Participants

Robert Jaffe; Director, Investor Relations; Funko Inc

Michael Lunsford; Interim Chief Executive Officer, Director; Funko Inc

Yves Lependeven; Acting Chief Financial Officer; Funko Inc

Cynthia Williams; Chief Executive Officer; Funko Inc

Eric Wold; Analyst; B. Riley Securities

Stephen Laszczyk; Analyst; Goldman Sachs

Linda Bolton Weiser; Analyst; D.A. Davidson & Co

Presentation

Operator

Good afternoon, and welcome to Funko's 2024 first-quarter financial results conference call. (Operator Instructions) As a reminder, this call is being recorded. I would now turn the call over to Funko's Director of Investor Relations, Rob Jaffe. Please proceed.

Robert Jaffe

Hello, everyone, and thank you for joining us today to discuss Funko's 2024 first-quarter financial results. On the call today are Michael Lunsford, our Interim Chief Executive Officer; Yves LePendeven, our acting CFO; and Cynthia Williams, our newly appointed CEO.
This call is being broadcast live at investor.funko.com. A playback will be available for at least one 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 US 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 2024 first-quarter 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 company's earnings press release issued earlier today.
I will now turn the call over to Mike Lunsford. Mike?

Michael Lunsford

Thanks, Rob, and good afternoon, everyone. I'll begin with the announcement made earlier today that our Board of Directors has appointed Cynthia Williams as Funko's next CEO. Cynthia's experience across the consumer products, gaming and e-commerce industries, combined with the growth she spearheaded while at Hasbro, Microsoft, and Amazon made her the clear choice to be our next CEO. We welcome Cynthia to the Funko family. I can tell you Cynthia is eager to get started, and I'm pretty eager for it to get started. She is here with us today and will make a few introductory comments a little later in our presentation.
Turning to our financial performance, we reported a solid overall first quarter. Net sales of almost $216 million were within our guidance range, albeit at the lower end. Sales of some lower-margin products shifted to Q2 from Q1. Otherwise, our net sales for the quarter would have been close to the midpoint of our expectations.
Gross margin of 40% and adjusted EBITDA of $10 million were both well above our expectations. One key driver for the increased gross margin was higher than expected margins on sales in the value channel which is the result of the processes we put in place to improve inventory management. Another key driver was lower than anticipated freight costs.
Operationally, we continued to make progress reducing our inventory levels and paying down debt. At the end of Q1, inventory was $112 million, down from $119 million at December 31, 2023, and total debt was down $27 million. This is on top of the progress we made last year, reducing inventory levels by more than half.
What a difference a year makes. Since Q1 of 2023, we've made tremendous progress reducing inventory levels, lowering fulfillment costs, and improving service levels. And just last month, almost two years to the day of opening our new warehouse in Arizona, we hit the milestone of over $100 million units shipped.
Turning now to our outlook. We are reiterating our full year 2024 guidance. As expected, a lack of new entertainment content, primarily due to the recent Hollywood strikes, impacted our Q1 top line. We expect the content schedule remaining soft into Q2 and then strengthening in the second half of the year.
With regard to freight, our original forecast assumed a substantial increase in shipping costs due to conflicts in the Red Sea. Freight costs in Q1 were lower than we anticipated and have stabilized. Nonetheless, our logistics team continues to look for ways to manage and mitigate fluctuations in these costs.
Turning briefly to a couple of recent product highlights and how they relate to our growth plan. With regard to focusing on our fans and unmatched brand, on our last call, we spotlighted our pre-sale capabilities with the limited edition, Jason Kelce Pop! figure.
Building on that success, we recently launched several exciting collaborations, including the DunKings and Project Fred, Big Boy, Coke, and Sprite campaigns. And earlier today, we launched our first edition of the Jumbo Chan line. This new collectible line initially features our nostalgic and iconic Freddy Funko in a new anime stylization. All of these exclusive drops of premium priced, limited edition, collectible items have all sold out and have been creating brand heat with our core customers.
To focus on fewer products done extremely well, we are emphasizing evergreen and replenishment sales of Bitty Pop! to drive SKU efficiencies and produce characters that consistently resonate with customers. And Pop! Yourself as a great example of investing in areas we have better control over and expect to be able to measure and grow profitably.
We continue to add options and accessories to our Pop! Yourself line. In Q1, Pop! Yourself sold especially well as a Valentine's Day gift and the team is gearing up for the upcoming Mother's Day and Father's Day holidays.
In April, we launched a Pop! Yourself 2-pack, strategically in time for the upcoming wedding season. Since launch, 2-packs have generated more revenue than the singles. What we thought was going to be a nice addition to the line has performed well above our expectations. And as a sign of the product's growing consumer awareness, Pop! Yourself was featured in a New York Times round up of best wedding gifts.
In combination, these highlights demonstrate how we keep the flywheel turning, where each action we take builds on the previous one, propelling positive momentum.
With that, I'll now turn it over to Yves to take you through the financials. Yves?

