Funko Inc
NASDAQ:FNKO
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Funko Inc
Earnings Call Analysis
Q4-2023 Analysis
Funko Inc
The company has demonstrated financial diligence in the recent quarter, ending the period with $36.5 million in cash and cash equivalents. They have shown a commitment to debt reduction, paying down $26.2 million of debt in the fourth quarter, leaving total debt around $273.6 million. Moreover, inventory levels were significantly cut to $119.5 million, a stark decrease to less than half the amount from the previous year, which signals a strategic move to address previous overstocking issues.
Looking ahead, the company has set a target for net sales between $1.047 billion and $1.103 billion for the full year 2024, with the anticipation of single-digit percentage growth in the latter three quarters. They expect to achieve this growth through a focus on high-margin product lines, direct-to-consumer (D2C) sales, and cost reduction measures from the previous year. The adjusted EBITDA is projected to fall within $65 million to $85 million. For the first quarter specifically, the net sales guidance stands between $214 million and $227 million, albeit with a slight downtick in gross margins primarily due to higher freight costs, while keeping SG&A expenses lower compared to the previous quarter.
The company is experiencing a leadership change following the CFO's decision to resign. His decision was influenced by the completion of the turnaround he was hired for, confidence in his successor, and the personal toll of commuting. This change is not expected to adversely affect the company's trajectory. In fact, the outgoing executive expressed strong confidence in the incoming CFO's capability to lead and continue the company's success.
The company reported a 30% growth in D2C sales, banking on unique offerings like 'Pop Yourself' and limited edition drops with higher price points to sustain and further this momentum into 2024. These initiatives align with the company's strategy to bolster D2C business, which is increasingly becoming a larger contributor to its revenue due to higher margins compared to traditional wholesale channels.
Despite the significant changes, company executives assure stakeholders of operational continuity and attention to detail during the interim period without a permanent CEO. A new CEO is expected to be announced by the next earnings call. Additionally, they emphasize that a shift in sales mix toward D2C channels and inventory management has resulted in a healthier business. This reflects a strategic pivot away from reliance on POS sales with certain wholesalers, one of whom has seen a notable decline.
The company has made commendable advancements in improving gross margins, returning them to historical norms or potentially even surpassing them. The emphasis now shifts to sustain this improvement and continue bolstering EBITDA margins. Planned efforts and cost reduction initiatives taken in the past year are expected to contribute to an improved SG&A ratio, which would subsequently drive EBITDA margin expansion. The results of headcount reductions will be notably reflected in financials starting in the second half of the year.
While expecting to 'comp up' in the latter half of the year, the company acknowledges that global shipping dynamics, such as issues in the Red Sea, could impact their ability to recognize revenue each quarter, enforcing vigilance in their approach to revenue projection and operational planning.
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Good afternoon, and welcome to Funko's 2023 Fourth Quarter and Full Year Financial Results Conference Call.
[Operator Instructions]
Please be advised that reproduction of this call involve or in part is not permitted without written authorization from the company. As a reminder, this call is being recorded. I'll now turn the call over to Funko's Director of Investor Relations, Rob Jeffrey. Please proceed.
Hello, everyone, and thank you for joining us today to discuss Funko's 2023 fourth quarter financial results. On the call today are Mike Lunsford, our Interim Chief Executive Officer; Steven Nave, the company's Chief Financial Officer and Chief Operating Officer; Yves LePendeven, our Deputy CFO.
This call is being broadcast live at investor.funko.com. A playback will be available for at least 1 year on the company's website. I want to remind everyone that during the course of this call, management's discussion will include forward-looking information. These statements represent our best judgment as of today about the company's future results and performance. Our actual results are subject to many risks and uncertainties that may differ materially from those stated or implied, including those discussed in our earnings release. Additional information concerning factors that could cause actual results to differ materially is contained in our most recent SEC reports. In addition, during this call, we refer to non-GAAP financial measures that are not prepared in accordance with U.S. generally accepted accounting principles and may be different from non-GAAP financial measures used by other companies.
