Funko(US:FNKO)2022-08-03 16:00Part I FINANCIAL INFORMATION Financial Statements The company reported significant net sales growth but decreased net income for Q2 and H1 2022, with increased inventory and negative operating cash flow Condensed Consolidated Statements of Income Q2 2022 net sales grew 33.7% to $315.7 million, but net income fell 24.6% to $15.8 million, driven by higher costs | Financial Metric | Three Months Ended June 30, 2022 (in thousands) | Three Months Ended June 30, 2021 (in thousands) | YoY Change | Six Months Ended June 30, 2022 (in thousands) | Six Months Ended June 30, 2021 (in thousands) | YoY Change | | :--- | :--- | :--- | :--- | :--- | :--- | :--- | | Net Sales | $315,716 | $236,110 | 33.7% | $624,059 | $425,287 | 46.7% | | Income from Operations | $8,943 | $27,291 | -67.2% | $28,746 | $44,086 | -34.8% | | Net Income | $15,793 | $20,944 | -24.6% | $30,311 | $32,030 | -5.4% | | Diluted EPS (Class A) | $0.28 | $0.34 | -17.6% | $0.53 | $0.52 | 1.9% | Condensed Consolidated Balance Sheets Total assets reached $1.14 billion by June 30, 2022, driven by a 40.6% inventory increase and new $70.0 million line of credit borrowing | Balance Sheet Item | June 30, 2022 (in thousands) | December 31, 2021 (in thousands) | Change | | :--- | :--- | :--- | :--- | | Cash and cash equivalents | $56,191 | $83,557 | -32.7% | | Inventory | $233,974 | $166,428 | 40.6% | | Total Assets | $1,138,680 | $967,503 | 17.7% | | Line of credit | $70,000 | $0 | N/A | | Total long-term debt, net | $147,094 | $155,818 | -5.6% | | Total Liabilities | $718,717 | $570,945 | 25.9% | | Total Stockholders' Equity | $419,963 | $396,558 | 5.9% | Condensed Consolidated Statements of Cash Flows Operating activities resulted in a $30.1 million net cash outflow for H1 2022, a reversal from prior year, mainly due to inventory build-up | Cash Flow Activity (Six Months Ended June 30) | 2022 (in thousands) | 2021 (in thousands) | | :--- | :--- | :--- | | Net cash (used in) provided by operating activities | $(30,139) | $71,431 | | Net cash used in investing activities | $(47,620) | $(11,129) | | Net cash provided by (used in) financing activities | $51,335 | $(17,116) | | Net change in cash and cash equivalents | $(27,366) | $43,219 | Notes to Unaudited Condensed Consolidated Financial Statements Notes detail the $14.0 million Mondo acquisition, $166.5 million term loan, $70.0 million revolver, and sales breakdown by product and geography - On June 8, 2022, the company acquired 100% of Mondo, a high-end pop culture collectibles company, for a preliminary purchase consideration of $14.0 million in cash. This acquisition is intended to expand Funko's product offerings into vinyl records, posters, and other high-end collectibles29 - As of June 30, 2022, the company had $166.5 million outstanding under its New Term Loan Facility and $70.0 million in borrowings under its New Revolving Credit Facility, with $30.0 million remaining available48 | Net Sales by Product Category (Six Months Ended June 30) | 2022 (%) | 2021 (%) | | :--- | :--- | :--- | | Core Collectible | 75.7% | 82.0% | | Loungefly | 19.2% | 13.5% | | Other | 5.1% | 4.5% | | Net Sales by Geography (Six Months Ended June 30) | 2022 (in thousands) | 2021 (in thousands) | | :--- | :--- | :--- | | United States | $463,361 | $299,704 | | Europe | $120,449 | $91,810 | | Other International | $40,249 | $33,773 | Management's Discussion and Analysis of Financial Condition and Results of Operations Q2 revenue grew 33.7%, but gross margin declined due to higher freight costs, and SG&A expenses rose 50.7%, impacting liquidity and necessitating a $70.0 million credit facility draw Results of Operations Q2 2022 net sales increased 33.7% to $315.7 million, but income from operations fell 67.2% due to a 6.4 p.p. gross margin decline and 50.7% rise in SG&A expenses | Metric (Q2 2022 vs Q2 2021) | 2022 (in millions) | 2021 (in millions) | Change | | :--- | :--- | :--- | :--- | | Net Sales | $315.7M | $236.1M | +33.7% | | Gross Margin % | 32.7% | 39.1% | -6.4 p.p. | | SG&A Expenses | $82.7M | $54.9M | +50.7% | | Income from Operations | $8.9M | $27.3M | -67.2% | - The decrease in gross margin was primarily driven by an increase in shipping and freight costs due to continued global supply chain capacity constraints and fuel-based surcharges101 - By product category in Q2 2022, Core Collectible sales grew 21.3% to $233.0 million, while Loungefly branded products saw a significant increase of 114.3% to $70.0 million99 Liquidity and Financial Condition Cash and equivalents decreased to $56.2 million, with $30.1 million net cash used in operations for H1 2022, leading to a $70.0 million credit facility draw and subsequent increase to $215.0 million - Net cash used in operating activities was $30.1 million for the first six months of 2022, compared to net cash provided of $71.4 million in the prior year period, primarily due to a significant increase in inventory134135 - On July 29, 2022, the company amended its credit agreement, increasing its New Revolving Credit Facility from $100.0 million to $215.0 million139330 - As of June 30, 2022, the company had $56.2 million in cash and cash