Yves Lependeven

Thanks, Mike. Hey, everyone. Thanks for joining us today. For the first quarter, total net sales were $215.7 million. Direct-to-consumer sales mix in Q1 was 23% of our gross sales, up from 19% in last year's Q1. This represents 5% direct-to-consumer sales growth, which we achieved despite a lack of new entertainment releases due primarily to the Hollywood strikes.
As we said previously, a key element of our strategy is to continue to grow our direct-to-consumer business, which in turn helps our gross margin. Gross profit was $86.3 million and gross margin was 40%, which was well above our guidance and significantly higher than our gross margin in any quarter in 2023.
SG&A expenses of 85.6 million included nonrecurring charges of $5.1 million, primarily related to severance and non-cash charges associated with exiting certain business lines. Adjusted net loss was $9.2 million or $0.17 per share which was better than our guidance range for the quarter. And finally, adjusted EBITDA was 9.6 million, which was well above our guidance range.
Turning to our balance sheet. At March 31, we had cash and cash equivalents of 26.1 million, which is after we paid down 27.4 million of debt in the first quarter. Our total debt was approximately $246.4 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. Total company liquidity was $69.1 million, and inventory was $112.3 million, which was down from a $119.2 million at December 31, 2023.
Turning to our outlook. We are reiterating our 2024 full year expectations, which are net sales of between 1.047 billion and $1.103 billion; and adjusted EBITDA of between $65 million and $85 million. For the 2024 second quarter, our guidance is as follows: net sales of between $225 million and $240 million; gross margin of approximately 38% to 40%, SG&A expense of $80 million to $85 million; adjusted net loss between $8 million or $0.15 per share and $4 million or $0.08 per share.
Finally, we expect adjusted EBITDA of between $9 million and $15 million. We expect our financial results to be stronger in the second half of 2024 than in the first half due to the natural seasonality of our business, as well as an expected easing of the impact of the Hollywood strikes.
Mike, that's it for our financial results. Back over to you.

Michael Lunsford

Thanks, Yves. In summary, we reported a solid overall financial performance in Q1. We continued to make progress reducing our inventory levels and paying down debt. Our outlook for 2024 reflects a renewed focus on our core business, especially those areas we have greater control over and believe we can grow profitably. And we announced our new CEO, Cynthia Williams who is expected to start on May 20.
With that, and before we open up the call for questions, I'll turn the call over to Cynthia who has comments she'd like to share. Cynthia?

Cynthia Williams

Thanks, Mike, and hi, everyone. I'm Cynthia Williams. And as you know, I'll be taking over as Funko's permanent CEO later this month. I thought it would be helpful to introduce myself before I began immersing myself in the company and my new role.
I'd like to start by saying I am incredibly excited about joining Funko. From my perspective, the company has lots of potential. Funko has a long history and is a leader in the collectibles space, has several global brands, innovative and unique products, and a passionate and loyal customer base system.
But the most exciting to me are the multiple opportunities for substantial growth, especially in the areas Mike discussed, anime, music, and sports, as well as the company's direct-to-consumer channel and international growth.
I believe Mike and the team have done an excellent job of refocusing the company on its core assets, reducing cost, improving the profitability, and creating a solid foundation upon which we can scale the company in a profitable way.
As you probably saw in the press release, I have a deep background with consumer products, gaming, and e-commerce, as well as extensive experience growing brands to a global consumer base. Having worked in adjacent industries and having had previous dealings with some of Funko's key customers and strategic licensing partners, I am ready to hit the ground running.
My first priority will be to get to know the management team and the employees at our various locations and do a deep dive to learn more about Funko's capabilities. In short order, I also intend to meet with our strategic partners and key customers.
With that brief introduction, we'll open the call for questions. Operator?

