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Funko Inc (NASDAQ:FNKO)
Q4 2018 Earnings Conference Call
February 28, 2019, 4:30 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good afternoon and welcome to Funko's conference call to discuss financial results for the fourth quarter 2018. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session and instructions will follow at that time.

Please be advised that the reproduction of this call in whole or in part is not permitted without written authorization from the company. As a reminder, this call is being recorded. On the call today from management are Brian Mariotti, Chief Executive Officer, Andrew Perlmutter, President, and Russell Nickel, Chief Financial Officer.

I will now turn the call over to Mr. Nickel to get things started. Please go ahead, sir.

Russell Nickel -- Chief Financial Officer

Thank you and good afternoon. A press release covering the company's fourth quarter and full year 2018 financial results was issued this afternoon and a copy of that press release can be found in the investor relations section of the company's website.

Management's remarks on this call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These may include statements regarding our business goals, plans, abilities and opportunities, industry and customer trends, growth, momentum, and investment initiatives, expectations regarding collaboration and license relationships, consumer engagement and brand awareness, acquisitions and related expenses, and anticipated financial performance.

Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors, including those discussed in the risk factors section of our form 10-Q for the third quarter 2018 and our other filings with the SEC. Any forward-looking statements made on this call represent our views only as of today and we undertake no obligation to update them.

Please note that we will be referring to certain non-GAAP financial measures on today's call such as EBITDA, adjusted EBITDA, adjusted EBITDA margin, adjusted pro forma net income, adjusted pro forma earnings per diluted share and net debt, which we believe may be important to investors to assess our operating performance. Reconciliations of non-GAAP financial measures to the most directly comparable GAAP financial measures are included in our earnings release and the investors relations section on our website at funko.com.

We have also prepared a visual presentation that investors can consult to follow along with this discussion and it can be accessed in the investor relations section of our website. I will now turn the call over to Brian.

Brian Mariotti -- Chief Executive Officer

Good afternoon and thank you for joining us. On the call with me are Russell Nickel, our CFO, and also Andrew Perlmutter, our President.

Funko just announced another great quarter that capped a fantastic 2018. Net sales in Q4 were up 38% to $233 million and that put our full year sales at $686 million, up 33% over 2017, which greatly exceeded our expectations. Our topline growth has significantly exceeded the growth targets we set when we went public in late 2017. We are seeing stronger than expected demand for our product and the properties that they represent both domestically and international.

In fact, our 2018 sales exceeded the 2019 sales consensus estimate established immediately after our IPO. We have beaten and/or raised guidance every quarter since we went public. We were even more bullish for 2019, guiding to 18% to 20% topline growth year over year. We're going to review many of the ways in which 2018 was a phenomenal year, but here are some highlights.

We completed our first full year as a public company with the stock far outperforming the broader markets and the traditional toy companies in the year. We made sales to thousands of new stores in markets all over the world and saw our domestic business grow 30% and our international sales rise 58%. We successfully integrated three acquisitions that we made in 2017, including Loungefly, which more than doubled their sales, and we refinanced our credit facility, slashing our interest cost, producing an annualized cash savings of over $6 million per year going forward.

Andrew and Russell are going to take you through more of the details of our Q4 performance and our growth expectations. But I want to start by telling you that not only did our sales exceed our own optimistic estimates, but demand for our products is so strong it has strained some of our operation. We consciously made spending decisions to achieve growth and expand our reach in the market as a whole knowing it would depress our margins in the near term.

As you might expect, meeting this stronger than expected demand required us to incur additional cost. It also strained our fulfillment capabilities, both domestically and in Europe, which led to significant increase in customer noncompliance chargebacks during the quarter. Both of these factors impacted our margins but allowed us to fill our customers' demand and more importantly satisfy our fans.

I want to emphasize that none of the actions we took in Q4 were the result of unusual discounting on our part or a sign of slacking demand. Quite to the contrary, through the entire quarter, demand for our products exceeded our expectations and our plans. We see so much opportunity to enlarge our market that we plan to pursue sales growth aggressively again in 2019.