equivalents and $140.3 million of working capital148 Quantitative and Qualitative Disclosures About Market Risk The company's market risk profile, encompassing interest rates, foreign currency, and inflation, remains materially unchanged since fiscal year 2021 - The company is exposed to market risks including interest rates, foreign currency, and inflation, with no material changes reported since the end of fiscal year 2021157 Controls and Procedures Management concluded that disclosure controls and procedures were effective as of June 30, 2022, with no material changes to internal control over financial reporting during Q2 2022 - Management concluded that as of June 30, 2022, the company's disclosure controls and procedures were effective at a reasonable assurance level159 - There were no material changes to the company's internal control over financial reporting during the second quarter of 2022160 Part II OTHER INFORMATION Legal Proceedings Material legal proceedings are discussed in detail within Note 7, "Commitments and Contingencies - Legal Contingencies," of the financial statements - For a discussion of material legal proceedings, the report refers to Note 7, "Commitments and Contingencies - Legal Contingencies," in the Notes to Unaudited Condensed Consolidated Financial Statements162 Risk Factors The company faces significant business, operational, organizational, and ownership risks, including supply chain issues, license dependency, TCG's influence, and potential stock dilution Business, Economic, Market and Operating Risks Operational risks include supply chain disruptions, high dependence on third-party licenses (e.g., 49% from Disney-owned properties), economic downturns, and a 170.9% increase in inventory - The business is highly dependent on license agreements, with the top ten licensors accounting for approximately 80% of sales for the six months ended June 30, 2022, and Disney-owned properties (Disney, LucasFilm, Marvel) collectively accounting for about 49% of sales170 - The company faces risks from economic downturns and inflation, which can reduce discretionary consumer spending and increase costs, leading to price increases on certain products to mitigate these pressures175176 - Inventory management is a key risk. As of June 30, 2022, inventories increased 170.9% over the prior year, primarily due to longer transit times from global supply chain issues. This could lead to excess inventory if consumer demand shifts200 Organizational Structure Risks Organizational risks include TCG's significant influence, substantial cash payments under the Tax Receivable Agreement, and Funko, Inc.'s dependence on distributions from FAH, LLC - Following the ACON Sale, TCG has significant influence over the company, including the right to designate two directors as long as it holds at least 20% of Class A common stock and veto power over certain corporate actions if it holds 22% or more271274275 - The Tax Receivable Agreement requires Funko to pay Continuing Equity Owners 85% of the tax benefits it realizes from the redemption or exchange of FAH, LLC common units. These payments could be significant and may be accelerated under certain conditions like a change of control282283 - As a holding company, Funko, Inc.'s principal asset is its interest in FAH, LLC. It depends on distributions from FAH, LLC to pay taxes, operating expenses, and payments under the Tax Receivable Agreement279 Ownership of Our Class A Common Stock Risks Class A common stockholders face risks of dilution from unit redemptions, no anticipated dividends, and increased compliance costs upon losing "emerging growth company" status by December 31, 2022 - Stockholders face potential dilution from the redemption of FAH, LLC common units held by Continuing Equity Owners for Class A common stock, and from shares issued under the company's equity incentive plans291293294 - The company does not anticipate paying any cash dividends on its Class A common stock in the foreseeable future, intending to retain funds for business growth and debt repayment297 - The company will cease to be an "emerging growth company" on December 31, 2022. This will subject it to increased regulatory requirements, including the auditor attestation of internal control over financial reporting required by Section 404(b) of the Sarbanes-Oxley Act306308 Unregistered Sales of Equity Securities and Use of Proceeds No unregistered sales of equity securities were reported during the period - None328 Other Information On July 29, 2022, the company amended its credit agreement, increasing the revolving credit facility to $215.0 million and transitioning the interest rate to SOFR - On July 29, 2022, the company amended its credit agreement, increasing the revolving credit facility from $100.0 million to $215.0 million and converting the interest rate index from LIBOR to SOFR330 Exhibits This section indexes exhibits filed with the Form 10-Q, including CEO/CFO certifications and the second amendment to the credit agreement - Key exhibits filed include Amendment No. 2 to the Credit Agreement, CEO and CFO certifications pursuant to Sarbanes-Oxley, and various XBRL data files334