Investors are encouraged to review Funko's press release announcing its 2023 fourth quarter and full year financial results for the company's reasons for presenting non-GAAP financial measures. A reconciliation of the non-GAAP financial measures to the most directly comparable GAAP financial measures is also attached to the earnings press release issued earlier today.
We have also posted supplemental financial information on the Investor Relations section of the company's website. I will now turn the call over to Mike Lunsford. Mike?
Thanks, Rob, and good afternoon, everyone. I'll begin with a few overarching comments on the past year. My first comment is on the general business front. 2023 was transformative for Funko. We addressed significant existing operational issues and executed a comprehensive cost reduction plan. The plan included eliminating unprofitable product lines and SKUs, 2 rounds of workforce reductions and aggressive reductions in our inventory levels, which I'll return to in a moment.
The major element of this transformation are now complete. My second comment is on the strategy front. Over the course of 2023, we grew our D2C business, which in turn helped us achieve consecutive quarterly increases in our gross margin. Growing our D2C business remains a key goal for us. We have more control over our D2C business and believe we can grow it profitably. So we were pleased to see D2C sales in Q4 comprised 26% of our mix and increased nearly 30% over the same quarter last year. My third comment is on the product front. We expanded our offering with 2 important product launches.
In early 2023, we entered the miniature collectibles market with the introduction of BidyPop. And around the middle of the year, we launched Pop Yourself online. Both products have been very well received by customers and were key contributors to our business in 2023.
My fourth comment is on the operational front. We achieved another important goal lowering the company's owned inventory levels. At year-end, inventory was $119 million, which was down more than 50% from $246 million at the end of 2022. And for our larger retail partners who provide us with POS data, inventory in the channel at the end of 2023 was 32% lower than at the end of 2022 and at healthy levels relative to POS sales.
Our growth in sales, improved gross margin and the rightsizing of our cost structure culminated in a successful Q4. Specifically, Q4 net sales were $291 million, gross margin was 38% and adjusted EBITDA was $23 million, all of which were at the upper end of our guidance range.
Turning now to 2024. We expect 2024 full year net sales to be comparable to down slightly from 2023. Regarding phasing of the quarters, we expect to achieve positive comps later in the year, but Q1 net sales to be lower than net sales in Q1 of last year. Our expectation is in part based on the following: first, we took deliberate action to manage down our inventory levels, and we eliminated a significant number of unprofitable product lines and SKUs; second, we are experiencing a softer content schedule, primarily due to the recent Hollywood strikes; and third, we face uncertainty around shipping costs, primarily due to current hostilities in the Red Sea.
Importantly, we expect 2024 full year adjusted EBITDA to be considerably higher than our 2023 full year adjusted EBITDA. The higher profitability we expect in 2024 compared with 2023 is based on the actions we are taking to, among other things, further expand our D2C business and increase sales of Pop Yourself and limited edition products, areas of our business where we have more control and that we believe we can grow profitably. We believe that by focusing on these areas, we will gain operating leverage and a greater percentage of our sales will flow to the bottom line.
In 2024 and beyond, our plan is to achieve long-term profitable growth. We will pursue our previously communicated plan, which centers around focusing on our fans and unmatched brand, running the business with financial discipline and focusing on fewer products done extremely well, investing in areas we can control, measure and grow profitably and keeping the flywheel turning where each action we take builds on the previous one, propelling positive momentum.
We believe this strategy is paying dividends. One recent example is the substantial reduction we made in both inventory and product SKUs, which shows how we are removing complexity from our business by focusing on fewer products. And another example is last month's sales event for our Jason Kelsey Pop figure. After a recent NFL playoff game, Jason Kelsey's shortlist celebration in the stands went viral. We saw this as just the kind of event we could memorialize for our fans. Multiple internal teams collaborated to launch a Jason Kelsey Pop figure, demonstrating how we are focused on our fans as well as our nimbleness and quickness to market.
