Funko, Inc. (FNKO) Q1 2020 Earnings Report, Transcript and Summary

Good afternoon. And welcome to Funko’s Conference Call to discuss Financial Results for the First Quarter of 2020. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. [Operator Instructions] Please be advised that reproduction of this call in whole or in part is not permitted without written authorization from the company. As a reminder, this call is being recorded. I will now turn the call over to Andrew Harless, Manager of Investor Relations to get started.

Thank you, and good afternoon. With us on the call today from management are Brian Mariotti, Chief Executive Officer; Andrew Perlmutter, President; and Jennifer Fall Jung, Chief Financial Officer. A press release covering the company’s first quarter 2020 financial results was issued this afternoon and is available on our Investor Relations website investor.funko.com. Before we begin, I need to remind you that management’s remarks on this call may contain forward-looking statements with the meaning of the Private Securities Litigation Reform Act of 1995. 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 three months ended March 31, 2020, 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. We will be referring to certain non-GAAP financial measures on today’s call such as EBITDA, adjusted EBITDA and adjusted EBITDA margin, which we believe may be important to investors to assess our operating performance. Reconciliation of non-GAAP financial measures to the most directly comparable GAAP financial measure are included in our earnings release. We have also prepared a visual presentation that investors can consult to follow along with this discussion and can be accessed at investor.funko.com. I will now turn the call over to Brian.