We're not managing for margin percentage. We're managing for continuing to dominate and enlarge this market. We intend to be disciplined about the investments we make, but we also intend to make those that we believe are needed for the long-term growth opportunities in front of us.

It was this mindset that enabled us to increase our sales 150% over three years from $274 million in 2015 to $686 million last year. Keeping up with this kind of growth is challenging, but we have shown our willingness and commitment to do so intelligently, and that will continue.

Licensers continue to look to Funko first as a way to connect their IP with their fanbase. Retailers on a global basis are looking to us to continue to drive traffic and engage with their customers and our fans.

To capture this high global demand that we are seeing and address some of the pressure points in 2018, we are planning to invest further in diversifying our product offerings, creating new avenues through which our fans can experience pop culture, most notably the expansion into the boardgame category with the acquisition of Forrest-Pruzan Creative, which Andrew will discuss later.

Our brand, including opening a retailtainment store in Hollywood given the overwhelming success of our HQ store in Everett, Washington and continuing to enhance our branding and brand placement at retail.

Our direct to consumer strategy, including continuing to enhance and expand our e-commerce capabilities and our planning capabilities, including refining our internal go to market strategy and process. And finally, our fulfillment capability, including improving our distribution network in the UK as well as systems and processes in the US and UK.

As I said earlier, our approach to 2019 is to go for the growth even more aggressively. We are guiding 18% to 20% sales growth this year, higher than the mid-teens growth rate for 2019 that Wallstreet is currently projecting. This higher growth guidance comes on top of sales that came in much higher than expected last year. We're not only raising the growth target, we're doing it on top of a higher base.

Our ability to guide to a higher level of growth in 2019 is a function of several factors. We see the increased momentum behind the Funko brand on a global basis. Our growth last year showed where there are even more opportunities in front us, including more international opportunities, growing our space at existing retailers, more product categories we can expand into that connect people to what it is they are a fan of.

We have a massive army of licenses combined with diversity of product lines and a fast fashion approach to getting them into the marketplace at lightening speed. Add to this the constant proliferation of content from movie studios, TV studios, streaming services like Netflix, video game publishers, new sports stars, music icons, and our growing library of evergreen content all leading to a growing base of properties that we can leverage.

2019 is looking like an A+ content year, including an above average number of big tentpole enterprise properties such as Captain Marvel, Avengers: Endgame, Toy Story 4, Frozen 2, and Star Wars -- Episode IX. In TV, we have new seasons of Game of Thrones, Stranger Things, and Rick and Morty. And in the video game area, we have a full year of Fortnite in 2019 as well as Kingdom Hearts and the continued strength of Overwatch.

We're also seeing great traction with sports and music as a part of our offering. Among the new products we released just before Toy Fair in New York, the top sellers on Amazon presales were BTS and Post Malone and Michael Jordan and LeBron James Special Edition Pop Vinyls.

Since Funko curates a large portion of retail programs in some of the top retailers around the world, our ability to create programs with many different types of products is an opportunity we did enjoy a few years back. Retailers look to us to help create demand and drive traffic by giving us expanded placement with different product categories. This position is a significant reason why we've been able to drive our high sales growth and why we're excited about the opportunities in front of us.

In summary, we had a great year and a terrific fourth quarter. Our strong performance in Q4 and the full year validates the power of the Funko brand and the market we believe we have created and continue to expand. We expect the investments we are making to improve our operations and enlarge the market to payoff nicely in 2019 and beyond.

Before I end, I want to thank our entire team, licensers, retail partners for their continued support that has contributed to our success to date and will drive our success going forward. As always, a special thanks to our amazing engaging fan base, whose passion and excitement is what motivates us every day.

With that, I will now turn the call over to Andrew Perlmutter, our President. Andrew?

Andrew Perlmutter -- President

Thank you, Brian. As Brian said, we're coming off a better than expected fourth quarter, which caps off a terrific year for Funko. I'm going to focus my comments on what we did last year to drive sales growth and what we're doing this year to keep the momentum going.

