Funko, Inc. — Q3 2021 Form 10-Q
Reporting period: Three and nine months ended September 30, 2021. Amounts are in millions except per-share data. Comparisons are with the corresponding 2020 periods, which were affected by COVID-19-related disruptions.
Business context and results
Funko designs and sells licensed pop-culture products, including figures, accessories and apparel, and began expanding into digital NFTs. It reports one operating segment. Pop! products represented 72.1% of Q3 sales and 76.3% of nine-month sales.
Financial performance
| Metric | Q3 2021 | Q3 2020 | Nine months 2021 | Nine months 2020 |
|---|---|---|---|---|
| Net sales | $267.7 | $191.2 | $693.0 | $426.0 |
| Gross margin, excluding depreciation and amortization | 36.0% | 38.6% | 38.5% | 38.7% |
| Operating income | $26.2 | $20.7 | $70.3 | $3.4 |
| Consolidated net income (loss) | $18.4 | $15.6 | $50.4 | $(5.1) |
| Net income (loss) attributable to Funko, Inc. | $11.9 | $9.8 | $32.2 | $(4.9) |
| Diluted Class A EPS | $0.28 | $0.27 | $0.80 | $(0.14) |
| Adjusted EBITDA (non-GAAP) | $40.2 | $36.2 | $111.0 | $47.0 |
Q3 sales rose 40.0%; nine-month sales rose 62.7%. Management attributed growth principally to higher sales through specialty retailers, e-commerce and direct-to-consumer channels, alongside more active licensed properties and higher sales per active property. Q3 growth was broad geographically, with Europe up 65.7%, the U.S. up 35.7% and other international sales up 19.1%.
Cost of sales grew faster than Q3 sales, reducing gross margin by 2.6 percentage points. Higher shipping and inbound freight costs, driven by global supply-chain capacity constraints, were the principal pressure; improved product margins partly offset them. Nine-month gross margin was down 0.2 percentage points. SG&A rose 45.5% in Q3, including increased personnel, marketing and administrative costs; for the nine months it increased 30.1%, but declined as a share of sales.
Cash flow, liquidity and debt
For the first nine months, operating cash flow was $78.8, compared with $60.3 in 2020; investing cash outflow was $17.2, mainly for tooling and molds; financing cash outflow was $20.5. Cash increased $41.0 to $93.2. Higher inventory and receivables were significant working-capital cash uses. Inventory was $140.8 at quarter-end, versus $59.8 at December 31, 2020; management said inventory was up 94% year over year, in part because longer transit times left substantial goods in transit.
Working capital was $167.8, versus $120.7 at year-end 2020. The September refinancing replaced the former term loan with a $180.0 term loan due in 2026 and a $100.0 revolving facility. At quarter-end, term debt was $180.0 principal ($177.6 net of discount); the revolver was undrawn, leaving $100.0 available. The company reported compliance with debt covenants. It recorded a $0.7 loss on extinguishment from writing off deferred financing fees.
Management stated that available liquidity was expected to fund operations, growth plans and planned capital expenditures for at least 12 months. The credit agreement includes leverage and fixed-charge coverage tests, restrictions on distributions and other covenants. Funko also reported an $82.4 Tax Receivable Agreement obligation, including accrued interest.
Outlook, risks and unusual items
- Outlook: The filing provides no numerical sales or earnings guidance. Management expected elevated freight costs to continue at least through early 2022 and said it had recently raised prices on certain products to help offset freight and inflationary costs.
- Supply chain and demand: Shipping constraints, longer delivery times, sourcing disruption, inflation and potential renewed COVID-19 impacts could pressure margins, product availability and results. Consumer preferences and licensed-property popularity can shift quickly; the business is seasonal, with more than half of historical sales generally in Q3 and Q4.
- Concentration: The top ten licensors accounted for approximately 77% of nine-month sales; Disney-related licensors Disney, Lucasfilm and Marvel together represented approximately 43%. The top ten customers represented approximately 44% of sales.
- Legal and contingent matters: On October 25, 2021, the court in the Ferreira securities action granted defendants’ motion to dismiss in part and denied it in part. On November 1, 2021, the Washington Court of Appeals reversed the dismissal of an IPO-related securities class action in most respects and remanded it. Outcomes and potential losses were not clear from the filing. A $0.5 contingent liability was recorded for possible U.S. Customs penalties related to previously identified duty underpayments; Funko had paid $7.8 to Customs in 2019.
- Other unusual items: Funko acquired a majority interest in TokenWave in March 2021; the acquired business’s results and purchase accounting were not material. It launched its first Digital Pop! NFT collection in Q3 and said future demand and commercial success were uncertain. The 2020 comparative Q3 sales figure reflects a correction that increased reported sales by $2.7, with an offsetting reduction to Q4 2020 sales.
Most important facts for investors to verify
- Whether freight, shipping delays and inventory in transit continue to weigh on gross margins and working capital, and whether recent price increases offset those costs.
- Inventory quality, sell-through and potential obsolescence as products arrive amid changing consumer demand.
- Progress on debt covenant compliance, cash generation and the capacity to meet debt service and Tax Receivable Agreement payments.
- Developments, potential exposure and insurance coverage in the securities litigation and Customs matter.
- Whether growth in sales channels, international markets and NFTs can continue without increasing reliance on concentrated licensors, customers and the Pop! brand.