The limited edition product went from moment to market in 11 days, and our fans responded by making Jason Kelsey one of our top-selling funko.com items of all time. Finally, a comment on our leadership team and search for a new CEO. Earlier today, we announced that Steve Nave, Funko's CFO and COO, will resign effective March 15, 2024. Steve joined us a year ago to help with our cost reduction and operational improvement plan. He led our efforts to address our excess inventory and improve our Buckeye distribution center, negotiate lower shipping costs, rightsize our cost structure and manage our liquidity and improve our free cash flow.
On behalf of the company, I want to extend our best wishes to Steve and thank him for his contributions. Yves LePendeven, our Deputy CFO and senior finance executive at Funko for the last 4 years will serve as acting CFO beginning March 15. I have worked with Yves for several years us now [indiscernible]. I have complete faith in Eve to lead our finance and accounting functions and to be our primary face to you, our analysts and investors.
I believe you will find him to be diligent and extremely knowledgeable, not just about our financials, but also our business. Turning to the CEO search. As many of you know, I took the role of interim CEO last summer with a mandate from the Board to set Funko on a solid foundation so that a new CEO will be able to focus on growing the company. We believe we now have in place a strong, lean, aligned, senior leadership team to support the arrival of a new CEO and the growth of Funko. We expect to announce our permanent CEO in Q2 of this year. I will now turn it over to Yves to take you through the financials. Yves?
Thanks, Mike. Hey, everyone. Thanks for joining us today. For the fourth quarter, total net sales were $291.2 million, which included wholesale channel sales of $216.7 million and direct-to-consumer sales of $74.5 million. Direct-to-consumer sales in Q4 represented 26% of net sales, up from 17% in last year's Q4. Sales of Pop Yourself were a key contributor to our Q4 direct-to-consumer results. Gross profit was $109.4 million and gross margin was 37.6%, which was well above our Q3 gross margin of 33.2%. The increase in gross margin was driven in part by growth in our higher-margin direct-to-consumer sales and lower freight costs.
SG&A expenses of $97.4 million included nonrecurring charges of $8 million, primarily related to fair market value adjustments for assets held for sale. As a percentage of net sales, SG&A expenses were significantly lower in the second half of 2023 compared with the first half due to the cost reductions we implemented during the year. SG&A expenses in the second half of 2023 declined to 32% of net sales from 38% in the first half.
Adjusted net income was $0.5 million or $0.01 per diluted share, which was within our guidance range for the quarter. And finally, adjusted EBITDA was $23.5 million, which was at the upper end of our guidance range.
Turning to our balance sheet. At December 31, we had cash and cash equivalents of $36.5 million, which is after we paid down $26.2 million of debt in the fourth quarter. Our total debt was approximately $273.6 million, which includes the amount outstanding under the company's term loan facility, net of unamortized discounts the balance on our revolving line of credit and our equipment finance loan. In the first quarter of this year, we also announced a transaction related to our games business from which we used the proceeds to further reduce our debt. And inventory was $119.5 million, which is less than half of the inventory we had at the end of last year and more than $40 million lower than our balance at the end of Q3.
Turning now to our outlook. For the 2024 full year, we expect net sales of between $1.047 billion and $1.103 billion. As Mike mentioned, while we expect net sales in Q1 of 2024 to be lower than net sales in Q1 of last year, we expect to achieve positive comps later in the year. Adjusted EBITDA of between $65 million and $85 million. The increase over last year's adjusted EBITDA is expected to be driven by growth in our higher-margin product lines and our direct-to-consumer business as well as the annualization of cost reduction measures implemented last year.
For the 2024 first quarter, our guidance is as follows: Net sales of between $214 million and $227 million, gross margin down slightly from Q4, primarily due to higher freight costs. SG&A expense in dollars decreasing from Q4, adjusted net loss between $17 million or $0.32 per share and $13 million or $0.24 per share. And finally, we expect adjusted EBITDA of between $0 million and $5 million. We expect our financial results to improve in the second half of 2024 due to the natural seasonality of our business as well as an expected easing of the impact of the Hollywood strikes and the recent shipping disruptions in the Red Sea and the actions we are taking to grow our direct-to-consumer channel top yourself and other areas of our business.
Mike, that's it for our financial results. Back over to you.