Good afternoon, everyone, and thank you for being on the call today. We hope you are all staying safe and healthy during this unprecedented time. Since our last call, only nine weeks ago, we have all had to adapt to a new way of life and Funko has pivoted accordingly. We are remaining nimble and acting swiftly to navigate the dynamic environment and best position Funko for both the remainder of 2020 and the long-term. Amongst our foremost priorities is the well-being of our employees, partners, and communities across the globe. We have implemented measures to safeguard the health of our employees, made strategic moves to mitigate business disruption and taken steps to strengthen our financial position. Let me provide a brief summary of the actions we have taken to date. We have closed all corporate offices, as well as our two flagship retail stores. We have implemented practices to safeguard workers at our distribution centers, including reduced staffing, staggered work schedules, heightened cleaning procedures and temperature screenings. We have intensified our focus on our e-commerce initiatives and increased the number of SKUs on our website. We have lowered expenses by implementing executive and senior level management salary reductions, furloughing a significant portion of our employees globally and cutting other areas of SG&A. We have reduced non-product development-related capital expenditures. We are proactively reducing incoming inventory to better align with the current demand we are seeing in the market, and most recently, we have secured an amendment to our credit facility, which provides us with covenant relief over the coming quarters, equally important we are actively exploring opportunities to further increase our flexibility and liquidity. Like many organizations out there, we have had to make some tough decisions in recent weeks. As a company, we are learning to do more with less and evaluating opportunities to eliminate redundancies and shift resources toward key growth priorities. We believe Funko will emerge from this crisis as a leaner and more efficient organization. Also, we believe we will be better positioned to reach our highly engaged and growing fan base with our broad array of product categories in a more cohesive way as we further align our operations and go-to-market strategy. Now I’d like to turn to the first quarter and how our business trends evolved as stay-at-home orders, business closures and social distancing guidelines took effect. Up until mid-March, we were tracking to meet our revenue expectations for the quarter and we were seeing solid consumer demand at retail. Additionally, we were optimistic about how our second quarter order book was filling up. However, in the final weeks of the quarter as non-essential retailers across the globe begin to close their doors and consumer demand shifted toward household essentials, orders started to get deferred and canceled and this has persisted into the second quarter. Additionally, some of our customers that remained open began to prioritize restocking essential goods and slowed replenishment orders. These trends developed more quickly in regions outside the U.S. especially Europe, which drove a significant decrease in our international business in March. Despite the topline pressures, we delivered strong gross margins and carefully managed operating expenses, which enabled us to preserve profitability in the quarter. Currently, we anticipate that Q2 is likely to be our most challenging quarter this year as we face the continued effects of COVID-19 around the world. Looking at our U.S. distribution channels, in the mass channel, we are seeing durable consumer demand and we anticipate we will see somewhat softer order volumes while customer capacity limits remain in place. We are continuing to gain traction in this important channel and expect to expand our shelf space by over 20% with one of our key mass market partners later this year. This will include an expanded product offering of accessories and soft line goods. In our specialty channel, most of our retailer doors remain closed. However, some are offering curbside pickup and continue to serve customers via their e-commerce sites, until stores reopen, we expect that shipments of our specialty customers will be limited. In our third-party e-commerce channel, we are seeing customers begin to restock non-essential items, resulting in improvements in order trends. In Europe, many of our key accounts remain closed or are operating at significantly reduced volumes. As a result, we have made the strategic decision in Europe to shift any new products that were planned to hit shelves in the second quarter into the third quarter to preserve demand for these new items. Therefore, we expect shipments in the region during Q2 will be minimal. Given all these puts and takes across the global retail landscape, we are anticipating a Q2 net sales decline of about 60% versus a year ago. That said, our relationships with our retail partners remained strong and we believe Funko will continue to be an important traffic driver in stores and online as the world emerges from the present situation. At the same time, Funko’s relationship with our consumers and fans continues to deepen as we add new categories, products and properties that they want to connect with. In the face of today’s challenging environment, we are focused on initiatives that will further strengthen our brand equity. We are encouraged to see some states beginning to ease stay-at-home restrictions and reopen stores this week. Recognizing this will be a gradual process, which we will likely see be somewhat uneven, we are optimistic that COVID impacts may begin to lessen in the second half of this year. Importantly, as retail customer and supply chain dynamics continue to evolve, we have begun acting quickly to mitigate inventory risk by working closely with our factories to reduce future purchase orders to align with demand trends. We have also shifted exclusive and mainline products to our retail customers that remain open and have decreased those offerings on Funko’s website. As we look at the new content slate for 2020, many studios have shifted movie release dates through the latter half of 2020 and into 2021. As a result, we have adjusted our manufacturing time line to match the new release schedules and for items that were already in production, we will be holding them at our factories and in our warehouses. While we do expect these movements to impact the timing of revenue, one of Funko’s key strengths is its ability to produce against evergreen properties, which we will continue to lean on. While we are confronting the challenges and mitigating the impacts of COVID, we remain committed that our key growth strategies which we believe are critical to our long-term health and