In 2018, our growth was balanced and came from multiple sources, including and expanded base of properties, new product categories, sales growth at existing retailers, and continued expansion and growth of our international retailer network. We had significant growth in the US and international and all of our international markets showed growth. We expect these factors to continue to be key drivers of our growth over time.

The cornerstone of our growth is the continued expansion of entertainment content across properties. In Q4, we sold against 583 active properties, which was up 35% from Q4 2017. As we said before, we expect this number to grow over time as the proliferation of content continues and we broaden our license portfolio. In the fourth quarter, not only did we increase the number of active properties 34% but we were also able to grow the sales per active property by 3%.

Our business is not dependent just on newly released content. In Q4, our top ten best-selling properties were as usual a mixture of new properties and evergreen and accounted for about 38% of sales in the quarter around the same percentage as last year. Those top ten properties in the quarter were Fortnite, which accounted for about 12% of sales, Harry Potter, Avengers: Infinity War, Marvel Studios Tenth Anniversary, Stranger Things, Overwatch, Star Wars Classic, Mickey Mouse, Dragon Ball Z, and the Nightmare Before Christmas.

The fact that Fortnite, which the Washington Post called "the biggest pop culture phenomenon of 2018" accounted for only 12% of our Q4 sales and 5% for the year, showcases how Funko is like an index fund of pop culture. The property is important, but it's just one of many in our portfolio.

Evergreen properties accounted for about 46% of our sales in Q4 and 47% for the full year. Again, this shows that we're not reliant on a small number of hits, nor are we reliant on only new content. As we say, everyone is a fan of something. As we expand our offering, we expect to attract new fans into the Funk-verse.

Since our founding in 1998, the backbone of our sales has been our figure business and we continue to see strong growth in that category, even as we continue to expand into new categories. Gross sales of figures overall including Pop Vinyl were up 38% for the fourth quarter and 33% for the year, right in line with our overall topline growth.

For the year, figures accounted for 82% of total sales, the same as in 2017. Our figure line or platform, Pop Vinyl, is in its ninth year and was up 48% in the fourth quarter and almost 39% for the year. Our gross sales of other products grew 37% for both the quarter and the year with our fastest-growing categories outside of figures being apparel, bags, wallets, and accessories, all of which grew faster in 2018 than our total sales.

Funko's customer diversification continues to be one of our key strengths. No single customer accounted for more than 9% of our total sales in either Q4 or the full year. On the digital side, we continued to grow third party e-commerce sales at a substantial rate, which supports the facts that our products resonate online. Our third-party ecomm sales were up 31% during the fourth quarter compared to last year and accounted for 17% of our total sales. For the full year, e-commerce sales were up nearly 45% and accounted for 15% of our total sales.

As we continue to improve and grow our B2C business, we expect to see some gains in 2019. Ultimately, our goal is to make our products available and accessible wherever and whenever our fans want them.

As part of the company's strategy to make our products and accessible and build out our customer experience, we are excited that we have redesigned our Beta App and will be relaunching it with the most update Funko products past and present. This mobile app was developed in response to our fans' feedback. It brings tools to the community so they can explore the most extensive Funko catalog of products, track their collections, and find which retail partners carry the items they're searching for. We expect this redesigned app to launch in the next few months.

To start 2019, Funko has already had a busy tradeshow season, attending Toy Fairs in Hong Kong, London, Nuremberg, and New York. We leveraged these events to announce new products, create points of engagement with our fans, and meet with retail partners. As we announced over 150 new products at the start of Toy Fair, many of those products quickly rose to the top of the best-selling lists in Amazon's toys and gam's action figure category.

As we said, we also use these shows to engage with our fans. Over the four days of Toy Fair, we had over 4 million engagements and made over 70 million fan impressions on social media. As we continue to strengthen our brand globally, we are also continuing to expand our social media reach and the following. At the end of 2018, we had over 3.5 million followers across Facebook, Twitter, Instagram, and YouTube and on YouTube, our videos amassed over 100 million views.

