right? If we don't do our dot com direct-to-consumer side, when people are spending more money and buying more items than ever before. So that's a really positive sign that we're seeing. Yes, there are outside pressures that we're dealing with it, that have had an effect on inventory. And we are always looking at the health of our inventories and decide including the adjuvant 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. And in the event where we have seen a pullback a little bit in Q4, we have been making the right edit to our inventory, whether it be cutting receipts or pushing receipts out to make sure that we are managing this and managing it down towards the end of the year. Definitely an area of focus.

Okay. Thank you. And then maybe a follow-up for you, Jen, as well. Can you just help us maybe better understand the components of the margin in 4Q, maybe how much of the -- can you give us like a full year gross margin range? And just to try and understand how much of the additional pressure is gross margin versus SG&A? And then just trying to understand within that how much of it is transitory and maybe related to inventory actions that you can get back 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 in the event we might have to do a little bit discounting because we know that inventory is tight across our retailers in the back half the year. So we've taken that into consideration. From an SG&A perspective, it's -- I'll let you guys do find (ph) their models, but 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.

And then when do you expect the ERP software system to be rolled out? And should this -- if it's in the middle of next year or should the pressure -- should you get this pressure back 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 and we're looking at actioning 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 containers, which we're seeing come down between 86,000 (ph) per container. So 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 cost with the growth and the infrastructure that we're having to invest in to support the growth. We would expect that to be middle of next year, we are pushing hard to get that ERP up and running, which also, by the way, brings that the software to optimize our warehouse which we build in the warehouse to run on WMS and because of the ERP delay that's pushing back on WMS. So we've obviously found a lot of manual work around, unfortunately, we'll get this -- the record 37% product out. Last quarter, we're going to continue to do so until we get this up and running, which is, like I said, we'll next year as what we're looking at.

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 down my head. You know, like, you really up until the second quarter when you did have it 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 meaning, did you know that you had these operational issues?

So on the Investor Day, if that's what you referred to, I think that's 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 seeing us executing against two major infrastructure projects, in order to deliver that due to revenue. It just so happened to fall in the year where there was this broader economic pressure. And again, I think 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 with that 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 that are pricing with our factory. We are rolling out starting in next year. It'll take like mainly in Q2 more broad-based price increases across the board. And 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 sort of sector. That tells you everything you need to know, right? The demand is there, right? 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 within a 100% within control, right? If a retailer, has the mandate to lower their inventory, we are going to be caught up in that, right? Even keeping key programs exclusive to their driving foot traffic to those retailers, there is a broader EBIT for our wholesale retail partners to end the year with wider inventory. I think that that's what you're -- 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 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 across the board are bringing down their inventories. It's not a direct reflection that 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 with the high-20s growth on the year. So we're still feeling there is demand out there for our products. Our online channel is demonstrated over that. And we feel good is about working through this near term as retailers want to get clean for their inventory by end of year. So that's -- those are the challenges that 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, we would like to give a more holistic picture on that. We did disclose 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 we'll be in Q4.

But those expenses of whatever magnitude it's going to be in like 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 actually currently working on getting more equipment into our distribution center to more 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 -- there are some additional expenses, but we should be one that help continue to support our growth and we are looking to get those down as we kind of move forward.

Thank you. [Operator Instructions] And our next question is from the line of Gerrick Johnson of BMO. Please go ahead.

Yeah. I'd actually rather give my time back to Linda, if she wants to keep going. Seriously, performance at your recent Comic-Con events. Wondering how those events New York and San Diego have gone for you guys now that everything's back in person and how are those events comparing to pre-pandemic? And then related just to this infrastructure thing, how did it become a surprise? How did it catch you off guard that you'd be -- was it the delay in the operating system or what was that that caused a surprise?

So let me kick it off Gerrick, it's Andrew. Thanks for the question. So let's talk with the in person events. We'll start there. San Diego Telecom was up strong double-digits. New York Comic-Con was up triple-digits as far as our sales were concerned. We could not even handle the demand that we had in our booth. That -- was the biggest complaint was, man, how do you guys grow your footprint here, so that you can satisfy more of the consumer demand? So it's like drinking out of the firearms, but they put it down. So we could not it, when I talk about the confidence that I have in our brand, that combined with what or combined with what we're seeing on funko.com is exactly what I'm talking about. So does that give you a good idea?

That's great. Yeah. Thank you.

Great. So on the -- why was it a surprise? So I think that it's a combination and can do China here as well. It was a -- we launched the new warehouse. We made the decision to move the new warehouse with a delayed ERP. And part of that ERP is what's called the WOS, which is warehouse soft -- warehouse management software thing. And basically, that helps you optimize the layout of that warehouse. And so when the ERP [Technical Difficulty], it came with the extra work around having to create manual processes to optimize that warehouse, which would normally have been done in an operating system, but unfortunately, we didn't have. So that's -- was it a surprise? I would say it caused us more manual processes than we expected. So, yes, I think that that was something that call us a little bit off guard, but obviously we're pushing through and we're creating the manual workarounds to continue to get that revenue out of the door.

And I would just add to that, given that we did launch it in Q2, we did expect -- in any new leasing, we did expect hiccups around the launch of it. What I think is the bigger, unfortunate part is that they continued on, whereas we expected them in the first of Q2. So you're seeing a little bit of that as well, but we are again investing in growth, investing in 3PLs. We specifically left our Loungefly business in a 3PL and not moved it in here to continue to support its growth. It grew 15% in the quarter. So we want to protect that business as well. So we are doing everything we can to fix our operational hiccups.

Okay. Great. And I know it's difficult given the nature of your distribution to give us a POS number for the quarter, but how about to you POS performance that your major mass market accounts?

Yeah. We are happy with what we're seeing going through register. Obviously, you're right, our POS is a lot different than some of the other people in the marketplace in terms of market distribution is so much more specialty oriented. But yeah, we're very happy we continue to see not only good unit but sell through, -- but also higher ASPs. So it's largely been positive. I will say, and obviously, there is the bit of over inventory situation that the retailers are dealing with across the board. And maybe it's not over inventory, but they're trying to cut back inventory. I'm sure you've heard back from other people where they are bookings that ended your clean on inventory. So I think that's actually some sort of effect on the newness of the pushback.

Okay. Thank you. Thank you, Andrew.

Thank you.

Thank you.

[Operator Instructions] And it appears we have no further questions being registered at this time. So I'll hand 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.