value of our business. On our year-end conference call in March, we outlined four key strategies for 2020. Let me provide you with a brief update on each of these priorities. Our first strategy is continuing to expand our pop culture business. This includes building fun and nostalgic evergreen programs at retail, as well as expanding within the unpenetrated genres. In the first quarter, our evergreen properties made up 58% of our total sales compared to 45% in the same period last year. This was driven by solid execution against some of our mainstay properties such as Star Wars Classic, Harry Potter, DC Comics and Marvel. We also saw positive initial response to both new and expanded lines. Our new Marvel Venomized line propelled Maximum Venom in the number eight spot on our top 10 property list for Q1. Our expanded offering of Pokemon performed extremely well, making it our second largest property in the quarter and The Mandalorian was our third largest property driven by shipments of our first products of the child. We saw tremendous demand for these items, which included Pop!, Vinyl, t-shirts and accessories and we will be building on this in the coming quarters. Our second area of focus in 2020 is driving continued product diversification. We are launching new products and building on current platforms to create new revenue streams and expand our consumer base. In the first quarter, we saw positive initial response from both retailers and fans to our launch of Vinyl Soda!, which was our fourth largest figure line in the quarter. Also, our Loungefly brand continued to perform well, growing 4% compared to last year. As consumers shifted their purchases towards stay-at-home activities, we also saw a seasonally strong pickup in consumer demand for our Funkoverse board games. While the board game business is still nascent for Funko, we are excited about the opportunity in front of us. We are moving aggressively to launch our new games and toys into the market during the latter part of this year. We will be releasing dozens of new offerings from Funko Games, including new Funkoverse titles, as well as licensed and non-licensed board games. Late in the second quarter, we will be launching our first ever battle-inspired game that will be targeting a younger demographic and mixes cooperative game play in micro collectibles. Additionally, our new long licensed toy offerings, Snapsies, Boogey Monsters and Gashouse Gang are all expected to hit toy aisles in the second half of 2020. Our third area of strategic focus is international expansion. Most of our overseas markets have been hit hard by COVID and we expect to see greater impact on our business internationally than domestically. As I noted earlier, we are limiting the shipments of the new items in Europe in Q2 to preserve demand while our stores remain closed. However, we are encouraged to see that countries such as Spain and Germany are beginning to relax guidelines. We continue to believe that there is significant opportunity to expand internationally and as the global economy begins to reopen and recover, we will be focused on capturing more international business across Europe, Latin America and APAC. Our fourth area of focus, which we view as an increasing priority is expanding our e-commerce business. We are accelerating our plans and investment to build a robust online platform and enhance our digital capabilities. The size and scope of our e-commerce business is evolving as we focus on transitioning to a more powerful selling model and ensuring that we have the operational infrastructure to build scale as demand grows. In the first quarter, our e-commerce business grew more than 50% but represented only a small percentage of the overall business, reflecting the significant opportunity in front of us. In early summer, we plan to re-launch funko.com to provide our fans with a more expansive e-commerce experience. The refreshed site will allow consumers to shop across new fandom categories such as movie, anime, sports and music, as well as broader site catalog, which has grown significantly since January. Additionally, the site will feature a recommendation engine that showcases related products to increase depth of purchase. To help drive traffic, we will be offering special promotions to our fan club and app users and collaborating with our studio partners and influencer communities through social media and other digital campaigns. To ensure we have sufficient resources and capabilities to meet demand, we are converting existing warehouse space in the U.S., which will be dedicated to our direct-to-consumer business. Additionally, we are planning to accelerate the expansion of our e-commerce capabilities in Europe later this year. As we focus on leveraging the significant D2C opportunity in front of us, I am particularly excited to tell you about our new Chief Marketing Officer, Ginny McCormick. Ginny comes to Funko with 15-plus years of toy industry experience, substantial expertise as a global brand leader and two decades of digital transformation work. Ginny was most recently Head of Global Media for Hasbro and joined us in late March. We couldn’t be more thrilled to have Ginny onboard as we continue to strengthen the Funko brand, expand our reach of consumers and broaden our product offerings, while ensuring we are surprising and delighting our fans. We believe our initiatives to diversify Funko’s revenue streams, coupled with the strategic acquisitions we have made over the past three years will pay dividends over the long-term. We believe Funko’s competitive advantages will provide resiliency in a challenging macro environment, diversity of products, licenses, consumers and channels, as well as low price points, speed to market in connection to key secular trends. We believe in the rise in pop culture and fandom will endure as entertainment and content continues to become ingrained in everyday life and Funko will continue to create products that connect fans to the content they love. We are operating and planning our business conservatively, but we are remaining nimble and acting decisively to ensure that when the economy begins to reopen we are prepared to ramp up as quickly as needed. Before I turn the call over to Jen, I would like to offer a huge thanks to the entire Funko team as they have taken every challenge head on and adapted quickly over the past couple of months. We would not be in the position we are today without the tireless efforts of everyone in our organization. Also, we are grateful for the continued support of our partners and our shareholders as we navigate these dynamic times. And finally, a big shout out to our fans who continue to be the lifeblood of Funko. We will always be committed to our fans and connecting them to the properties they love. I will now turn the call over to Jen.