Before I turn the call over to Russell, let me say a few words about our recently announced acquisition of Forrest-Pruzan Creative. Forrest-Pruzan is one of the boardgame industry's most experienced and highly respected design and development groups. Their business has historically been designing games that are licensed to other companies such as Hasbro, Mattel, Spin Master, Ravensburger, and Asmodee, just to name a few.

FPC design and partnered with Ravensburger to publish Villainous, which won the 2018 Game of the Year Award, the highest award a game can receive within our industry. Forrest-Pruzan's revenue has traditionally been driven off licensing royalties with their publishing partners. FPC owns the underlying design and has over 500 designs in their current catalog. Going forward, we will be developing games under the Funko Games brand and have access to this catalog of game designs.

Our focus in the near-term will be to bring the Pop brand to the boardgame aisle, but our plan is to broaden the offering over time. The boardgame category is substantially larger than the action figure category. With over 20 years of boardgame experience, the former FPC team will lead the charge into this completely new stream of revenue for Funko.

With this acquisition, Funko games will bring boardgamers into the Funkoverse where they will discover the broad offering of other products that we have. We believe that aligning this new category and combining it with our expertise in pop culture and the diversity of 1,100 licenses and properties further solidifies our position as the leading pop culture solution for licensers, retailers, and consumers. We deliver pop culture to our fans and boardgames is another avenue in which people can experience their favorite properties. We see this as the perfect fit.

While I'm excited about this move, we don't expect it to have a material impact on top or bottom line results this year. We think that over time, this will prove to be a low risk, high reward move that will contribute to our future growth.

Russell Nickel -- Chief Financial Officer

I'll now turn the call over to Russell to discuss our financial results. Thanks, Andrew. Good afternoon, everyone. As was the case throughout 2018, our strong fourth quarter results were broad-based and reflected a number of positive underlying trends. Net sales in the quarter increased 37.6% to $233.2 million and were driven by strong and balanced global demand for our products across a higher number of properties.

On a geographical basis, in the fourth quarter, net sales in the United States increased 29.8% to $158.8 million and net sales internationally increased 57.8% to $74.5 million. As you recall, earlier in the year we implemented a new ERP system in the UK and rolled out a 3PL operation in Mainland Europe to support the growth. These investments helped us achieve growth in net sales in Europe of 37% in the fourth quarter over the prior year. We believe this growth was still constrained by some system limitations and the capacity of our fulfillment network in the UK given the higher than expected demand.

On a product category basis, in the fourth quarter, net sales of figures increased 37.9% to $188.3 million and net sales of other products such as bags, accessories, apparel and homewares increased 36.6% to $45 million in the quarter.

As Andrew noted, sales in the quarter of Pop Vinyl figures increased 48% on a global basis over the prior year and as a brand, Pop was up 52% over the prior year. Gross margin, which excludes depreciation and amortization decreased 260 basis points from Q4 of last year to 36.7%.

As we communicated after the third quarter, gross margins in the third and fourth quarter of 2017 were atypically high and we knew at the time that margins would get lower year over year in the second half of 2018, due primarily to price reductions we took in Europe at the start of 2018 to streamline pricing across markets as well as a significant shift toward more FOB sales, which while neutral to operating income, do result in a lower gross margin percentage.

There were a number of other factors that adversely impacted gross margins in Q4, most having to do with the higher than expected demand driving decisions and actions we took during the quarter in order to better serve our customers and fans. Before detailing some of these factors, I want to stress, as did Brian, that the gross margin reduction was not at all the result of a higher promotional support, price discounting, or a reduction in demand. Quite the contrary -- it was the higher than expected demand that triggered us to incur many of these additional costs.

This increased demand resulted in higher shipping and freight costs. At the request of some retailers, we air-freighted some of our Fortnite products in order to get products on the shelf as fast as possible. These costs were typically passed through to our customers and did not cost us gross profit dollars, but they did negatively impact our gross margin percentage.

