Funko, Inc. — FY 2018 Form 10-K Summary
Reporting period: Fiscal year ended December 31, 2018. This is an annual report, not a standalone fourth-quarter filing; the filing also provides unaudited quarterly results. Unless stated otherwise, amounts below are U.S. dollars.
Business context
Funko designs and sells licensed pop-culture products, primarily figures, through retail, distributor, e-commerce and direct-to-consumer channels. It reported one operating segment. Pop! products represented 76% of 2018 sales. International sales accounted for 32% of sales, up from 27% in 2017.
Financial results and liquidity
| Metric | FY 2018 | FY 2017 | Change |
|---|---|---|---|
| Net sales | $686.1 million | $516.1 million | +32.9% |
| Gross margin, excluding depreciation and amortization | 37.6% | 38.5% | −0.9 percentage points |
| Income from operations | $63.5 million | $42.1 million | +50.8% |
| Net income | $28.3 million | $5.6 million | +405.6% |
| Net income attributable to Funko, Inc. | $9.4 million | $3.7 million | +151.2% |
| Class A diluted EPS | $0.37 | $0.04 | — |
| Operating cash flow | $50.0 million | $23.8 million | — |
| Cash and cash equivalents at year-end | $13.5 million | $7.7 million | — |
Cost of sales rose 34.9%, faster than sales, and gross margin declined. Management attributed the margin decrease mainly to a higher average royalty rate (16.1% versus 15.0%), minimum-guarantee reserves, customer compliance chargebacks and inventory reserves. Selling, general and administrative expenses rose 28.4%, but declined to 22.6% of sales from 23.4%.
Net cash used in investing activities was $27.5 million, including $26.9 million of property and equipment purchases, primarily for tooling and molds. Net cash used in financing activities was $15.0 million. Working capital was $122.8 million at year-end, compared with $94.1 million a year earlier.
Year-end debt was $247.3 million, comprising $227.3 million under the new term loan (net of discount) and $20.0 million drawn on the revolving facility. The term loan matures in October 2023; the facilities carry variable rates and are secured by substantially all borrower assets. The revolving commitment was increased from $50 million to $75 million in February 2019.
Material changes and quarterly results
- Sales growth reflected a broader portfolio and expanded retail distribution: active properties increased 34%, to 672. U.S. sales grew 23.9%; international sales grew 57.2%, primarily due to Europe.
- Fourth-quarter 2018 net sales were $233.2 million, versus $169.5 million in fourth-quarter 2017. Quarterly net income was $17.1 million versus $7.5 million; net income attributable to Funko, Inc. was $6.0 million versus $5.6 million.
- Interest expense declined to $21.7 million from $30.6 million, while the company recorded a $4.5 million loss on extinguishment of debt related to refinancing its former facilities.
- 2018 included $4.1 million of foreign-currency transaction loss in other expense and approximately $1.0 million of severance costs associated with senior-management departures. Adjusted EBITDA was $116.2 million, a non-GAAP measure; reported EBITDA was $94.0 million.
Outlook, risks and contingencies
Management stated that available liquidity was expected to support operations, growth plans, capital expenditures and public-company costs for at least the next 12 months, while cautioning that future cash flows and revolving-credit availability might not be sufficient. The filing gives no specific sales or earnings guidance. Stated growth priorities include expanding retail relationships and international sales, broadening product categories and developing the Funko brand across channels. Funko acquired board-game developer Forrest-Pruzan Creative in February 2019.
- Licensing and demand: Products depend heavily on third-party licenses, which are generally two- to three-year agreements and not automatically renewable. Disney, Lucasfilm and Marvel together represented about 34% of sales in 2018. Changing pop-culture preferences and concentration in the Pop! brand create demand risk.
- Margins, inventory and supply chain: Minimum guarantees, royalty audits, inventory obsolescence, seasonal demand, production concentrated among third-party manufacturers, and exposure to tariffs and shipping disruption could affect results.
- Debt and liquidity: Variable-rate borrowings expose the company to interest-rate changes; management estimated a 1% rate change would affect annual interest expense by approximately $2.5 million. Credit covenants restrict certain activities and require financial-ratio compliance.
- Legal matters: Securities class-action lawsuits alleging misleading statements in connection with the IPO remained pending. The company said liability was not probable or reasonably estimable and stated it believes it has meritorious defenses. A separate $9.5 million reserve related to ongoing and future royalty audits was disclosed.
- Other exposures: Foreign exchange, Brexit-related uncertainty, U.S.–China tariffs, product-safety compliance, retail-customer financial health and data-security risks are identified. The company reported no off-balance-sheet arrangements and said it was in compliance with credit covenants at year-end.
Important facts for investors to verify
- Whether sales growth and international expansion continue, and whether Funko can sustain margins as royalties and minimum-guarantee reserves change.
- Cash conversion and working-capital needs, particularly receivables, inventory and seasonal inventory build.
- Debt repayment, variable-rate exposure, covenant headroom and use of the expanded revolver.
- Renewal terms and sales exposure for major licenses, including the effect of the January 2019 Disney-related renewals.
- Developments in the securities litigation and royalty audits, and any resulting financial exposure.
- Impact of the 2019 board-game acquisition and lease-accounting adoption on reported results and balance-sheet comparability.