Funko, Inc. — Q1 2019 Form 10-Q
Reporting period: Three months ended March 31, 2019; comparisons are with the three months ended March 31, 2018 unless otherwise noted. Funko designs, sources, and distributes licensed pop-culture consumer products. Results are unaudited and the company cautions that first-quarter results are not necessarily indicative of the full year, partly because of seasonality.
Financial performance and liquidity
| Metric | Q1 2019 | Q1 2018 / comparison |
|---|---|---|
| Net sales | $166.8 million | $137.2 million; up 21.6% |
| Gross profit and gross margin, before depreciation and amortization | $63.5 million; 38.1% | $51.3 million; 37.4% |
| Operating income / margin | $12.6 million / 7.6% | $7.2 million / 5.2% |
| Net income, consolidated | $7.1 million | $2.2 million |
| Net income attributable to Funko, Inc. / diluted EPS | $2.2 million / $0.08 | $0.9 million / $0.04 |
| Operating cash flow | $27.3 million | $9.5 million |
| Cash and cash equivalents | $22.5 million at March 31, 2019 | $13.5 million at December 31, 2018 |
| Working capital | $112.4 million at March 31, 2019 | $122.8 million at December 31, 2018 |
| Debt | $251.6 million principal outstanding: $229.1 million term loan and $22.5 million revolver | Carrying value, net of debt issuance costs, was $247.1 million |
Investing cash outflow was $10.0 million, including $6.4 million net cash consideration for the Forrest-Pruzan acquisition and $3.6 million of capital expenditures. Financing cash outflow was $7.6 million, including $8.1 million of distributions to continuing equity owners and $2.9 million of term-loan repayments. Cash increased $9.1 million during the quarter.
Material changes and business drivers
- Sales growth reflected more active licensed properties and demand across regions and product categories. Active properties rose 34.6% to 611, while average sales per active property fell 9.7%.
- U.S. sales increased 22.3% to $108.7 million; international sales increased 20.1% to $58.1 million. Figures sales rose 17.6% to $136.0 million; other products rose 42.5% to $30.8 million, primarily reflecting Loungefly and other softline growth.
- Gross margin improved 0.7 percentage point. Management cited lower product costs and shipping and freight costs as a share of sales, partly offset by higher customer chargebacks and royalties as a share of sales. The comparison also benefited from $1.8 million of Toys “R” Us shipment costs in Q1 2018 for which no revenue was recognized.
- SG&A increased 17.3% to $40.8 million, but declined to 24.5% of sales from 25.4%. Drivers included higher personnel expense and commissions, equity compensation, and rent and facilities costs.
- Net interest expense fell 30.9% to $4.1 million, which the company attributed to lower rates under its new credit facilities. Other expense was $0.1 million versus $1.4 million of other income in Q1 2018, largely reflecting foreign-currency transaction gains and losses.
- Funko acquired Forrest-Pruzan Creative, a board-game development studio, on February 11, 2019, to expand into board games. Preliminary consideration was $11.9 million, including cash, 126,757 Class A shares, and deferred or held-back cash. The preliminary allocation included $8.9 million of goodwill; the purchase accounting was not final.
Outlook, risks, and unusual items
- No specific revenue, earnings, or margin guidance is provided. Management said cash, operating cash flow, and revolver availability are expected to fund operations, growth plans, capital expenditures, and public-company costs for at least the next 12 months, while warning that additional financing could be needed if cash generation or facility availability proves insufficient.
- The company says more than 50% of sales have historically occurred in the third and fourth quarters; Q1 is typically the lowest-volume and least-profitable quarter. Demand and results can fluctuate with consumer trends, content-release timing, and product mix.
- Licensed-product and brand concentration is material: the top ten licensors accounted for about 77% of Q1 2019 sales, and Disney, Lucasfilm, and Marvel together about 40%. Pop! products represented about 81% of sales. The filing highlights renewal, royalty, consumer-demand, and licensing risks; Disney, Lucasfilm, and Marvel licenses were renewed in January 2019.
- The company recorded an $18.6 million increase in Tax Receivable Agreement liabilities following redemptions of 3.3 million FAH, LLC common units; total obligation including accrued interest was $25.4 million at quarter-end. The agreement generally requires payments to continuing equity owners equal to 85% of specified tax benefits.
- Lease accounting adoption on January 1, 2019 added operating lease right-of-use assets and liabilities. At March 31, lease liabilities were $37.5 million and right-of-use assets $33.1 million. A ten-year retail-location lease commenced April 1, with approximately $21.1 million of base rent over its term, subject to abatements and variable costs.
- Debt is secured by substantially all assets of the borrowers and certain subsidiaries, carries financial covenants, and matures October 22, 2023. Funko reported compliance with all covenants at March 31. It amended the revolver to $75 million; $22.5 million was drawn at quarter-end.
- Funko filed a preliminary shelf registration statement on April 20 that, if effective, could permit company offerings of up to $100 million of securities and resale by certain holders of 31,934,185 Class A shares. Offerings are not assured, but could dilute shareholders or add selling pressure.
- Pending securities class actions allege misleading statements or omissions related to the IPO. The company said liability was not probable or reasonably estimable and asserted it had meritorious defenses. Royalty audits also remain a risk; the company reported an $8.2 million reserve for ongoing and future audits.
- Other key risks include tariff and trade-policy exposure, foreign-currency movements, reliance on third-party manufacturers and retailers, inventory forecasting, customer and licensor concentration, and potential dilution from unit redemptions and equity issuance.
Important facts for investors to verify
- Whether sales growth, active-property expansion, and growth outside figures persist, and whether average sales per active property stabilizes.
- Whether gross-margin gains are sustainable after considering product mix, royalties, customer chargebacks, freight, and the prior-year Toys “R” Us comparison.
- How operating cash flow and working capital perform through seasonal inventory build-up, and the company’s remaining borrowing capacity and covenant headroom.
- The final Forrest-Pruzan purchase-price allocation and the acquisition’s contribution to results.
- The size, timing, and cash impact of Tax Receivable Agreement payments, including effects of future unit redemptions.
- Developments in securities litigation and royalty audits, and any resulting losses or settlements.
- Whether the preliminary shelf registration becomes effective and whether company or shareholder sales occur.