Thanks, Brian, and good afternoon, everyone. Before I review the first quarter financials, I will begin by outlining the steps we are taking to manage expense and preserve cash in response to the COVID crisis. In recent weeks, we have made a number of strategic decisions that enable us to increase flexibility, reduce costs, strengthen our financial position and improve overall liquidity. Most recently, we successfully amended our credit facilities to provide greater near-term flexibility, which most notably include the financial covenant waiver for Q2 and Q3 of this year. In recent weeks, we implemented cost-cutting initiatives across the business. We furloughed roughly 40% of our global workforce, executed 20% salary reductions for the executive team and other members of upper level management, reduced Board of Directors’ compensation by 20%, implemented a hiring freeze and deferred merit increases. Additionally, we significantly reduced expenses across several other buckets, including marketing, travel, professional fees and contract labor. As a result of these initiatives, we expect to capture approximately $15 million of SG&A savings in the second quarter of 2020. For perspective, Q2 SG&A dollars are now expected to be down moderately on a sequential basis from Q1. As we look at the second half of 2020, we are planning our business against multiple recovery scenarios and we will be managing our expense base with the goal of maintaining our new minimum liquidity covenant of $30 million. In addition to cost reductions, we have also taken several actions to preserve cash and increase liquidity. First, we drew down approximately $29 million under our revolver in late March to increase our cash on hand. At quarter end, we had approximately $46 million of availability under the revolver. Second, we reduced non-product development capital expenditures, cutting total CapEx spend by approximately one-third for the year. And third, we have been proactively managing working capital by reducing incoming inventory to align with anticipated demand. At the end of April, we had over $60 million of cash on hand and $46 million of availability under our revolver, resulting in over $106 million of liquidity. We believe the underlying strength of the business and our financial flexibility will enable us to navigate the impacts of COVID. That said, we believe it is prudent to explore opportunities to secure additional liquidity and we are continuing to evaluate options. Now turning to our first quarter financials, our topline results reflect a combination of tough comparisons to last year, as well as various impacts of COVID during the quarter, particularly the past two weeks to three weeks of March. As we previewed on our year-end earnings call, we experienced manufacturing disruptions and delayed shipments throughout the period. Additionally, we saw incremental pressure on our business in the final weeks of the quarter as retail store closures and social distancing measures took effect. First quarter net sales came in at $137 million, down 18%. As a reminder, we are comping against a number of high-performing properties in Q1 of 2019 including Fortnite, Avengers: Endgame, Captain Marvel, the final season of Game of Thrones and Toy Story 4. The number of active properties in Q1 increased 11% to 681 and the net sales per active property were $201,000, down 27% year-over-year. In the quarter, our top 10 performing properties were, Star Wars Classic, Pokemon, Mandalorian, Avengers: Endgame, Harry Potter, Naruto, DC Comics, Maximum Venom, Dragon Ball Z and Fortnite. We continue to see underlying strength in the evergreen category, including diversity of products and number of properties. As a percentage of our total mix, evergreen properties accounted for 58% of net sales, which increased 13% compared to last year. Some of our stronger-performing evergreen programs in the quarter included Harry Potter, Star Wars Classic, Pokemon, Maximum Venom and DC Comics. In the first quarter, net sales in the U.S. decreased 10%, while international sales decreased 34%, reflecting the negative effect of COVID on overseas markets, particularly Europe within the quarter. On a product category basis, Q1 net sales of figures were down 18% to $111 million, while other sales decreased 18% to $25 million. Sales of our Pop! branded products were down 16% in the quarter and Loungefly was up 4%. The first quarter gross margin came in at over 40%, up 240 basis points versus a year ago. The increase in gross margin is a result of improved product margins and enhanced inventory management processes implemented in the latter half of 2019. The strength of product margins in the quarter was driven by higher average selling prices driven by a mix shift towards D2C sales, as well as higher margins on our Loungefly products and sales to our European customers. We expect gross margins to remain strong in 2020, but also anticipate there will be puts and takes throughout the year due to a variety of factors, such as lower sales and volumes, changes in purchase orders, the focus on our e-commerce business and our launch of higher margin games and non-license toys later this year. Selling, general and administrative expenses increased to $47 million, primarily reflecting an increase in headcount, rent and facility costs, as well as professional fees. We anticipated SG&A deleverage as a percentage of sales coming in at 34.6% versus 24.2% a year ago. From an earnings perspective, adjusted EBITDA came in at $11 million, and adjusted EBITDA margin was 8%. While net sales were pressured by tough comparisons to last year and the impact of COVID, gross margins remained strong and we carefully managed expenses throughout the quarter. Turning now to the balance sheet and cash flow, we ended the first quarter with cash and cash equivalents of $55 million and total debt of $243 million. Inventory totaled $53 million, down 30% versus a year ago and 14% from year-end. We generated cash flow from operations of $37 million and capital expenditures totaled approximately $5 million. As I mentioned earlier, our liquidity as of April 30 was over $106 million. As Brian discussed, we currently expect the second quarter will be our most challenging quarter in 2020, as many of our retailer stores remain closed, and consumers adhere to stay-at-home orders and social distancing guidelines. We also anticipate there will continue to be heightened pressure within international markets. While we are beginning to see some states reopen this week, in light of ongoing uncertainty both here and abroad, we are not providing full year outlook at this time. We appreciate your time this afternoon. Now Brian, Andrew and I will be glad to take your questions.