Question and Answer Session

Operator

(Operator Instructions) Eric Wold, B. Riley.

Eric Wold

Thanks. Good afternoon and I'm glad to be on the call. It's my first time here and welcome, Cynthia. I guess a couple of questions for me. I guess, one, you talked to the main drivers behind the stronger gross margin in Q1 and the guidance for Q2 of 38% to 40%. I guess what are the main variables that would take you to the 38% or the 40% within that range? And given what you see in Q1 and expect for Q2, should we think of these -- this gross margin in the high 30% to 40% kind of a new baseline going forward?

Yves Lependeven

Hey. Eric. This is Yves. Thanks for the question and good to have you on the call. Yeah, I guess I could speak to that first again reiterating why our margin was 40%. Our gross margin was 40% in Q1, so we did benefit from a few things. Freight costs were lower than we initially expected, direct-to-consumer mix was 23% of sales, and we did benefit from having a much cleaner inventory position than we've had in the past year. So all of those were the drivers.
And then when you think about Q2, we feel good about maintaining direct-to-consumer at around that 20% to 25% of our sales mix, which will help our gross margin. The freight costs we anticipate will remain pretty stable.
I think that the main difference between a 38% and 40% gross margin would be timing of shipments to our wholesale customers. As you know we have a wide variety of products and customers and so sales mix can have a little bit of impact on gross margin, but we feel pretty, pretty good about that range right now.

Eric Wold

Perfect and the second question obviously -- sorry.

Michael Lunsford

Sorry, Eric. I think the second part of your question was -- this is Mike, was that, is this the new normal, this 40 -- 38% to 40% the new normal. I don't know that we're willing to commit to that yet, but certainly seems that we've gotten to a point where that is something you could perhaps build your models around.

Eric Wold

Perfect. And then last question. Yves, you're expanding that the Pop! Yourself and promoting around a variety different events and holidays. Any early read that you want to share on the percentage of customers coming to your website to order a Pop! Yourself, but have never ordered on your site before and if you're seeing any trends of them returning at later dates purchases outside the Pop! Yourself realm?

Yves Lependeven

Without getting into specific numbers and even by we'll know more what we've shared and what we can share, I would say that the percentage of people who are coming in to buy Pop! Yourself are very high percentage, are first-time customers.
And that is great news for us and something that we're trying to leverage every chance we get. We're not far enough along yet, to tell you what the follow-up purchase is from that group. It is not as high as our main core customers -- or main products customers coming in now, but we see a pathway forward to get there. I think in the next six months that's something that we'll have more insight into and can share.

Michael Lunsford

Yeah, the only color I would add to that would be that -- keep in mind, we really have just launched Pop! Yourself online last August and we had a -- we're really pleased with how it did over the holiday period and we're trying to now make it a year-round business, right? So we're capitalizing on other holidays such as Valentine's Day, and Mother's Day, and Father's Day.
And as we're going through that process, we're learning a lot about these new customers that are coming to our site. And in some cases, it's right. It's a different shopper coming in for a Father's Day gift than the person coming in for the Mother's Day gift. So we're still learning, but it's early days with this product line and we see a lot of upside potential.

Eric Wold

Perfect. Thank you, both.

Michael Lunsford

Thanks Eric.

Yves Lependeven

Thanks, Eric.

Operator

Stephen Laszczyk, Goldman Sachs.

Stephen Laszczyk

Hey. Great. Thanks for the questions, and welcome, Cynthia. But maybe first on US versus international growth, I think there's about 10 percentage points of delta in the first quarter with US underperforming Europe. I'm just curious, if you could talk a little bit more about the dynamics at play there and how you expect the US versus European growth to trend throughout the year?
And then secondly, on product innovation, I was wondering if you could talk a little bit more about the product and innovation slate, as you look into the back half of the year? I know the film slates ramping up home and it sounds like there might be some opportunity there. Just curious if you could expand on that. Thank you.

Yves Lependeven

Sure. Hey, Stephen. And I'll take the first part of that question and I think probably Mike will want to speak to the product innovation. But you're right, a pretty, pretty big delta between the growth rates in the United States and Europe. But just keep in mind, I think in the European market, we've had a much more stable business over the past couple of years.
And we have had a lot of success with really building an evergreen program there. So I would say that the main difference there in Q1 was that in the US, we were a little bit more impacted by the Hollywood strikes and the content slate whereas in Europe, they have a much more on a higher portion of their business is related to evergreen sales, which weren't quite as impacted.
Mike, do you want to take the product innovation?