Also, given the higher demand and volume, we incurred considerably higher customer noncompliance chargebacks than we have historically. Customer noncompliance chargebacks arise when we fall short in adhering to our customers fulfillment requirements, for instance, missing a shipping window, failure to provide an advanced ship notice, or placing the shipping label in the wrong place on the carton.

It is likely that if we had slowed down on our shipping, we would have been able to avoid or minimize some of these chargebacks. But we made a decision not to slow shipments so as to better supply our customers and ultimately our end consumers. We're working both internally and with our customers to mitigate these charges in the future.

Finally, late in the quarter, one of our customers, HMV in the UK, declared bankruptcy. Consistent with our revenue recognition policy. We did not recognize any revenue on shipments made within the fourth quarter even though the full cogs are being recognized. This bankruptcy cost us about $1 million on the gross profit line, an additional $800,000.00 in bad debt reserve, which was recorded in SG&A.

Over time, we continued to expect to be able to get gross margins higher than the levels we are seeing now, but we do not intend to sacrifice long-term growth opportunities in order to do so. As we exited the fourth quarter, our channel inventory remained in a very good position heading into the new year and in the quarter, sell-through at the retailers where we can measure this was up about 10% over 2017 and up 15% in the second half of the year.

In the quarter, selling, general, and administrative expenses increased 20% to $45 million from the prior year. The majority of this increase in dollars was driven by the growth in the business as well as incremental investments associated with strategic initiatives, including our direct distribution operations in Europe and other international markets as well as our Loungefly operations and Funko Animation studios.

As we had indicated last quarter, we are starting to see leverage against our operating expenses. As a percent of net sales, SG&A expenses were 19.3% in the quarter compared to 22.1% in the fourth quarter of last year and an improvement of 280 basis points.

Of all of our major SG&A expense items, the only ones that were not lower as a percent of net sales in the fourth compared to last year were stock compensation expense and facilities and rent, which reflects the continued expansion of our operations to support future growth.

Depreciation and amortization expense in Q4 increased 11% from the prior year to $10.2 million. The majority of the $1 million increase was from higher depreciation on mold and tilling cost as we continued to expand our product offerings as well as our lease hold improvements at our corporate offices and warehouse facilities.

Our reported operating income in Q4 was $30.5 million, up 57.3% from the $19.4 million we reported last year. Despite the investments we have made to grow the business and despite the lower gross margin in the fourth quarter, operating margin as a percent of sales was 13.1% in the quarter of 2018 compared to 11.4% in Q4 of 2017.

Net interest expense decreased 34% to $4.5 million from $6.9 million in the fourth quarter of 2017. This was due to lowered interest rates that came from our lenders in the first quarter in 2017 and again in the fourth quarter after we refinanced their debt.

As a result of these factors and even with the negative impact from the HMV bankruptcy, adjusted pro forma net income was up 127% to $22.5 million compared to $9.9 million in Q4 2017. Adjusted pro forma earnings per diluted share was $0.44 compared to $0.20 in the fourth quarter of 2017. Adjusted EBITDA increased 42% to $44.8 million. This represents a 19.2% adjusted EBITDA margin, which increased 50 basis points over Q4 in 2017.

Again, despite the reduction in gross margin and increased investments we have made in the business, we are again achieving adjusted EBTIDA leverage. Touching on a few balance sheet highlights, we ended the fourth quarter with net debt of $233.8 million compared to $226.1 million at the end of 2017.

Inventory at year end was $86.6 million versus $79.1 million at year end 2017, an increase of only 10%, despite sales being up 38% in Q4 and up 33% for the year. Without going through all the detail for the full year, I will summarize certain key metrics for Fiscal 2018, all of which can be found in our press release.

Net sales in 2018 were $686.1 million, up 33% compared to $516.1 million in 2017. Adjusted pro forma net income was $41.5 million in 2018, up 138% compared to $17.4 million in 2017. Adjusted pro forma earnings per diluted share were $0.82 in 2018, up 141% compared to 2017 and adjusted EBTIDA in 2018 was $116.2 million, up 29% versus $89.9% in 2017.