Thanks, Yves. In summary, we reported a solid overall financial performance in Q4. We significantly reduced our inventory levels and used a portion of our cash to pay down debt. We have completed the major elements of our 2023 cost reduction and operational improvement plan and our outlook for 2024 reflects a renewed focus on our core business especially those areas where we have greater control and believe we can grow profitably.
Before we open up the call for questions, Steve has a couple of comments he'd like to share about his resignation. Steve?
Thanks, Mike. Hey, everyone. I'll cut to the chase. My decision to resign was influenced by a few factors: First, we largely completed and accomplished the job I was brought in for, which included fixing operational issues, improving our financial profile, rightsizing inventory, managing liquidity and improving our free cash flow.
Second, I believe Yves is a strong financial executive and is highly qualified to take over the CFO role. As a matter of fact, when we began succession planning last fall, we promoted Yves to Deputy CFO, as you know. With the operational improvement plan now complete, my role would focus more on the CFO side, a role that I believe Yves is imminently qualified to assume. And third, as some of you know, I live in Minnesota, and the weekly commute to the Seattle area has really begun to wear on me, my family and the company.
Taken together, this is a good time for me to exit, and I take great comfort in knowing that the company is in significantly better financial shape today than this time last year. Yves was the primary architect of our 2024 plan, so I'm confident the baton being passed to him will be seamless to you. Look, I've thoroughly enjoyed my time at Funko, especially the people I've met and worked with. They are very talented and dedicated bunch of capable people doing amazing things. I've enjoyed interacting with many of you in the investment community and keeping you [ apprised ] of our progress. It's been an interesting and fun ride. I'm proud of what we've accomplished this past year, and I look forward to watching Funko's continued success. I will continue to bleed Funko Blue until the day I die, I'll leave it there for now. With that, I'll turn the call back over to the operator so we can take your questions. Operator?
[Operator Instructions]
First question comes from Stephen Laszczyk with Goldman Sachs.
Maybe Michael first, on the '24 guide. Could you perhaps expand a little bit on some of the assumptions that are underlying guidance? I think you called out some specific factors like the delivered actions taken on the inventory side, the Hollywood strikes easing, some shipping issues abating. Could you just dive in a little bit deeper on each of those and perhaps how that reconciles with your outlook for the broader industry in '24 and just how you arrived at the '24 guidance. And I have a followup.
Sure. So let me start with sort of separating Q1 from the rest of the year. when I came in last July, we put a plan together for a turnaround, and that plan extended all the way through the end of Q1. We knew we would be making choices then with things that were already being post shipping from factory, et cetera, that we were going to limit some of our financial upside all the way through the end of Q1, just to get everything cleared out as it were. So we will see that impact in Q1. That's one of the comments that I made. The other comments are more general for the rest of the year. I think it is a light content year from Hollywood, so we're fighting a declining trend there with growth in a lot of other areas, particularly Pop Yourself, the new limited edition drops that we're doing, growth in our D2C channel, a new evergreen strategy that's going to be a large percentage of our sales going forward, et cetera. So that will -- we'll see some single-digit percentage growth in the last 3 quarters of the year, first part of the year, will be down versus last year.
Got it. And maybe just a follow-up on D2C growth. You called out, I think, D2C sales increasing by nearly 30%. And sounds like you expect that to continue to some degree into '24. Could you maybe just talk a little bit more about the drivers of that growth and the level of momentum you expect to continue into this calendar year?
Absolutely. So Pop Yourself is the biggest one. That is through our direct-to-consumer channels, both in the stores and online. We'll continue to see good growth there. That is a big part of our strategy. In addition, today, as a matter of fact, we started -- we -- project Fred launched, you'll see a limited addition drop that we did today. You're going to see a number of those over the course of the year. The Jason Kelsey pop was another one. We've added some other elements in like that, that will be actually very high revenue drops because they're just -- they're a much higher price point than you're used to seeing from us. As a matter of fact, the one today, which is a Bob's Big Boy drop is a $295 price point. So you'll see a lot of that from us this year, and that will drive the D2C revenue on top of what we normally would be doing which includes expansion to other territories and other things in that part of our business.
