Funko, Inc. — Q3 2020 Form 10-Q
Business context and reporting period. This unaudited quarterly report covers the three and nine months ended September 30, 2020. Funko designs and sells licensed pop-culture consumer products, primarily figures, through retail, distributor, e-commerce and direct-to-consumer channels. Results were materially affected by COVID-19 disruptions to retail demand and supply chains.
Key financial metrics
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Net sales | $191.2 million | $223.3 million | $426.0 million | $581.6 million |
| Gross margin, excluding D&A | 38.6% | 38.3% | 38.7% | 37.8% |
| Income (loss) from operations | $20.7 million | $22.6 million | $3.4 million | $52.5 million |
| Net income (loss) | $15.6 million | $15.5 million | $(5.1) million | $34.1 million |
| Net income (loss) attributable to Funko, Inc. | $9.8 million | $8.6 million | $(4.9) million | $16.0 million |
| Adjusted EBITDA (non-GAAP) | $36.2 million | $40.6 million | $47.0 million | $97.3 million |
Cash flow and liquidity. For the first nine months, operating cash flow was $60.3 million, investing cash outflow was $14.7 million, and financing cash outflow was $39.7 million. Cash rose to $31.9 million from $25.2 million at year-end 2019. Working capital was $100.2 million, versus $101.6 million at year-end.
Debt. At September 30, debt carrying value was $208.1 million, including $22.5 million current and $185.7 million long-term; term-loan principal was $211.5 million. No revolver was drawn, and $75.0 million was available. The term loan matures September 23, 2024. The company reported compliance with its amended credit agreement covenants.
Material changes versus prior comparable periods
- Q3 sales declined 14.4% year over year; nine-month sales declined 26.7%. Nine-month results shifted from $34.1 million net income to a $5.1 million net loss.
- International sales fell 33.8% in Q3 and 46.4% for the nine-month period, primarily reflecting weaker European sales. U.S. sales declined 4.3% in Q3 and 16.2% year to date.
- Management attributed lower sales to store closures, reduced store traffic and customer orders, weaker consumer demand, and supply interruptions. E-commerce and direct-to-consumer growth partly offset Q3 declines.
- Gross margin improved year over year, attributed to product margins and inventory-management improvements, partly offset by higher freight costs. SG&A fell 21.5% in Q3, but for nine months it declined only 6.6% while rising to 29.9% of sales from 23.5%.
- Cash from operations was $60.3 million versus $63.0 million in the prior-year period. Capital spending fell to $14.7 million from $27.2 million; prior-year investing also included acquisition spending.
Outlook, risks, contingencies and unusual items
- COVID-19 outlook: Funko withdrew its 2020 financial guidance in March and did not provide replacement quantified guidance in this filing. Management expected a gradual recovery and warned of downward pressure on European sales in Q4 2020 from renewed restrictions, particularly in the U.K. Further closures or sourcing problems could worsen results.
- Liquidity and financing: Management believed liquidity was sufficient for at least 12 months, but could not assure needs beyond that period given pandemic uncertainty. It was evaluating possible debt, equity or equity-linked financing; such financing could add restrictions or dilute shareholders. The May 2020 credit amendment waived financial covenants for Q2 and Q3, revised future covenant terms, and temporarily imposed minimum liquidity requirements. The company said it had met the leverage test to exit that minimum-liquidity requirement during Q3.
- Impairment: Despite market capitalization remaining below book value and COVID-19 triggering impairment assessments, the company recorded no goodwill impairment for the nine months. It cautioned that further market declines or worse pandemic impacts could cause future impairment.
- Customs matter and controls: Loungefly’s historical customs-duty underpayments were reported at approximately $7.8 million and paid in 2019. A $0.5 million reserve remained for potential penalties; additional penalties could exceed the reserve. Management identified a material weakness in internal control over financial reporting related to completeness and accuracy of customs-duty calculations. Disclosure controls were reported ineffective, and remediation was ongoing.
- Litigation: A consolidated securities class action concerning 2019 disclosures and shareholder derivative actions remained pending; the company said liability was not currently probable or reasonably estimable. A separate Washington state securities action was dismissed with prejudice, but an appeal was pending.
- Other exposures: Key risks include dependence on licensed properties and major licensors, customer concentration, inventory obsolescence, third-party manufacturing and sourcing, foreign exchange, tariffs, and debt service. The top ten licensors represented approximately 79% of nine-month sales; Disney-related licensors accounted for approximately 45%.
Important facts for investors to verify
- Whether Q4 demand and retail reopening trends matched management’s expectations, especially in Europe, and whether supply-chain disruptions persisted.
- Cash generation, working-capital and inventory trends, revolver availability, covenant compliance, and any new financing or changes to guidance.
- Progress in remediating the customs-related material weakness and any further U.S. Customs action or penalties beyond the recorded reserve.
- Developments in the securities and derivative litigation, and the status of the pending appeal in the Washington case.
- Potential future impairment indicators and the sustainability of gross margin improvements amid freight costs, product mix and reduced sales volumes.