Turning to our outlook for 2019, we expect net sales of approximately $810 million to $825 million or an increase of approximately 18% to 20%, adjusted EBTIDA of approximately $133 million to $143 million, which would be approximately 17% of net sales, relatively consistent with our performance in 2018, even as we make the investment Brian alluded to earlier to accelerate our growth and adjusted pro forma earnings per diluted share in a range of $1.05 to $1.15, which assumes a blended corporate tax rate of 25% and a weighted average diluted share count of 53.5 million shares.

As Brian said, we will be investing in a number of areas to support further growth opportunities. Some of these investments are being made ahead of the expected revenue benefit and some of the spending will produce near-term benefit. Areas of investment spending include our acquisition of Forrest-Pruzan Creative, which positions us well in the boardgame category.

Given the response to our store in Everett, Washington, we are opening an additional retail store in Hollywood, which we see as a way to get further exposure to the Funko brand and connection with our fans. We will see pre-opening expenses in 2019 ahead of the revenue benefit that is expected once the store opens later this year.

Continued and expanded use of third-party merchandisers, which helped us in Q4. We can expect a pretty quick payback on this spending as they help to keep the content on the shelf fresh and relevant. Expansion and consolidation of our distribution network in Europe, particularly in the UK, which will help us realize greater revenues in this important market, our sales and our ability to onboard new customers in 2018 were somewhat constrained and we expect these investments to start paying off in 2020.

And of course, we are continuing to invest in our sales and operations team in order to enhance growth and improve our efficiency. These steps will cost us but they are a big part of why we are confident in raising our sales growth guidance to 18% to 20%.

A final comment about guidance for 2019 -- please recall that in 2018, as we prepared for the rollout of our ERP in Europe, we consciously pulled forward approximately $5 million in sales into Q1 from Q2. We won't have that same pull forward this year, so our growth in the first quarter could be somewhat less than the full year growth rate.

With that, I would now like to turn the call back over to the operator to start the Q&A session.

Questions and Answers:

Operator

Thank you. At this time, we'll be conducting a question and answer session. If you would like to ask a question, please press *1 on your telephone keypad. The confirmation tone will indicate your line is in the question queue. You may press *2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the * key.

Our first question comes from the line of Erinn Murphy with Piper Jaffray. Please proceed with your question.

Erinn Murphy -- Piper Jaffray -- Analyst

Great. Thanks. Good afternoon. Really nice job on a solid end to year. My first question on the guidance of 18% to 20% for the year -- for the balance of the year, how should we think about the run rates for the US and international. Particularly for the US, if you could touch on what you saw in the fourth quarter with respect to Walmart, that was a very strong Q4 number for the US. I'm curious what you're seeing with the extensions there.

Russell Nickel -- Chief Financial Officer

In regard to the growth we're expecting in 2019, domestically, we're expecting about 10% to 15% growth in the domestic markets and then really the rest of the markets making up the rest with really strong growth continuing in Europe for an overall balance.

Andrew Perlmutter -- President

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

Erinn Murphy -- Piper Jaffray -- Analyst

Then just on the gross margins, going back to some of the comments -- is anything structurally changed outside of your doing more FOB in Europe? But from getting back to 39% or getting there over time -- I'm curious if you think if anything is truly structural. Also in the release and the transcript, you talked about loyalty. Is that mix or are there any specific renegotiations happening with some of your key partners that would continue to hinder the gross margin rate?

Russell Nickel -- Chief Financial Officer

In regard to the gross margin, it was largely mix that drove the difference between Q4 this year and last year. There was no change in our negotiations with our licensers that should have an impact. In regard to structural changes, there's nothing structural. After having bought Underground Toys, we gave back some of that margin at the beginning of this year to more streamline and align pricing on a global basis.

Then obviously there's the shift as more retailers want our products and want our products sooner, they're moving and shifting to an increased percentage of their buys coming directly from our factories. It's a shift between gross margin percentage and SG&A.