[Operator Instructions] Your first question comes from the line of Erinn Murphy with Piper Sandler. Erinn, your line is open.

Hey. My first question is really just to dig into the international business a little bit more, could you just maybe share how it progressed throughout the quarter, so starting in January, February, March? And then as you think about Q2, you obviously referenced Europe you are going to have a minimal shipping, but curious on if you could just share what you are seeing in APAC, Canada, any other kind of big regions for you?

Yeah. Erinn, I can start…

Yeah. Hey, Erinn.

Yeah. Go ahead.

Go ahead, Brian.

I can go and start. Erinn, I think, that, obviously, like, we said, at the beginning of the call, we were doing really good globally first and second quarter or the first and second month of the quarter and then halfway obviously through March when COVID really hit. So I would tell you that strategically everything was going as planned. Our initiatives were making sense on a global basis and then, obviously, the wall -- the rug came right out from everybody’s feet. So I think what we are seeing now in international is just the beginnings of some of these countries beginning to open up doors. They were down considerably. Almost everybody in Europe was shuttered and -- but we are seeing, over the last two weeks, three weeks, the beginnings of people getting back on track, but we are taking definitely a conservative approach on the rest of the world. I think EMEA is very similar to Southeast Asia and Latin America in the same regard as -- of the way we are viewing our international business. I mean, we are going to be very conservative coming out of this. And -- but we also believe that the demand for our products is higher than ever, I mean, the fact that we are up at one of our biggest retail partners in the mass channel year-over-year is staggering, considering what the world is going through right now. So we believe when the world returns to some semblance of normality, we are going to pick up right where we left off but we will come out of it a leaner organization, and hopefully, a more profitable organization.

Yeah. helpful. And then -- yeah. Go ahead.

I was just going to say, you could think about really LatAm and Canada operating more like the U.S. where you saw Europe and Australia …

Okay.

…have -- and Asia have directionally the same growth over the quarter.

Okay. And then, I guess, just on -- maybe, Brian, this is a good question for you on your factory partners, you referenced, obviously, having to cancel some orders, which makes sense. But you are a big piece of a lot of the factories that you work with, so I am just curious how your partners feel about it, how are you kind of partnering together in what’s clearly a very challenging time?

Yeah. That’s a great question. It’s tough. I mean, you don’t want to be myopic and distinct that this just affects us, right? I mean, we look at it as let’s make sure that our employees are healthy, first and foremost and that’s always the most important. And the same thing applies to our manufacturing partners. I mean, I have been -- I know some of these families that own some of these factories going on 16 years now. And this is tough. It was tough for them in China when they first got roll and they were -- COVID hadn’t hit in the U.S. yet and they were struggling, and they were having problems getting people back and we try to be supportive there and then all of a sudden, when they got back up and running, it hit here. And luckily, the move to Vietnam has certainly helped throughout in terms of capacity. It’s helped in terms of cost of goods stability, quicker manufacturing. But we are just trying to make sure that we are cognizant of their businesses. I think they understand in this unprecedented time, the flexibility is the key. It’s just constant communication. They have been very understanding in the fact that we have reduced some of the order quantities, we have delayed some things and they know that they have to be nimble for us to get through this situation unscathed and if they can support us, then we will support them as we pull through this. And I think it’s been amazing that our teams have launched these great relationships with these factories and this is part of our success coming out of this. I think that no one is excited about what’s happening and this is -- but this could be a lot worse for us and I think we are coming through this pretty well, and I think when -- again, when this thing is over, we are going to get back to being the great company that we were before.

