Funko, Inc. — Q2 2018 Form 10-Q
Reporting period: Unaudited quarter and six months ended June 30, 2018; comparisons are with the corresponding 2017 periods. Funko designs, sources and distributes licensed pop-culture products. It reports one operating segment. Unless noted otherwise, financial amounts below are in millions of dollars.
Financial performance and liquidity
- Revenue: Q2 net sales were $138.7, up 32.4%; first-half sales were $275.9, up 35.4%. Management attributed growth mainly to an expanded portfolio: active properties rose 26.2% in Q2 and 25.2% in the first half. First-half U.S. sales grew 24.3%, while foreign sales grew 65.9%.
- Margins and operating results: Gross margin, excluding depreciation and amortization, was 38.2% in Q2 versus 37.0%, and 37.8% for the first half versus 36.2%. Operating income was $9.1 in Q2 versus $4.1, and $16.3 for the first half versus $5.4. SG&A was $34.2 in Q2 and $69.0 year to date; it represented 24.7% and 25.0% of sales, respectively.
- Profit and EPS: Consolidated net income was $0.9 in Q2 versus a $4.5 loss, and $3.1 for the first half versus a $10.2 loss. Net income attributable to Funko, Inc. was $0.4 in Q2 and $1.3 for the first half. Class A basic/diluted EPS was $0.02/$0.01 for Q2 and $0.06/$0.05 for the first half; comparable 2017 EPS is not presented because the IPO had not yet occurred.
- Non-GAAP measures: Adjusted EBITDA was $19.9 in Q2 versus $17.8, and $37.4 for the first half versus $31.3. These company-defined non-GAAP measures include adjustments such as equity compensation and foreign-currency transaction effects and should not be viewed as substitutes for GAAP results or cash flow.
- Cash flow: First-half operating cash flow was $22.1 versus $15.8. Investing used $14.8, including $14.1 of property and equipment purchases; financing used $5.1. Cash increased $3.2 to $10.9. Working-capital movements included a substantial reduction in accounts payable.
- Debt and liquidity: Debt carrying value was approximately $248.5 at June 30, including $42.3 drawn on the revolving facility; cash was $10.9. Working capital was $67.3, down from $94.1 at year-end 2017. Funko reported compliance with credit-facility covenants. The March 2018 credit amendment reduced interest margins and increased the revolver borrowing base by $20.0, subject to conditions.
Material changes and management commentary
- Q2 growth spanned figures and other products, U.S. and international sales. For the first half, figures remained 83.4% of sales. The company said European growth and higher European product margins benefited gross margin.
- Management cited higher personnel and commission costs, facilities costs, and depreciation related to tooling, molds and facilities. First-half margin also reflected approximately $1.8 of costs for Toys “R” Us shipments for which no revenue was recognized.
- Interest expense declined, largely following debt repayments funded with IPO proceeds. Other expense was $2.6 in Q2 and $1.2 for the first half; management linked the period’s foreign-currency transaction effects to this line. The MD&A describes first-half “other income,” while the statement of operations presents an expense—an apparent inconsistency to verify.
- Funko said it expects liquidity sources to support operations, growth, planned capital expenditures and public-company costs for at least 12 months, but cautioned that future cash flows and revolver availability may not be sufficient. Management noted that more than half of sales have historically occurred in Q3 and Q4, with seasonal working-capital needs.
Risks, contingencies and unusual items
- Licensed-product exposure: The top ten licensors represented approximately 72% of first-half sales; Disney, Lucasfilm and Marvel collectively represented approximately 35%. Pop!-branded products were approximately 77% of first-half sales. License renewals, royalties, changing consumer tastes and the popularity of licensed content are key risks. The company reported a $6.4 reserve related to ongoing and future royalty audits.
- Retail and inventory exposure: Toys “R” Us was winding down U.S. operations; Funko cited costs on shipments for which revenue was not recognized. Retail customer concentration, retailer financial health, demand forecasting and excess inventory are disclosed risks.
- Litigation: Securities class actions allege misleading statements or omissions in connection with the IPO. Related state-court suits were consolidated and a consolidated complaint was filed August 1, 2018; a separate federal action was also disclosed. Funko said liability was not probable or reasonably estimable and stated that it believes it has meritorious defenses.
- Debt and structure: Debt service, restrictive covenants, seasonal working-capital needs and potential Tax Receivable Agreement payments may constrain liquidity. The agreement generally requires payments to continuing equity owners equal to 85% of certain realized or deemed tax benefits.
- Accounting and other items: The company adopted the new revenue standard using the modified retrospective method with no reported financial-statement impact. It expects the lease-accounting standard effective in 2019 to have a material balance-sheet impact. Certain 2017 acquisition purchase-price allocations remained preliminary.
Most important facts for investors to verify
- Whether sales growth, especially international growth, can be sustained without weakening margins or increasing working-capital needs.
- The composition and recurrence of foreign-currency effects and the apparent inconsistency in the filing’s description of first-half other income versus reported other expense.
- Revolver availability, covenant headroom, debt-service burden and the impact of seasonal cash requirements.
- Exposure to major licensors, the Pop! product line, royalty audits and minimum guaranteed royalties.
- Developments and potential financial consequences of the securities litigation, Toys “R” Us-related shipments, and Tax Receivable Agreement obligations.