Funko, Inc. — Q1 2020 Form 10-Q
Reporting period: Three months ended March 31, 2020; unaudited, compared with the three months ended March 31, 2019. Funko designs and sells licensed pop-culture products, primarily figures, through retail, distributor and direct-to-consumer channels.
Financial performance and liquidity
| Metric | Q1 2020 | Q1 2019 |
|---|---|---|
| Net sales | $136.7 million | $167.1 million |
| Gross margin, excluding depreciation and amortization | 40.4% | 38.0% |
| Operating income (loss) | $(3.0) million | $12.7 million |
| Net income (loss) | $(5.7) million | $7.1 million |
| Net income (loss) attributable to Funko, Inc. | $(4.1) million | $2.2 million |
| Class A basic and diluted EPS | $(0.12) | $0.08 |
| Adjusted EBITDA (non-GAAP) | $10.6 million | $25.3 million |
| Cash from operating activities | $37.0 million | $27.3 million |
Revenue fell 18.2%. U.S. sales decreased 9.5% to $98.5 million; international sales decreased 34.4% to $38.2 million. Figures sales declined 18.3% to $111.3 million, while other product sales declined 17.7% to $25.4 million. Funko attributed lower sales to a weaker content lineup and COVID-19 disruption. Active properties increased 11% to 681, but average sales per active property declined 27%.
Cost of sales declined 21.5% to $81.4 million, lifting gross margin to 40.4% from 38.0%, which management attributed to improved product margins and inventory management. SG&A increased 16.9% to $47.3 million, or 34.6% of sales versus 24.2%, reflecting higher personnel, facilities and professional fees. Interest expense declined 34.8% to $2.7 million, mainly following a 2019 credit-agreement margin reduction.
Cash and cash equivalents were $55.4 million at March 31, up from $25.2 million at year-end 2019; working capital was $93.2 million, down from $101.6 million. Operating cash flow benefited substantially from working-capital movements, including lower receivables and prepaid assets. Capital expenditures were $5.0 million. The filing does not provide free cash flow as a reported measure.
Debt under the credit facilities was $242.5 million, including $28.7 million drawn on the revolving facility; $46.3 million remained available at quarter-end. Funko reported compliance with its covenants as of March 31. Debt matures in September 2024. The company’s gross margin and adjusted EBITDA are non-GAAP or management-defined measures, respectively; adjusted EBITDA was $10.6 million versus $25.3 million a year earlier.
Outlook, risks and unusual items
- COVID-19: Management said the pandemic weakened demand, reduced customer orders and disrupted suppliers. It expected the greatest 2020 impact in Q2, with a significant sales decline versus Q2 2019. European Q2 shipments were expected to be minimal after planned product arrivals were shifted to Q3; management cautioned that demand might not be preserved.
- Response and liquidity: Funko furloughed a significant portion of employees, cut senior-management salaries by 20%, reduced operating costs, planned inventory and non-product-development capital spending, and managed working capital. Management believed liquidity would support at least 12 months, but warned that longer-term needs could exceed available resources and said it was considering debt, equity or equity-linked financing.
- Credit amendment after quarter-end: On May 5, 2020, lenders waived financial covenants for Q2 and Q3 2020, imposed minimum liquidity of $30 million until the leverage ratio falls below 2.50:1.00, and increased interest and fees until at least $50 million of specified net equity or convertible-debt proceeds are received. The amendment also adjusted leverage requirements after the waiver period.
- Impairment and inventory: COVID-related market-capitalization decline triggered goodwill and intangible-asset assessments; no impairment was recorded at March 31. Further market declines or prolonged pandemic effects could result in future impairment. Funko had written down $16.8 million of inventory in Q4 2019.
- Customs and controls: Funko disclosed a material weakness in controls over the completeness and accuracy of Loungefly customs-duty calculations; disclosure controls were deemed ineffective. It had previously paid $7.8 million for identified customs underpayments and recorded a $0.5 million contingent liability for potential penalties. Remediation was underway.
- Legal matters: Securities class actions and a derivative action filed in 2020 relate to alleged statements concerning 2019 results. Funko said the claims were not currently probable or reasonably estimable and intended to seek dismissal. Earlier securities litigation remained pending after an amended complaint.
- Other risks: Revenue depends heavily on licensed properties and major licensors; Disney, Lucasfilm and Marvel together accounted for about 40% of sales in each period. The filing also highlights customer concentration, seasonality, supply-chain and foreign-currency exposure, and significant debt and tax-receivable-agreement obligations.
No formal full-year financial guidance was provided. Funko said Q1 results are not necessarily indicative of full-year results and cautioned that pandemic conditions and future developments were uncertain.
Important facts for investors to verify
- Whether Q2 sales and European shipments matched management’s stated expectations, and whether delayed products reached retailers in Q3.
- Liquidity, cash generation and revolver availability after the May 5 credit amendment, including compliance with its $30 million minimum-liquidity requirement and the effect of higher borrowing costs.
- Progress in raising capital, if needed, and the potential dilution or additional debt and covenant restrictions.
- Whether the Loungefly customs-control weakness is remediated, and whether further customs penalties or legal liabilities arise.
- Whether further COVID-related deterioration triggers goodwill or intangible-asset impairment, and how inventory and license-related royalty obligations develop.