Funko, Inc. — Q2 2020 Form 10-Q
Reporting period: Three and six months ended June 30, 2020. Financial amounts below are in U.S. dollars; monetary figures are in millions unless stated otherwise.
Business context and reporting period
Funko designs and sells licensed pop-culture products, including figures, plush, accessories, apparel and homewares. COVID-19 disrupted retail operations, customer orders and product supply during the period. The company operates as one reportable segment.
Financial performance and liquidity
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Net sales | $98.1 | $191.2 | $234.8 | $358.3 |
| Gross margin, excluding D&A | 36.6% | 37.2% | 38.8% | 37.6% |
| Operating income (loss) | $(14.3) | $17.1 | $(17.3) | $29.8 |
| Net income (loss) | $(15.0) | $11.4 | $(20.7) | $18.6 |
| Net income (loss) attributable to Funko, Inc. | $(10.6) | $5.1 | $(14.7) | $7.3 |
| Class A diluted EPS | $(0.30) | $0.16 | $(0.42) | $0.24 |
| Adjusted EBITDA (non-GAAP) | $0.2 | $31.4 | $10.8 | $56.7 |
For the six months, net cash provided by operations was $32.2, versus $48.0 in 2019; investing used $11.7 and financing used $6.3. Cash increased $15.9 to $41.1. Operating cash flow benefited from working-capital movements, particularly lower receivables; it was below the prior-year period.
At June 30, cash was $41.1, working capital was $80.0, and total debt under the credit facilities was $239.9, comprising $214.4 of term-loan borrowings and $29.1 on the revolver, net of debt discount for the term-loan carrying amount. Revolver availability was $45.9. The company reported compliance with applicable covenants, with financial covenants waived for Q2 and Q3 2020 under a May amendment.
Material changes versus the prior comparable period
- Q2 sales fell 48.7%; six-month sales fell 34.5%. Management attributed the declines primarily to COVID-related store closures, lower customer orders and weaker consumer demand.
- International Q2 sales declined 70.5% to $20.2, especially in Europe; U.S. sales declined 36.5% to $77.9. European product arrivals planned for Q2 were shifted into Q3.
- Q2 gross margin decreased to 36.6%, as higher shipping and freight costs relative to sales partly offset improved product margins and inventory management. Six-month gross margin increased to 38.8% from 37.6%.
- Q2 SG&A declined 10.4% in dollars but increased to 39.9% of sales from 22.8%. Six-month SG&A increased 2.7%, while sales fell substantially.
- The company moved from profit to loss in both the quarter and first half. Six-month interest expense declined 31.8% to $5.3, primarily reflecting lower borrowing rates.
Outlook, risks and unusual items
- Management said the greatest 2020 impact was in Q2 and expected any second-half recovery to be gradual. It warned that renewed closures or slower reopenings could worsen results and that supply-chain disruption could affect Q3 and later 2020 periods. The filing provides no numerical earnings or sales guidance.
- Funko furloughed and laid off employees, reduced planned inventory and certain capital spending, cut operating costs, and temporarily reduced senior management salaries. It also shifted some production from China to Vietnam; alternate sourcing could increase costs or delay supply.
- The May credit amendment waived specified financial covenants through September 30, 2020, added a minimum-liquidity requirement of $30.0 until a leverage condition is met, and increased interest and fees until at least $50.0 of qualifying net financing proceeds are received. Management said worsening conditions could affect future covenant compliance and require further amendments.
- Management believed available liquidity could support operations for at least 12 months, but said longer-term sufficiency was uncertain and it was evaluating additional debt, equity or equity-linked financing. Such financing could increase debt or dilute shareholders.
- Management identified a goodwill impairment trigger after market capitalization fell below book value, but recorded no goodwill or long-lived-asset impairment at June 30. Further market declines or a longer-lasting pandemic could lead to future impairment.
- Disclosure controls were not effective because of a material weakness in controls over Loungefly customs-duty calculations. Funko reported approximately $7.8 of historical duty underpayments, paid that amount in 2019, and recorded a $0.5 contingent liability for potential penalties. Remediation efforts were underway.
- Pending matters include a securities class action and shareholder derivative actions relating to allegations about prior disclosures. The company said liability was not probable or reasonably estimable. A separate consolidated 2018 state securities action was dismissed with prejudice on August 5, 2020.
- Sales are concentrated: the top ten licensors represented about 75% of six-month sales, Disney/Lucasfilm/Marvel about 40%, and the top ten customers about 45%. Pop! products represented about 81% of six-month sales.
Important facts for investors to verify
- Whether retail reopenings, customer orders and consumer demand recover as management expected, and how Q3 and subsequent sales compare.
- Cash generation, working-capital requirements, revolver availability and compliance with the amended liquidity and post-waiver debt covenants.
- Whether the customs-duty control weakness is remediated, and whether U.S. Customs assesses penalties beyond the recorded liability.
- Progress and potential exposure in the securities and derivative litigation, and any changes to legal accruals or disclosures.
- Potential impairment exposure and the effects of licensed-property, customer and product concentration on sales and margins.