Michael Lunsford

I will. Hey, Stephen. Nice talking to you. I would say second half innovation you won't -- there are any surprises there. It's stuff that we've been working on for the last year and I've talked about pretty constantly at this point. But I think as Cynthia comes in, and we look at a longer-term plan, there are opportunities to innovate in new areas. But for now, what you'll see from us is more Pop! Yourself, more Bitty. We're making good progress with Mondo.
We've started launching the limited editions which I talked about in the call, and we have a whole slate of those for the second half of the year. And then Loungefly and Core will continue to innovate on form factors and on content. But there won't be anything that shouldn't --really just, oh my God, they've come up with something new in the next six months not a new form factor, et cetera. We are very excited for a few movies this summer including Deadpool, which we think will have some interesting stuff around.

Stephen Laszczyk

Great. Thank you, guys.

Michael Lunsford

Thank you.

Operator

Linda Bolton Weiser, D.A. Davidson & Company.

Linda Bolton Weiser

Yes. Hello. Thank you and welcome to Cynthia. So I have a question about the SG&A level guidance for second quarter. That figure of $80 million to $85 million. I think it still seems elevated versus the run rate SG&A level prior to when you had the operational difficulties. So I'm wondering you've made headcount reductions, you've done streamlining, et cetera. What is still elevating that level of SG&A?

Michael Lunsford

Well I'd say -- Linda, thanks for the question. So first on SG&A, one of the big differences you have to keep in mind from -- compared to the past few years is that we're really growing that direct-to-consumer business which has the benefit of having a higher gross margin.
But it also has more variable SG&A including marketing costs especially as we're trying to grow and build brand new product lines like Pop! Yourself and attracting those new customers to our website. So that's one key difference.
The other thing I'd say is that, of course, SG&A as a percent of sales in a quarter like Q1 where we had a lower content slate, and so forth, that's obviously not where we want to be in the long run. As you look at our guidance for Q2 and then think about the back half of the year as sales are going to ramp up sequentially, we'll absolutely bring that SG&A as a percentage of sales down quite a bit.

Linda Bolton Weiser

Okay. Thank you. And then I'm just curious about how things stand with the big national retailer. Are you just is the status quo in terms of where you're at now, or are there going to be some initiatives to try to gain shelf space? Or what do you -- what are you thinking right now about that whole channel?

Michael Lunsford

Well, I think that Bitty Pop! is the place right now where we're making more inroads with mass and value than with any of our other products. We're seeing significant pickup by the two large brick-and-mortar mass retailers there and we'll continue to see that. And the good news there is that that's not in our usual shelf space. That's front-of-store, that's impulse that'll eventually be in (technical difficulty) toy we think. So that's a big pickup for us in the long term.

Linda Bolton Weiser

Okay. And then I guess in terms of -- I don't know if Cynthia -- is she answering questions? If so, I'd be curious to know what her initial first impressions are about the company, the culture, and personnel? Like is she feeling that there needs to be a Chief Operating Officer or is there anything she can say about both those topics?

Cynthia Williams

Hi, Linda. Nice to meet you. This is Cynthia. I have had -- most of my interaction at this point has been with the Board of Directors. I've had an initial social conversation with my executive leadership team. So I'll be spending the first 30 days going really deep getting to know the people and the business. And then over the next 60 days focused on any impacts we need to do to the strategy and the plan. And but my first impressions are incredibly positive.

Linda Bolton Weiser

And are you relocating to the Pacific Northwest?

Cynthia Williams

Actually I've been in the Pacific Northwest for about 17 years since I started at Amazon in 2007. And so fortunately, I don't even need to relocate now. I'll be in the Everett headquarters.

Linda Bolton Weiser

Oh wow, great. Sounds good. Thank you.

Operator

Thank you. And we have no further questions in the queue at this time. So I'd like to hand back to the management team for any closing remarks.

Michael Lunsford

Thank you, operator. Thank you, everyone, for joining us on the call today. As always thanks to our fans, employees, and partners for their support. This will be my last earnings call. Cynthia will be taking over and sharing our progress on our next call. I have enjoyed working with you, our analysts and investors, and assure you, I am leaving you in better hands than my own. Goodbye, everybody.

Operator

This concludes today's call. Thank you all for joining. You may now disconnect your lines.