Funko, Inc. — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018; comparisons are with the three months ended March 31, 2017 unless otherwise noted. Funko designs, sources and distributes licensed pop-culture products. The statements consolidate FAH, LLC, of which Funko, Inc. owned 48.3%; reported consolidated earnings therefore include income attributable to non-controlling owners.
Key financial results
| Metric | Q1 2018 | Q1 2017 |
|---|---|---|
| Net sales | $137.2m | $99.1m |
| Gross margin, excluding depreciation and amortization | 37.4% | 35.3% |
| Operating income | $7.2m | $1.4m |
| Net income (loss), consolidated | $2.2m | ($5.6m) |
| Net income attributable to Funko, Inc. | $0.9m | ($5.6m) |
| Class A EPS, basic and diluted | $0.04 | Not presented |
| Operating cash flow | $9.5m | $27.1m |
| Capital expenditures | $5.9m | $8.8m |
Sales increased 38.5%. Management attributed growth to portfolio expansion and the Underground Toys and Loungefly acquisitions. Active properties rose 8.6% to 454, while average sales per active property increased 27.5%. U.S. sales grew 16.3% to $88.9m; foreign sales grew 113.6% to $48.4m, primarily reflecting European growth following Underground Toys. Figures represented 84.2% of sales.
Cost of sales rose 34.1%, slower than revenue growth, supporting the 2.1 percentage-point gross-margin improvement. Management cited higher European product margins and the prior-year $1.5m inventory step-up charge; higher royalties and $1.8m in Toys “R” Us shipment costs for which no revenue was recognized partly offset the improvement. SG&A rose 38.7% to $34.8m, broadly in line with sales; personnel, facilities and infrastructure costs increased. Net interest expense declined 15.6% to $5.9m. Other income of $1.4m primarily reflected foreign-currency gains.
Company-reported non-GAAP EBITDA was $17.9m, versus $8.1m; Adjusted EBITDA was $17.5m, versus $13.5m. These measures include management-defined adjustments and should not be treated as substitutes for GAAP results or cash flow.
Liquidity, cash flow and debt
At March 31, 2018, cash was $6.5m and working capital was $75.2m, compared with $7.7m and $94.1m at December 31, 2017. Current assets were $193.7m and current liabilities $118.5m. Operating cash flow fell to $9.5m from $27.1m, mainly due to working-capital movements, including lower accounts payable and accrued liabilities. Investing used $6.5m; financing used $3.5m. Cash declined $1.3m during the quarter.
Reported debt was $241.7m, comprising $208.1m of long-term debt net of unamortized discount and $33.5m drawn on the revolving facility. Funko paid $15.4m on the term loan during the quarter. A March credit-agreement amendment required a $13.0m term-loan prepayment, reduced specified interest margins and increased the revolver borrowing base by $20.0m subject to conditions. The filing reports compliance with debt covenants at quarter-end. Management said liquidity sources were expected to fund operations and planned needs for at least 12 months, while cautioning that future cash generation and financing availability are not assured.
Outlook, risks and notable items
- No numerical quarterly or annual guidance is provided. Management expects growth opportunities from products, properties and international markets, but notes that property activity and sales per property can fluctuate with pop-culture trends.
- Sales are seasonal: historically, more than half of annual sales occur in the third and fourth quarters, while Q1 is typically the lowest-volume and least-profitable quarter. Growth may have obscured the full effect of seasonality.
- Significant business risks include reliance on short-term, non-automatically-renewable licenses; the top ten licensors generated about 70% of Q1 sales. Pop! products accounted for about 78% of sales. Retailer concentration, changing consumer tastes, product and inventory forecasting, third-party manufacturing, foreign exchange and international operations also pose risks.
- Toys “R” Us announced a U.S. wind-down; it represented about 3.4% of 2017 sales. The quarter included $1.8m of related shipment costs without recognized revenue.
- Six putative securities class actions had been filed by March 31, 2018, with another filed April 2. The complaints allege misleading statements or omissions related to the IPO. Funko says it believes it has meritorious defenses; liability was not considered probable or reasonably estimable.
- Funko adopted the new revenue standard on January 1, 2018 with no material financial-statement impact. It expects the new lease standard, effective in 2019, to materially affect the balance sheet.
- The company is controlled through its governance arrangements by ACON and other continuing equity owners. Continuing owners may redeem FAH, LLC units for cash or Class A shares, and the Tax Receivable Agreement may require Funko to pay them 85% of specified realized or deemed tax benefits.
Investor verification points
- Check whether sales growth and the margin improvement persist after accounting for acquisitions, product mix, royalty costs and the one-time prior-year inventory step-up.
- Monitor operating cash conversion, working-capital movements, seasonal inventory needs and available revolver capacity.
- Verify debt balances, interest costs, covenant headroom and the effect of the March amendment and term-loan prepayment.
- Assess exposure to major licensors, Pop! products, large retailers and the Toys “R” Us wind-down, as well as the outcome and potential costs of the IPO-related litigation.
- Review future disclosures on Tax Receivable Agreement payments, unit redemptions and potential share dilution, and on the lease-standard implementation.