We now turn to Linda Bolton-Weiser with D.A. Davidson.
Yes. So I don't mean to sound sort of ticky when I'm asking this, but like who is running the business or who will be once Steve leaves in about a week on a day-to-day basis because Andrew Perlmutter has left the company and your new CEO is still not quite on board. So how should we gain comfort that the wheels aren't going to fall off and who is the operating head sort of until the new CEO comes.
Linda, this is Steve. I'll share some thoughts, and then I'm sure Mike wants to -- will probably want to add something. It's a fair question, except what I would point to is when Brian was here, I was much more active in kind of the way you say it, the running of the company. Mike came in, in August, into July and has been very, very active running the company doing all the things that you would expect the CEO to be doing. Linda, you know Yves, and I think most of the investment community knows Yves, there's not a ball here to be dropped on the finance side.
Yves is incredibly capable, and I'm sure over time, he'll prove to you that he's a better CFO than I could ever be. On the operations side, I brought in a very senior executive that I -- earlier in '23 that I've worked with in the past. He is obviously incredibly capable. I think these results speak for themselves. I don't see there really being much of a void, if at all, with my departure. So the company is going to continue to be run by Mike. Yves is going to be slide right into the CFO. And Roland, let's be honest. He's done most of all the heavy lifting for me anyway. -- operations is going to be in good shape. So I really don't think it's -- I understand your question. I don't think it's something to be concerned about. But Mike, I don't know if you want to...
Linda and anyone else, I guess, time is not a proxy for attention, but I come up to every Sunday night at 08:00 and I leave Everett Friday night at 05:00 or 06:00. And I'm here 24 hours a day in between, and I'm in the office, except for when I'm sleeping and getting a little bit of time in, in the gym. I pay an enormous amount of attention to every detail in this company. I can even tell you where people park in the parking garage. I understand your question. I don't think it's a cheeky one. I hope my response isn't [indiscernible], but I am paying attention to the details.
Okay. That sounds good. And on the CEO, naming your new CEO front, it sounds like you're getting close. Would it be fair to say it would be the earlier part of second quarter and not the later part of second quarter?
My hope would be that on the next earnings call, you will hear our new CEO's voice.
Okay. Sounds good. And then just turning to performance in the channel. I mean I know you may not have specific POS numbers to share. But I guess I'm assuming it's POS -- is kind of down trending down year-over-year. Why would that be when demand on your own D2C website is so strong? Where -- why would there be a difference in demand trends in store versus on your D2C website?
Yves here, and I'll kind of begin the answer to this question. I think what you're seeing is, yes, POS sales are still down, I would say, high single-digit percentage. The trend did improve throughout the year last year. But really, what you're seeing is the mix shift into our own direct-to-consumer channel. So we've shared that over the past few years, a lot of our top line growth was driven with some of our retail partners.
And obviously, we are now favoring the higher-margin direct-to-consumer channel and direct connection with our fans. So I wouldn't read too much into the POS trend itself. Yes, it's down. I think it is -- it's resulting in a healthier mix of business for us. And the last thing I'll point to and Mike commented in the call is that we've really seen tremendous progress in inventory in the channel. So both our owned inventory has come down 50%, and we kind of quoted inventory in the channel for those customers that report that information to us was down 30% throughout the year. So relative to sales, we look at weeks of supply, and we're right in that kind of sweet spot in the range that we like to see it. So I think that's a good indicator of a healthy business out there.
Only thing I would add is we have not calling out names, but we do have 1 particular wholesaler who's significantly down year-over-year. And if you take those numbers out, our wholesale channel is not significantly off of where it would have been at this point.
Okay. That's good to know. And then on the cost side or on the margin side, I mean, congratulations, Steve and everybody, but gross margin improvement is really impressive. And you're back to normal historical levels, I would say even maybe higher, I'd have to look at it. But -- so the gross margin is great. But going forward, how do we continue to improve EBITDA margin. And remind us when you anniversary the headcount reductions because that will happen, the anniversary, I think, will be in the second half of the year, so that SG&A ratio, how is it going to improve because that has to be the driver, I guess, of more EBITDA margin expansion. So maybe you could comment on that.
