Funko, Inc. — Q3 2023 Form 10-Q
Reporting period: Three and nine months ended September 30, 2023. Amounts are in U.S. dollars; financial statement figures are unaudited. Funko sells licensed pop-culture products, with approximately 31% of nine-month sales generated outside the United States.
Financial performance and liquidity
| Metric | Q3 2023 | Q3 2022 | Nine months 2023 | Nine months 2022 |
|---|---|---|---|---|
| Net sales | $312.9 million | $365.6 million | $804.9 million | $989.7 million |
| Gross margin, excluding depreciation and amortization | 33.2% | 35.0% | 27.8% | 34.3% |
| Operating income (loss) | $(5.4) million | $17.4 million | $(100.4) million | $46.1 million |
| Net income (loss) | $(16.2) million | $11.1 million | $(153.2) million | $41.5 million |
| Net income (loss) attributable to Funko, Inc. | $(15.0) million | $9.6 million | $(143.3) million | $34.2 million |
| Adjusted EBITDA | $25.4 million | $35.7 million | $3.7 million | $103.7 million |
- Revenue and margins: Q3 sales fell 14.4% year over year; nine-month sales declined 18.7%. Lower sales and inventory reserves and adjustments weighed on margins. U.S. sales fell 20.4% in Q3 and 23.1% for the nine-month period; Europe grew 6.6% in Q3 but declined 2.7% over nine months.
- Expenses and interest: Q3 SG&A was $94.0 million, or 30.0% of sales, versus 26.8% a year earlier. Nine-month SG&A rose 8.0% to $279.7 million. Nine-month net interest expense increased to $20.6 million from $5.9 million, reflecting higher debt balances and rates.
- Cash flow: Nine-month operating cash flow was $(2.9) million, compared with $(64.7) million in 2022. Investing cash outflow was $35.6 million, including $30.9 million of property and equipment purchases; financing cash inflow was $51.3 million. Cash increased to $31.9 million from $19.2 million at year-end 2022.
- Balance sheet and debt: At September 30, cash was $31.9 million, inventory $162.1 million, and working capital was negative $16.8 million. Debt comprised $141.0 million drawn on the revolver, $144.0 million of term-loan principal, and $16.6 million under an equipment finance loan; the balance-sheet carrying amount, including the revolver and net of debt discounts, was approximately $299.5 million. No revolving-credit availability remained.
Material changes, unusual items, and outlook
- Retailers slowed restocking and some canceled orders amid a challenging retail environment. Management said it adjusted inventory purchasing toward core products. Active properties and average sales per active property both declined in the periods discussed.
- Nine-month results include a $30.1 million inventory write-down under a plan to improve U.S. warehouse efficiency, plus $8.6 million of disposal costs for unfinished and finished goods held at offshore factories. The Q3 period included $6.1 million of finished-goods disposal costs, primarily associated with customer order cancellations.
- A full $123.2 million valuation allowance against deferred tax assets drove nine-month income tax expense to $130.9 million. Separately, Funko recorded a $99.6 million gain after reducing its tax receivable agreement liability because related future tax benefits were no longer considered probable and estimable. These items materially affect reported nine-month net loss; the liability could be reinstated if use of the tax benefits becomes more likely.
- Other notable charges included $6.2 million related to terminating a lease that had not commenced, reduction-in-force and related costs, and a $0.5 million debt-extinguishment loss. The company also paid $1.0 million of customs penalties and interest during Q3 related to previously identified duty underpayments.
- Guidance and liquidity: The filing gives no numerical sales or earnings guidance. Management said it believes liquidity is sufficient for at least the next 12 months, but cautioned that operating cash flow and financing availability may be insufficient. The February 2023 credit amendment imposed a covenant waiver period through Q4 2023, restricted revolver draws and payments, raised borrowing margins, and reduced the facility size; the facility is scheduled to fall to $150 million after December 31, 2023. Financial covenants return for the quarter ending March 31, 2024. Management expected covenant compliance for at least one year based on current forecasts, but warned results could affect its ability to comply.
- Controls, management, and risks: Disclosure controls were not effective as of September 30 because previously reported material weaknesses in internal control remained under remediation. The filing cites leadership changes, concentrated reliance on licensed properties and major licensors, inventory and retail-demand risks, indebtedness and covenant restrictions, and ongoing securities and derivative litigation. Management says the outcomes of pending matters cannot be predicted with certainty.
Important facts for investors to verify
- Whether sales, gross margin, inventory levels, and operating cash flow stabilize after retailer destocking and inventory reductions.
- Current borrowing availability, near-term revolver obligations, and compliance with covenants when the waiver period ends and financial tests resume.
- Whether the deferred-tax-asset valuation allowance or tax receivable agreement liability changes, and the potential cash and earnings effects.
- Progress and testing results for remediation of the material weaknesses in financial reporting controls.
- Developments in the securities and derivative litigation, the customs matter, and any potential unrecorded contingencies.