Funko, Inc. — Q1 2022 Form 10-Q
Reporting period: Three months ended March 31, 2022; unaudited. Comparisons are with the three months ended March 31, 2021 unless otherwise noted. Dollar amounts are in millions except per-share data.
Business context and results
Funko designs and sells pop-culture products, primarily under third-party licenses. The company reports one operating segment. Q1 sales rose sharply from a pandemic-affected prior-year quarter, supported by higher sales to mass-market retailers, e-commerce sites and specialty retailers. The company said active licensed properties increased slightly to 763, while average sales per active property increased 62.8%.
| Metric | Q1 2022 | Q1 2021 | Change |
|---|---|---|---|
| Net sales | $308.3 | $189.2 | +63.0% |
| Gross margin, excluding depreciation and amortization | 35.3% | 41.4% | -6.1 percentage points |
| Operating income | $19.8 | $16.8 | +17.9% |
| Net income | $14.5 | $11.1 | +31.0% |
| Net income attributable to Funko, Inc. | $9.9 | $6.5 | +51.7% |
| Basic / diluted Class A EPS | $0.25 / $0.23 | $0.18 / $0.17 | Higher |
| Adjusted EBITDA (non-GAAP) | $36.3 | $29.8 | Higher |
Revenue mix and margins
- By branded category, Core Collectible sales were $239.6 million (+52.8%), Loungefly sales were $50.1 million (+103.5%), and Other sales were $18.6 million (+140.0%). Core Collectible represented 77.8% of sales, versus 82.9% a year earlier.
- U.S. sales increased 70.1% to $232.2 million; Europe increased 43.5% to $57.1 million; other international sales increased 48.3% to $19.1 million.
- Gross margin declined as freight and shipping costs rose amid global supply-chain capacity constraints. Management said it had partially mitigated cost inflation through price increases and expected further inflation in inbound shipping and product costs.
- SG&A rose 53.0% to $78.4 million, mainly due to higher personnel and related costs. SG&A was 25.4% of sales, compared with 27.1%.
- Interest expense fell 45.9% to $1.2 million, primarily because average debt outstanding was lower. Adjusted EBITDA and other non-GAAP measures are supplemental and should not be treated as GAAP results or cash available for discretionary use.
Cash flow, debt and liquidity
- Operating cash flow was negative $23.0 million, versus positive $37.5 million in Q1 2021. Management attributed the year-over-year deterioration primarily to working-capital movements, including a $52.2 million cash-flow use from accrued expenses and other liabilities.
- Capital expenditures were $19.2 million, primarily for the Buckeye, Arizona distribution facility and production tooling and molds. Operating cash flow less capital expenditures was approximately negative $42.1 million, calculated from the reported figures.
- Cash and cash equivalents were $33.1 million at March 31, down from $83.6 million at December 31, 2021. Working capital was $164.5 million, versus $167.6 million at year-end.
- Term-loan borrowings were $171.0 million principal ($168.9 million carrying value, net of unamortized discount); no revolver was drawn, leaving $100.0 million available. The term loan matures in September 2026. The company reported compliance with debt covenants at quarter-end.
- The Tax Receivable Agreement obligation, including accrued interest, was $85.6 million at March 31, of which $7.8 million was current. The agreement generally requires payment to Continuing Equity Owners of 85% of specified tax benefits.
- Management believed available liquidity was sufficient for operations and planned capital expenditures for at least 12 months, but cautioned that future cash generation and revolver availability might not meet all needs.
Outlook, risks and unusual items
- The filing provides no quantified full-year revenue, earnings or margin guidance. Management noted that Q1 is historically the lowest-sales and least-profitable quarter, with more than half of annual sales historically occurring in Q3 and Q4. Interim results are not necessarily indicative of the full year.
- Management expected personnel costs to remain elevated through at least Q2 2022 to support the U.S. warehouse transition and because of wage, commission and benefit inflation. The new Buckeye warehouse lease commenced during the quarter.
- Supply-chain delays and higher freight costs remain material concerns. Management reported inventory up 161% year over year, primarily because longer transit times left significant inventory in transit; the balance sheet shows inventory of $161.5 million at quarter-end versus $166.4 million at December 31, 2021.
- Key business risks include dependence on licensed properties and third-party content, rapid shifts in consumer tastes, inventory forecasting, retailer concentration, third-party manufacturing, inflation, foreign exchange and economic conditions. The top ten licensors represented approximately 73% of Q1 sales; Disney, Lucasfilm and Marvel together represented approximately 42%. The top ten customers represented approximately 47%.
- Legal matters include securities litigation and other stockholder suits. On May 3, 2022, the parties in the Ferreira securities litigation agreed in principle to a settlement, subject to court approval; the company said insurance would cover the settlement cost. A separate Washington state securities case continued after the state supreme court denied review on May 4. The company also disclosed a $0.5 million contingent liability for potential customs penalties related to historical Loungefly duty underpayments; additional penalties, if imposed, could exceed the accrual.
- Subsequent events: on April 26, 2022, Funko amended its credit agreement to permit additional restricted payments from specified funding sources. On May 3, it made a $74.0 million capital contribution to FAH, LLC and completed a recapitalization. ACON also agreed to sell shares representing about 25% of combined voting power to an affiliate of The Chernin Group, subject to closing conditions; Funko expected TCG to have significant influence. These events occurred after quarter-end.
- Management reported effective disclosure controls at March 31 and no material changes in internal control over financial reporting during the quarter. The company remained an emerging growth company through December 31, 2022.
Investor verification points
- Whether revenue growth and sales per active property persist beyond the pandemic-affected comparison quarter, and how product, property and retailer demand evolve.
- Whether freight, product and labor inflation ease or are offset by pricing, and whether gross margin can recover from 35.3%.
- Inventory quality, in-transit levels, sell-through and potential obsolescence or write-down exposure.
- Operating cash conversion, capital spending, cash balances, revolver availability and continued covenant compliance.
- The closing and governance effects of the ACON-to-TCG transaction, and the cash and dilution implications of the Tax Receivable Agreement and continuing-equity redemptions.
- Developments and potential exposure in securities and stockholder litigation, customs-duty matters, and royalty audits; the filing reported a $14.5 million reserve for ongoing and future royalty audits.