Funko, Inc. — Q2 2022 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2022. Funko is a pop-culture lifestyle company selling licensed collectibles, Loungefly products and other merchandise. Unless noted, amounts below are in millions of dollars.
Financial performance
| Metric | Q2 2022 | Q2 2021 | Six months 2022 | Six months 2021 |
|---|---|---|---|---|
| Net sales | $315.7 | $236.1 | $624.1 | $425.3 |
| Gross margin, excluding D&A | 32.7% | 39.1% | 33.9% | 40.1% |
| Operating income | $8.9 | $27.3 | $28.7 | $44.1 |
| Net income | $15.8 | $20.9 | $30.3 | $32.0 |
| Net income attributable to Funko, Inc. | $14.7 | $13.8 | $24.6 | $20.3 |
| Diluted EPS | $0.28 | $0.34 | $0.53 | $0.52 |
| Adjusted EBITDA | $31.8 | $41.1 | $68.0 | $70.8 |
Q2 sales grew 33.7%; first-half sales grew 46.7%. Management attributed growth to stronger sales through specialty, mass-market and e-commerce channels, as well as comparison with pandemic-affected 2021 periods. Loungefly sales more than doubled year over year in both the quarter and first half. Despite sales growth, operating income fell 67.2% in Q2 and 34.8% in the first half as cost of sales and SG&A grew faster than revenue. Gross-margin pressure principally reflected higher freight and shipping costs amid supply constraints and fuel surcharges. Management said it had raised prices on some products to partly offset inflation in freight and product costs.
Q2 net income included an $11.0 million discrete tax benefit from releasing a valuation allowance on an outside-basis deferred tax asset. The first-half effective tax rate was negative 21.1%; reported net income and earnings comparisons should be considered in light of this tax benefit. Diluted EPS also reflects a higher diluted share count than the prior-year period.
Cash flow, balance sheet and debt
- First-half operating cash flow was negative $30.1 million, versus positive $71.4 million in 2021. The company cited a $103.8 million year-over-year adverse working-capital impact; inventory and prepaid expenses and other assets were significant cash uses.
- First-half investing cash outflow was $47.6 million, including $33.7 million of property and equipment purchases and $14.0 million for Mondo. Financing cash inflow was $51.3 million, mainly from a $70.0 million revolver draw.
- At June 30, cash and cash equivalents were $56.2 million, compared with $83.6 million at December 31, 2021. Working capital was $140.3 million, down from $167.6 million.
- Debt at quarter-end included $70.0 million drawn on the revolving facility and $166.5 million of term-loan principal (reported term debt net of discount was $164.5 million). The company had $30.0 million of revolving availability under the then-$100.0 million facility and reported covenant compliance.
- On July 29, 2022, after quarter-end, the revolver commitment was increased to $215.0 million and the interest-rate reference was transitioned from LIBOR to SOFR and other applicable benchmarks. This increases borrowing capacity, not cash on hand.
Changes, outlook and risks
- Inventory was $234.0 million at June 30, versus $166.4 million at December 31, 2021. The filing also states inventory was 170.9% above the prior-year period, citing longer transit times and goods in transit. Management warned that delayed receipts could leave inventory mismatched with demand.
- SG&A increased 50.7% in Q2 and 51.8% in the first half. Drivers included personnel and warehouse costs, professional fees, marketing and costs associated with consolidating U.S. distribution operations into the Buckeye, Arizona facility. Management expected personnel and related costs to remain elevated through at least year-end 2022 and ERP costs to remain elevated as implementation steps continued into early 2023.
- The June acquisition of Mondo, a high-end pop-culture collectibles business, had preliminary cash consideration of $14.0 million. Purchase-price allocation remained preliminary; the filing recorded $6.2 million of goodwill and a $2.3 million trade-name intangible asset. Mondo’s post-acquisition operating contribution was not material.
- The company stated that available liquidity was expected to support operations, growth plans and capital expenditures for at least 12 months, but cautioned that this depended on operating cash generation and revolver availability. It disclosed no specific revenue or earnings guidance in the supplied filing text.
- Key risks include persistent freight, product and wage inflation; supply-chain disruption; inventory and demand forecasting; reliance on licensed properties and concentrated licensors; retail customer and supplier concentration; foreign exchange and international operations; debt and covenant requirements; and execution of warehouse and ERP transitions. The top ten licensors accounted for about 80% of first-half sales, while Disney-related licensors collectively accounted for about 49%.
- Legal matters include securities and derivative litigation. A securities class-action settlement was preliminarily approved after quarter-end; the company said insurance would cover the settlement cost. Other securities-related cases remained pending or stayed. The filing also reported a $15.3 million reserve for ongoing and future royalty audits and a $0.5 million contingent liability for potential U.S. Customs penalties related to previously disclosed duty underpayments.
- A shelf registration effective July 26, 2022 permits the company to offer up to $100.0 million of securities and certain stockholders to resell 17.3 million Class A shares. Such offerings or resales could affect dilution and the share price. TCG acquired a substantial stake from ACON in May 2022 and has significant governance influence.
Important facts for investors to verify
- Whether freight and product-cost inflation eases, pricing offsets costs, and gross margins recover.
- Inventory levels, transit times, customer orders and any resulting markdowns or write-downs.
- Operating cash flow and working-capital trends, including seasonal cash needs, revolver usage and covenant headroom.
- The final Mondo purchase-price allocation and its integration, sales contribution and profitability.
- Progress and costs of the Arizona warehouse transition and ERP implementation.
- Developments in pending litigation, royalty audits and the customs matter, including any amounts not covered by insurance or existing reserves.
- Potential dilution or market impact from equity issuance, stockholder resales, unit redemptions and the company’s tax receivable agreement obligations.