Okay. And then just last question, maybe for Jen. Inventory, can you just talk about how you see the cadence of it throughout the year, when do you expect it to peak, and yeah, I guess, I will pause there. Thank you.

Yes. Great question. So as we started to realize the impact of some of our specialty retailers and their doors closing, we quickly got on our inventory and started working to make sure that we aligned it with where we anticipate currently the year to come in. So we -- through Q2, we were able to impact our June receipts, cutting back a lot of replenishment. We also took the approach of looking at content and what was being pushed the following year and making sure that we aligned our inventory and production of that to align with when the content was coming out. So we have approached it two ways. One, just making sure that we are aligned with our sales. Two, aligning the content with when it’s coming out. As you see -- what we have done so far, though, is like I said, we have cut back our receipts in June and then we took more aggressive approaches for Q3 and Q4 to make sure that we don’t get ahead of ourselves. If we start to see things rebounding, we feel very confident in our ability to chase to get more inventory back into the system.

Yeah. Erinn, I think, Jen, brings up a great point. Our ability to chase and that goes to relationships with the factory. We are going to make mistakes underproducing and chasing than we will overproducing and I think that is where our relationships over the years are going to allow us to quickly replenish if we have to and not lose that overall revenue uplift without the risk having the inventory in hand.

Great. Thank you and all the best.

Your next question comes from the line of Stephanie Wissink with Jefferies. Stephanie, your line is open.

Thank you. Good afternoon, everyone. Just a quick follow-up on Erinn’s question on inventory, I am wondering if you can talk a little bit more about the flow of goods to your retailers and how the inventory position is at retail. How should we think about any sort of order risk as we move through the next couple of quarters based on the inventory already in channel?

Yeah. Andrew, why don’t you start with that, the first part of that?

Okay. Great. Yeah. So I will say that as the onset of the COVID effects took a hold of retail, we were pretty aggressive with our retail partners to ensure that, we weren’t sort of like hoping for the best. We were having a very real conversation with them about what they needed, when they thought they were going to need it, were they going to close down, where their warehouse is going to be, running partial crews because they were just doing e-commerce and no stores. And we quickly saw that the store closures were escalating and we took aggressive actions to either stop producing products for them during that time window or if the product was already here or on its way, reallocating it to other retailers who were open for business. So I would say that a lot of our retailers have continued to ship their dotcoms, which has been very successful for most of our mid-tier specialty customers. We have seen a lot of traction more so than we probably would have expected during this time, so they were able to move a lot of the inventory they had coming in for stores. Do -- we have gotten the question, do we think that the inventory is going to be stale when they open their stores back in a couple of months and we think the answer to that is no. And there’s two reasons why. One, I will remind you that 58% of the inventory that we shipped into the channel in Q1 is what we consider evergreen. Those were evergreen products. So that is a product that’s not tied to any specific movie or TV show release or anniversary. That’s an evergreen, sells every single day, item, so that’s 58% of the inventory. That’s part of it. And the other part of it is, the truth is that we don’t believe the stores have been closed long enough to cause our products to get stale. If the stores didn’t open until August, maybe that would be a different conversation, but we see the majority of our stores starting to open right now and we think that barring some states that really push the open date beyond, we think that the majority of them will be opened up by June.

Okay. Great. And then one for you, Jen, really quickly, just on your comments on SG&A. I think you mentioned $15 million of savings down quarter-on-quarter. How should we think about the permanence of some of those savings versus just the transitory nature of the situation we are in and investing back into some of those areas in the back half or in the following year once the business starts to recover?

Yeah. Thanks. So in terms of SG&A, how we are really thinking about it is, we are managing to multiple scenarios, of course, we think we have a good forecast in terms of how we are going to project the year. But that being said, we all know there’s many different permutations that can come from what we are currently experiencing. I would say one thing we have learned from this is our ability to do more with less and so as we continue to progress through the year we will definitely become a more efficient and slimmer organization per Brian’s comments. Some of the other areas in terms of investment, whether it be marketing or other areas of SG&A, those will all be determined upon how fastly or how quickly the business ramps back up. Right now we are just making sure that we are being as responsible as possible given the fluidity of the situation. So we have great plans to currently come out the other side of this for 2020, but obviously, as the scenarios change we will adjust accordingly.