Erinn Murphy -- Piper Jaffray -- Analyst

Okay. I guess for the year, as you think about 2019, should we modeling a march forward from where you ended Q4 or is there any thoughts on how you're thinking about even just first half, second half for the GM?

Russell Nickel -- Chief Financial Officer

With the opportunities and growth opportunities we see in front of us, the fact that retailers want us to air-freight in product on their behalf. Those are negative from a gross margin percentage but they don't impact our gross profit. We're not guiding to a specific. I'd probably hold it around the same lines of where we saw this year, knowing there are opportunities that might impact that. We're focused on the long-term growth and healthy growth of the business.

Operator

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

Stephanie Wissink -- Jefferies -- Analyst

Thanks. To follow-up on one of Erinn's questions, I'm curious if you can talk about the new retailers you're seeing coming off the tradeshows, also in the sports category. Brian, one for you, as we think about 2019 and the content, should we think about the number of new properties and the dollars per property going up?

Brian Mariotti -- Chief Executive Officer

Thanks. I'll take the second question first. It is an interesting year for us because the content is so good. You can potentially see us not leverage as many unique properties because we're dealing with A+ content. We're not hit driven. If we had something that was a big movie that we can't anniversary in for a quarter, we'll make it up with two, three, ten products. It will be interesting to see how the year shakes out. There could be a potential to make less properties this year because of the strong content. Repeat the first question though. I'm not sure I understood that one.

Stephanie Wissink -- Jefferies -- Analyst

Erinn had asked about music and sports. You're opening some new retail channels with some of those.

Brian Mariotti -- Chief Executive Officer

Yeah. I think that Footlocker and Fanatics are two great examples of retail partners that desperately wanted to get into the business of pop culture. Obviously, Fanatics being an etailer, geographical concerns traditionally with the sports goes away on an e-commerce platform. We've seen some amazing success. I think both Pop Footlocker and Fanatics crashed on LeBron and Michael Jordan exclusives we gave them.

Pop Footlocker is really happy with their basic two quarters worth of sales in our category and how they're leveraging our everyday pop culture content to align with -- sometimes Nike activations or Adidas activations, we're seeing a parallel consumer that's a sneakerhead that is crossing over into our pop culture world. They already have that collecting bug in their DNA. So, two great retailers that we're continuing to expand with music and sports.

Stephanie Wissink -- Jefferies -- Analyst

Final one, just on the acquisition -- did that come with any owned IP that you're looking to exploit down the road or is it more of a platform acquisition around the gaming and gaming development?

Andrew Perlmutter -- President

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

Brian Mariotti -- Chief Executive Officer

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

Operator

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

Michael Swartz -- SunTrust Robinson Humphrey -- Analyst

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

Russell Nickel -- Chief Financial Officer

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

Michael Swartz -- SunTrust Robinson Humphrey -- Analyst

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

Brian Mariotti -- Chief Executive Officer

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

Michael Swartz -- SunTrust Robinson Humphrey -- Analyst

Thanks a lot. I appreciate it.

Operator

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

Michael Ng -- Goldman Sachs -- Analyst

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

Andrew Perlmutter -- President

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

Michael Ng -- Goldman Sachs -- Analyst

Great. My second question is just about the US sell through. I think you said it was up 10% in the quarter. Could you help reconcile some of the gap there? was it just a function of Walmart stocking up and expanding shelf space? Do you expect sell through to accelerate in 2019?

Brian Mariotti -- Chief Executive Officer

It's a great question. I'll remind you -- we get sell through data from about 15 of our top customers in the US. So, it's not all of our top customers. We did have a couple customers, one, like Walmart, that stocked up as they moved into a new retail store. We also saw some e-commerce platforms that changed their buy-in habits. Also, in order to -- they just were beginning to understand what pop culture and what our products specifically can mean with them. So, they started to increase their overall buy.

I will say for the retailers that report to us. It's important to note that the sell through was up about 10%, but their channel inventory was up only 8%. We're seeing a very strong correlation between the sell through and the levels of inventory that they're caring, which is why we're seeing a healthy level -- we feel good about the channel inventory as a whole going into 2019.

