Funko, Inc. — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018; comparisons are with the same 2017 periods. Funko designs, sources, and distributes licensed pop-culture products. It reports one operating segment. Amounts below are in U.S. dollars.
Financial performance
- Q3 revenue: $176.9 million, up 23.9% year over year. Consolidated net income was $8.1 million, versus $8.3 million; net income attributable to Funko, Inc. was $2.0 million, versus $8.3 million. Class A EPS was $0.09 basic and $0.08 diluted.
- Nine-month revenue: $452.8 million, up 30.7%. Consolidated net income was $11.2 million, compared with a $1.9 million loss in 2017; $3.3 million was attributable to Funko, Inc., with $7.8 million attributable to non-controlling interests.
- Margins: Gross margin, excluding depreciation and amortization, was 38.4% in Q3 versus 40.9%; it was 38.1% for both nine-month periods. Q3 operating income was $16.8 million, down 3.2%; nine-month operating income rose 45.2% to $33.1 million.
- Interest and taxes: Net interest expense fell to $5.8 million in Q3 and $17.2 million year to date, mainly following debt repayments funded with IPO proceeds. Nine-month income tax expense was $2.0 million.
- Cash flow: Nine-month operating cash flow was $21.4 million, versus $10.4 million. Investing used $21.5 million, including $20.9 million of property and equipment purchases; financing provided $3.6 million. Cash increased $2.8 million to $10.6 million.
- Liquidity and debt: Working capital was $78.8 million, down from $94.1 million at December 31, 2017. At September 30, debt carrying value was $259.1 million, including $54.9 million drawn on the line of credit; cash was $10.6 million. The company reported compliance with its debt covenants.
- Supplemental measures: Adjusted EBITDA was $34.1 million for Q3 and $71.5 million year to date, compared with $27.0 million and $58.3 million. These non-GAAP measures include adjustments and should not be treated as substitutes for GAAP results or cash flow.
Changes and management commentary
- Growth was attributed to a broader product and licensed-property portfolio and improved distribution and retail placement. Active properties increased 38.3% in Q3 to 553; average sales per active property fell 10.4% in the quarter. For the nine months, active properties rose 28.2% to 600 and average sales per property rose 1.9%.
- International sales increased 44.1% in Q3 and 56.8% year to date, primarily reflecting European growth. International sales represented 32.1% of nine-month sales, compared with 26.8% in 2017.
- Q3 gross margin declined, in part because of lower average selling prices in Europe, direct-from-factory shipments with discounts, and selective European price reductions. Nine-month margin was flat despite product-mix and royalty pressures.
- SG&A rose 26.9% in Q3 and 32.2% year to date, reflecting business expansion, personnel and facility costs, equity compensation, and European distribution and other operations. SG&A included $1.0 million of severance related to senior-management departures and a one-time $2.0 million Disney-license consent fee. Nine-month results also included $1.8 million of costs related to Toys “R” Us shipments for which no revenue was recognized.
- Management stated that existing liquidity and expected resources should fund operations and plans for at least 12 months, while cautioning that future cash generation and financing availability are not assured. The filing gives no quantified revenue or earnings guidance. Management noted that more than half of historical sales occur in the third and fourth quarters, making seasonality and holiday demand relevant.
Debt, contingencies, and key risks
- Subsequent refinancing: On October 22, 2018, Funko entered new facilities comprising a $235 million term loan and $50 million revolver, primarily to repay the prior facilities. The term loan matures in 2023; stated pricing is Euro-Rate plus 3.25% or Base Rate plus 2.25%, with potential leverage-based reductions. The new agreement includes financial covenants and restrictions.
- Licensing: Disney, Lucasfilm, and Marvel license renewals were under negotiation. Those related licensors accounted for about 35% of nine-month sales; the top ten licensors accounted for about 72%. The company accrued the $2.0 million consent fee, but said its amount, timing, and final renewal terms were uncertain. A $7.7 million reserve related to ongoing and future royalty audits was also disclosed.
- Concentration and demand: Pop! products represented approximately 76% of nine-month sales. The filing highlights fast-changing consumer tastes, short product life cycles, retail and customer concentration, inventory forecasting, competition, and dependence on third-party licensors and manufacturers.
- Legal matter: Securities class actions alleging misleading statements in connection with the IPO were consolidated in Washington state court; a separate federal putative class action was also disclosed. Funko moved to dismiss the consolidated state action and said liability was not then probable or reasonably estimable.
- Other exposures: The filing identifies foreign-currency and international-operating risks, substantial debt and working-capital needs, and potential Tax Receivable Agreement payments. Funko recognized a $6.6 million Tax Receivable Agreement liability during 2018. Management reported disclosure controls were effective.
Investor verification checklist
- Check progress and final terms of the Disney, Lucasfilm, and Marvel renewals, including any fees or royalty changes.
- Track gross margin, European pricing and shipment mix, royalty costs, and the effect of Toys “R” Us-related costs.
- Review cash conversion, working-capital movements, seasonal inventory, revolver usage, and compliance with the new credit covenants.
- Monitor outcomes and potential exposure from the securities litigation and royalty audits, and the amount and timing of Tax Receivable Agreement payments.
- Assess continued reliance on Pop! products, major licensors, key retailers, and third-party manufacturers as sales expand internationally.