Thank you.

Your next question comes from the line of Michael Ng with Goldman Sachs. Michael, your line is open.

Great. Thank you very much for the question. I just had a follow-up on the second quarter sales outlook, was the shifting of products from 2Q to 3Q just for Europe or is that something you are doing globally? And could you just help us think about what the geographic breakdown of that 60% decline could look like, is it largely concentrated in international and less so domestically or will both geographies see similar declines? Thanks.

Jen, do you want to start with the first part?

Sure. Yeah. So as we look at Q2 and keeping in mind we are into May now and most of Europe has been closed down for the quarter. We don’t anticipate -- we specifically made the decision to shift the goods into Q3. So we do expect to see some really tough business for our European business going forward for the quarter. That being said, our specialty retailers have been closed, it will be about two months of the quarter as well here in the U.S. So both channels we are seeing some challenges on the topline, but definitely we see a little bit more challenge within the European business.

Great. And just as a quick follow-up, could you provide any help around how we should think about operating cash flows for the year or maybe the quarter? Thank you.

Yeah. We feel really confident about where we are from a liquidity standpoint. We don’t typically give out what our cash flow forecast is on a quarterly basis. But we are managing to multiple scenarios. As I mentioned earlier, if we see continued pressure versus where we are today, I would say, at this point, it looks as though retailer stores are starting to open back up. If we see a relapse or something else happen within the economy, we are prepared to take additional adjustments to continue to preserve cash and maintain our liquidity.

Great. Thank you so much.

Your next question comes from the line of Alex Perry with Bank of America. Alex, your line is open.

Thanks for taking my question and I hope everyone is doing well. I guess, first, maybe for Brian, a little higher level. Can you talk about how you would expect the business to perform in a more recessionary consumer environment and any historical perspective you could provide?

Yeah. Alex, great question. Look, I would only tell you I have been doing this 16 years with Funko and we have grown every year. So this -- it took a global pandemic for Funko not to grow. So I am going to say that we have done a great job as a company year-after-year and that means there were some tight economic times in 2008, ‘09, 10. But we look at our products as impulse. The average price of our products is about $8 and it’s tied to things that mean a lot to people. So maybe someone isn’t going to be rushing back to the movie theaters anytime soon because they just don’t want to deal with the drama or the headache or the potential danger of going to a theater. But they watch something on demand, they watch something on Netflix and we offer them an opportunity to tie to things that are really important that are life, the pop culture moments, the sports moments, the music moments, the video game moments for not a lot of money and we have proven through 16 straight years of growth that we can handle bad economic times and still grow as a company. But it did take a global pandemic for us to break our streak this year. But we like where we are at. We like the fact that we have a varied sense of products that reach a ton of different people on a global basis for not a lot of money and these things bring joy in times that -- where things are tough. And I see this through the continued demand and support of our products being purchased as we go through this global pandemic and the reaching out of our customers and the engagement of our fan base while this is going on. They still love pop culture more than ever and this is probably the most unprecedented time of people consuming pop culture as everybody’s binge watching show after show and downloading movie after movie and there’s going to be a heavy appetite for our products coming out of this, we are certain of that.

That’s really helpful. And I guess just my second one, can you talk a little more about how the content slate for 2020 has evolved versus your original expectations maybe nine weeks ago when we heard from you last? Thanks.

Yeah. Look, it shifted, and I will tell you, thank goodness, some studios made some really quick decisions on Black Widow, Wonder Woman 1984 and some other Minions movies where they pushed some of the bigger initiatives that we had planned back into the second half of this year when hopefully the world remains a little bit more, I guess, back to normal hopefully and into ‘21. So I will tell you that as we continue to see each and every week, just a little bit, glimmers of hope that volume is coming and doors are back opening again. We are going to see a stronger second half content slate than pre-COVID would have indicated. And then we are going to see some of those shifts from 2020 to 2021 are going to tack on to an already A plus content year, and we are already looking at 2022believe it or not, that was already a pretty strong year and now some of the stuff that’s been shifted from ‘21 to ‘22 is going to make that a stronger year. So we really like our position coming out of this. Once -- again, once this thing hopefully goes away, we are 100% convinced that this business is going to go back to thriving and the people’s love of pop culture and entertainment is only going to be heightened from all the time they have had to consume it. And the content slate looks better now pre-COVID in the second half of the year and in ‘21 and ‘22 than we originally thought.