Michael Ng -- Goldman Sachs -- Analyst

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

Brian Mariotti -- Chief Executive Officer

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

Michael Ng -- Goldman Sachs -- Analyst

Brian, I want half of that.

Brian Mariotti -- Chief Executive Officer

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

Operator

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

Gerrick Johnson -- BMO Capital Markets -- Analyst

In terms of Forrest-Pruzan, can you talk about what proportion of your current library of licenses would be transferable to games?

Andrew Perlmutter -- President

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

Gerrick Johnson -- BMO Capital Markets -- Analyst

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

Russell Nickel -- Chief Financial Officer

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

Gerrick Johnson -- BMO Capital Markets -- Analyst

Okay. Great. Maybe one last question -- I thought I heard you say that increased FOB sales lowered your margin in the quarter. Wouldn't that help your gross margin? Help me understand how that would lower your gross margin.

Russell Nickel -- Chief Financial Officer

Typically, when we sell to retailers from an FOB, we're given a discount from the topline. So, they're covering the freight costs. So, there's that element. There is typically an increase in royalty costs related to it. It's decrease in gross margin given the discount that we give.

Operator

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

Christopher Horvers -- JP Morgan -- Analyst

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

Brian Mariotti -- Chief Executive Officer

I don't think so. We've looked at the rest of the world really strategically. I think we just added two people in Latin America. From '17 to '18, I think we grew that about 700%. So, it doesn't change the philosophy that we believe that content resonates on a global basis. I think what the expanded category success has allowed us to do is continue to create wonderful whimsical programs for our key retail partners and be able to garner all of the categories within that space instead of having to farm some of that stuff out to other manufacturers.

That's been really the key that we can basically carry a section, whatever the section would be, if it's an 80s retro TV section, if it's a section all about ad figures, we have all the categories necessary to carry that section and just getting that expertise in these adjacent categories has really helped us with our retail partners understand that we truly are a one-stop shop for anything and everything that is pop culture. It's really paid off.

Christopher Horvers -- JP Morgan -- Analyst

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

Brian Mariotti -- Chief Executive Officer

I think we've focused so much time and energy the last year in half in helping Target build up target.com and Walmart build up Walmart.com and seen great success with Amazon growing their business as we've grown our own B2C. I don't think we're ever going to see any one retailer definitively own pop culture because it is so vast and is so diverse and when you go back to see a Pop Footlocker who' really putting a foothold into music and sports and Fanatics, who's putting a foothold into sports, you're going to see multiple players there.

We have to get better with our search engine capabilities and our marketing and making sure we garner more and more of that direct to consumer sales. But no, I don't see, unless Andrew has a differing opinion, any way anyone could definitively own this. It's too broad of a category and too mainstream.

Andrew Perlmutter -- President

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

Christopher Horvers -- JP Morgan -- Analyst

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

Russell Nickel -- Chief Financial Officer

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

Christopher Horvers -- JP Morgan -- Analyst

Then last one from me -- any expectation around the level of debt on the balance sheet? Do you anticipate paying any of that down? Are you going to keep that level of leverage?

Russell Nickel -- Chief Financial Officer

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

Christopher Horvers -- JP Morgan -- Analyst

Understood. Thanks, guys. Have a great year.

Brian Mariotti -- Chief Executive Officer

Thank you for your interest and support of Funko and we look forward to speaking to you guys on the first quarter of 2019 earnings if not sooner. Thank you very much.

Operator

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

Duration: 58 minutes

Call participants:

Brian Mariotti -- Chief Executive Officer

Russell Nickel -- Chief Financial Officer

Andrew Perlmutter -- President

Erinn Murphy -- Piper Jaffray -- Analyst

Stephanie Wissink -- Jefferies -- Analyst

Michael Swartz -- SunTrust Robinson Humphrey -- Analyst

Michael Ng -- Goldman Sachs -- Analyst

Gerrick Johnson -- BMO Capital Markets -- Analyst

Christopher Horvers -- JP Morgan -- Analyst

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