Let me start with an overall comment and then these guys can give you more detail. But you've hit the nail on the head, Linda, on something that I'd like everyone to be looking more closely at, which is the EBITDA margin versus gross margin. As we shift from wholesale to D2C and specifically inside of D2C on Pop Yourself, the line items that make up our cost shift dramatically from the gross margin side of the business to the SG&A side.
So we've actually made a ton more progress than you can even see at the summary level on gross margin because we're selling more things that require more hands to touch them. So over time, you're going to see our gross margin probably get capped to some extent, but the net margin is going to get a lot higher. With that, I'll turn it over to them.
Yes, I would just add to that, that how I would think about the guidance. You could look at our Q4 results and see that that's a good indicator that we're already kind of performing where we expect to see our financials throughout 2024. So like you said, we achieved the gross margin, and we're in the back in the high 30s. We think we can sustain that margin throughout 2024.
A lot of that improvement was driven by the price increases that we put through about a year ago and then the mix shift towards D2C. And then obviously, freight continues to be a nice tailwind for us. But now with the continued kind of higher mix of direct-to-consumer that we have planned for 2024, we'll kind of maintain that margin in the high 30s. And as Mike said, we're annualizing a lot of cost savings from the risk that we did in -- earlier in Q1 of 2023 and then in July of 2023. But there are some offsets to that. Part of growing that direct-to-consumer channel requires us to spend more marketing dollars to attract the fans to our site. So that's what you see going on in SG&A. But overall, when you look at the bottom line margin, it is improving. And I think that as we kind of round the corner past Q1, we start comping up later in the year, and then we're not providing guidance just yet for the years to come. But I think as we are able to grow that top line, again, you'll see really good flow-through to the bottom line.
Okay. And then just on the comment you made about the last 3 quarters of the year being up, what you say, low single digit, I think. Can you just clarify, do you mean cumulative the last 3 quarters all together, up low single digit or it starts being up low single digit in the second quarter.
Let me answer that. I think we said specifically, we expect to comp up later in the year. We are hopeful that we can comp up in each of those 3 quarters. Right now, though, we're watching that Red Sea situation very closely because it is impacting our transit times and some of the -- our ability to kind of recognize revenue in each quarter. So I didn't specifically say we comp up in every quarter, but we do think that throughout the year, we will be able to have easier comps compared to last year.
And part 2, just remember, Q1 of this year is comping against a pretty effective Q1 of last year, but not really, right? Because that Q1 had some leftover sales from Q4 that came through because inventory was delayed. And then that led to the inventory overstocking for the rest of the year. So it's just -- Q1 is just a tough comp.
Okay. And just to follow on your comment about the Red Sea. So I assume that's only affecting sales or shipments from Asia to Europe which really is not a huge part of your sales. So I guess I'm curious why that is such a major effect impact. And also, it seems like there would just be a delay, not that you're not getting the product from Asia to Europe. So can you give a little bit more color on that?
I think that's exactly right, Linda. We're saying that the Red Sea has more of an impact on Q1 specifically. We don't think it's going to be disruptive to our full year sales projection. So just based on those longer transit times, a little bit higher costs that we've seen come through and there -- it is -- you're right, primarily an EMEA impact, but there could be knock-on effects to the rest of the world. So again, we're just watching it very closely. What we know today is reflected in our guidance right now.
Okay. And sorry to keep going on. But I just -- I missed what you said about how much actual debt reduction was there in the first quarter related to that transaction?
So we haven't commented on the actual number. You'll see it in our Q1 results, but we paid down $26 million of debt in Q4, and we are continuing to pay down debt in Q1.
This concludes our Q&A. I will now hand back to the management team for final remarks.
Thank you, everyone, for joining us on the call today. As always, thanks to our fans, employees and partners for their support, and thank you to our investors and analysts for joining the call and listening in. We look forward to sharing our progress on our next call in 9 weeks. Goodbye, everyone.
Ladies and gentlemen, today's call has now concluded. We'd like to thank you for your participation. You may now disconnect your lines.