Thank you. That’s very helpful. Best of luck going forward.

Thank you.

Thanks.

[Operator Instructions] Your next question comes from the line of Tami Zakaria with JP Morgan. Tami, your line is open.

Hi. Thanks for taking my question. So I wanted to understand the gross margin performance in the quarter better. Did the inventory write-down you took in the fourth quarter benefit you in the first quarter and how are you thinking about gross margin in the second quarter and should we expect it to leverage similarly versus the first quarter?

Great. Thanks, Tami. So essentially what you saw in the first quarter was two things come to light. As we shifted our channel mix to be more heavily D2C-oriented, as well as we did see strong growth in some of our higher margin categories like games, we did see a benefit from the sales mix shift in the quarter. So that accounted for roughly about half of the improvement. And I would say the other half is really through a lot of our inventory management practices that we have been putting into place at the end of last year to where we have just been a little bit tighter on inventory as we move through the course of the year and so that’s what you are really seeing there. As we look forward to gross margin, we do think we will have a strong gross margin throughout the year. That being said, there will be puts and takes in each of the quarters as different things impact the business, whether it be a sales mix shift from one product category to the next or whether there’s unforeseen circumstances accompanying the COVID crisis that we have to take other actions. So that’s currently how we are thinking about gross margin on the year.

Got it. That’s really helpful. And very quickly, can you comment on the margin difference between your D2C sales versus retail partner sales?

Yeah. We don’t typically break those out. But if you think about it, we are getting -- on our own e-commerce website we are getting full retail for those goods, where we sell them wholesale to our retailers where they get the retail price. So, obviously, there is a difference there, but we don’t typically break that out. And you also have to keep in mind, our own e-commerce D2C growing very rapidly, it’s still a small piece of our business.

Got it. Thank you so much.

Absolutely.

Your final question comes from the line of Gerrick Johnson with BMO Capital Markets. Gerrick, your line is open.

Hi. Good afternoon. So a lot of your customers, I don’t know if it’s a lot, I really don’t know how many of your customers are small business owners, but I am assuming there are quite a few hobby shops, local toy stores and so forth. Maybe you could tell us how big of a percent of your total sales that might be and I assume some of these guys are under some stress, so just curious as to your exposure to that channel? Thank you.

Yeah. Gerrick, god question. Look, obviously, what makes us unique is that we do reach so many doors, right, on a global basis and a lot of that does come from smaller customers. Thank goodness a lot of those customers do have websites. They do have online sales. Some of them are now going into curbside drop-off products. But for every small customer that maybe doesn’t make it through this, the idea that where Funko averages 13%, 14%, 15% total business in the mass channel is how we combat that. And I think that there’s so much room and white space for us to grow with Walmart, Target and Amazon, and we have purposely kept that artificially low. So not everybody is going to make it out of this pandemic and we understand that. But for us to be even pre-COVID to be up with Walmart is dramatically as we are with less content year-over-year compared to what we would Marvel Avengers: Endgame and Captain Marvel and Spider-Man and all the -- Game of Thrones content and all the stuff that was happening in ‘19to have lesser content but to actually grow that business through this pandemic is obviously very encouraging for us. So, yeah, you are right, not everybody that we sell to all these stores will probably make it through, Gerrick. But there’s so much room to make that business up and then some by putting a little bit more emphasis on some of the bigger channels that we support.

Okay. Great. And all the new products that you wanted to ship for the fall, particularly in your games segment, everything there is on track?

Yeah. Absolutely. All the game and toy initiatives will still be executed in the second half of the year, but, yes, absolutely.

Okay. Great. Thank you.

Thanks, Gerrick.

Ladies and gentlemen, this concludes today’s conference call. On behalf of Funko thank you for participating. You may now disconnect.