Business context and reporting period
Funko, Inc.’s 10-K covers the fiscal year ended December 31, 2017. Funko designs and sells licensed pop-culture products, primarily figures, through retail, distributor and direct-to-consumer channels. It reported one operating segment. The year-over-year comparison is affected by acquisitions and the November 2017 IPO and related reorganization; Funko consolidated FAH, LLC while holding 48.3% of its economic interest at year-end.
Financial performance and liquidity
| Metric | 2017 | 2016 |
|---|---|---|
| Net sales | $516.1 million | $426.7 million |
| Gross margin, excluding depreciation and amortization | 38.5% | 34.3% |
| Operating income | $42.1 million | $44.1 million |
| Net income | $5.6 million | $26.9 million |
| Net income attributable to Funko, Inc. | $3.7 million | $26.9 million |
| Adjusted EBITDA (non-GAAP) | $89.9 million | $97.0 million |
| Cash from operating activities | $23.8 million | $49.5 million |
Revenue grew 20.9%. Gross margin improved mainly because 2017 did not include the large inventory fair-value step-up recorded after the 2015 ACON acquisition, and from improved Funko UK product margins. Operating income declined 4.5%; higher SG&A, depreciation and amortization, and financing costs outweighed sales growth. Net income was also affected by $5.1 million of debt-extinguishment loss, $30.6 million of net interest expense, and $1.5 million of income tax expense. Basic and diluted 2017 EPS were each $0.04; EPS reflects only the post-IPO period.
Year-end cash was $7.7 million and working capital was $94.1 million, versus $6.2 million and $54.9 million, respectively, in 2016. Total debt was $233.9 million, including $10.8 million drawn on the revolver; substantially all assets secure the credit facilities. Operating cash flow fell by about half, with working capital use—particularly higher inventory—contributing to the decline. Investing cash outflow was $65.2 million, including $33.6 million for property and equipment and cash consideration for acquisitions. No off-balance-sheet arrangements were reported.
Material changes versus the prior year
- Sales increased by $89.4 million. International sales rose 88.5% to $140.0 million, largely following the move to direct European distribution; U.S. sales rose 6.7% to $376.1 million.
- SG&A increased 56.0% to $120.9 million, reflecting public-company costs, acquisitions and growth investments, including personnel and marketing. Bad-debt expense also rose, including a $2.0 million allowance for Toys “R” Us receivables following its announced U.S. wind-down.
- Funko acquired Underground Toys’ assets, Loungefly and A Large Evil Corporation (renamed Funko Animation Studios). Acquired businesses expanded international distribution, accessories and media capabilities.
- The November IPO raised approximately $117.3 million net. Proceeds and cash on hand repaid the Term Loan B, subordinated notes and then-outstanding revolver balance; the company retained a $10.8 million revolver balance at year-end.
- Pop! products represented 70% of 2017 sales, up from 64% in 2016. Sales from the top five properties declined to 23% from 36%, while active properties increased to 500 from 396.
Outlook, risks, contingencies and unusual items
The filing provides no quantified revenue or earnings guidance. Management’s stated priorities include growing sales with existing retailers, entering additional channels, broadening product offerings, expanding internationally and developing direct-to-consumer and digital engagement. Management said liquidity should be adequate for at least the next 12 months, while noting that cash generation and financing availability are not assured. A March 2018 credit amendment provided for a $13 million Term Loan A prepayment, lower interest margins and a larger revolver borrowing base, subject to conditions.
- Key operating risks include rapidly shifting pop-culture demand, reliance on short-term and non-automatically-renewable licenses, product and brand concentration, inventory forecasting, retailer health and concentration, and dependence on third-party manufacturers concentrated in Asia. Pop! was 70% of sales; the top ten licensors were 72%.
- Debt is variable-rate; management estimated a 1 percentage-point rate change would alter annual interest expense by about $2.2 million. The credit agreement has financial tests and restrictive covenants; Funko reported compliance at year-end.
- Five putative securities class actions filed from November 2017 through March 2018 allege materially misleading IPO disclosures. Funko stated that liability was not then probable or reasonably estimable and said it believes it has defenses.
- Funko recorded a $5.0 million reserve for ongoing and future royalty audits. It also recorded $2.9 million of reserves for prepaid royalties estimated not to be recoverable, primarily related to a subscription-box business being phased out in 2018.
- The Tax Cuts and Jobs Act produced a provisional $4.6 million tax expense, principally from remeasuring deferred tax assets. The company’s tax analysis was ongoing. Under the Tax Receivable Agreement, Funko may owe continuing equity owners 85% of certain realized or deemed tax benefits; no TRA liability was recorded at year-end.
- Quarterly sales are seasonal: 60.5% of 2017 sales occurred in the third and fourth quarters. The Q4 unaudited table reports sales of $169.5 million and net income of $7.5 million, versus $132.4 million and $15.8 million in Q4 2016.
Important facts for investors to verify
- Whether sales growth and improved gross margin persist after accounting for acquisitions and purchase-accounting effects, and whether SG&A growth moderates.
- Cash conversion, inventory levels, receivables and retailer exposure, particularly the Toys “R” Us balance and other customer credit risks.
- Debt amortization, variable interest costs, covenant headroom and the impact of the March 2018 credit amendment.
- License renewals, royalty-audit outcomes, minimum guarantees and the company’s dependence on Pop! and major licensors.
- Final acquisition purchase-price allocations, tax effects and any future cash obligations under the Tax Receivable Agreement.
- Developments in the IPO-related litigation and the financial exposure, if any.