Business Overview and History:
Funko, Inc. is a leading pop culture lifestyle brand that has captivated the hearts and minds of fans worldwide. From its humble beginnings as a small company specializing in collectible vinyl figures, Funko has evolved into a diversified entertainment powerhouse, offering a vast array of products that allow fans to express their passion for their favorite franchises.
Funko, Inc. was formally established as a Delaware corporation on April 21, 2017, with the primary purpose of completing an initial public offering (IPO) of its Class A common stock and related transactions. The company was created to carry on the business of Funko Acquisition Holdings, L.L.C. (FAH, LLC) and its subsidiaries. As the sole managing member, Funko, Inc. operates and controls all of FAH, LLC's operations and conducts its business through FAH, LLC and its subsidiaries.
The origins of Funko date back to 1998 when Mike Becker founded the company in Snohomish, Washington. Initially focusing on bobblehead dolls, Funko gradually expanded its product range to include a wide variety of licensed pop culture consumer products. The company's business model revolves around licensing agreements with major entertainment companies, allowing them to create products based on popular movies, TV shows, video games, musicians, and sports teams.
A significant milestone in Funko's history occurred in 2015 when ACON Investments, L.L.C. acquired the company. This acquisition provided Funko with additional resources and capital to accelerate its growth. In the years following the acquisition, Funko expanded its product offerings, distribution channels, and global footprint, opening offices and distribution centers in the United States, Europe, and Asia to support its international expansion.
Funko's IPO took place in November 2017, raising approximately $184 million. The IPO allowed the company to pay down debt and provided additional capital for business investments. However, the years following the IPO presented several challenges for Funko, including managing rapid growth, inventory issues, and leadership changes. In response to these challenges, the company took steps in 2023 to streamline operations, reduce inventory, and strengthen its management team.
Financial Performance and Ratios:
Funko's financial performance has been a mix of successes and challenges in recent years. For the fiscal year 2023, the company reported annual revenue of $1.10 billion, a net loss of $154.08 million, annual operating cash flow of $30.93 million, and annual free cash flow of -$4.20 million. In the most recent quarter (Q2 2024), Funko reported revenue of $247.66 million, net income of $5.42 million, operating cash flow of $45.89 million, and free cash flow of $36.78 million. This represents a 3.2% increase in revenue compared to the same quarter last year, primarily due to higher sales to direct-to-consumer customers, mass-market retailers, and distributors.
The company's gross margin for the second quarter of 2024 was a strong 42%, up from 29.2% in the same period last year, driven by improved inventory management, a shift towards higher-margin direct-to-consumer sales, better than expected margins on value channel sales, and a recapture of inventory reserves.
Funko's current ratio, a measure of its short-term liquidity, stood at 0.92 as of June 30, 2024, indicating the company's ability to meet its short-term obligations. The quick ratio was 0.59. The company's debt-to-equity ratio was 1.08, suggesting a moderate level of leverage. Funko's return on equity (ROE) for the trailing 12 months was -19.24%, reflecting the challenges the company has faced in recent years.
As of June 30, 2024, Funko had $41.55 million in cash and $60 million available under its $150 million Revolving Credit Facility.
Navigating the Evolving Retail Landscape:
The pop culture merchandise industry has been subject to significant changes in consumer preferences and shopping habits, particularly with the rise of e-commerce and the shift away from traditional brick-and-mortar retail. Funko has had to adapt to these market shifts, which have impacted its financial performance.
In 2023, the company experienced a slowdown in sales due to a weaker content slate, coupled with macroeconomic pressures that led to order reductions from some of its retail partners. This resulted in a net loss for the year and the recognition of a full valuation allowance on the company's deferred tax assets.
However, under the leadership of newly appointed CEO Cynthia Williams, Funko has been taking steps to stabilize its business and position itself for future growth. The company has focused on reducing its inventory levels, improving its direct-to-consumer (DTC) channel, and diversifying its product offerings to attract a broader range of fans.
In the second quarter of 2024, Funko reported a 3% year-over-year increase in net sales, with its DTC channel now accounting for 23% of gross sales, up from 18% in the same period last year. The company has also introduced new product lines, such as Bitty Pop!, a successful entry into the miniature collectible space, and Bittyverse, an extension of the Bitty Pop! line that allows fans to mix and match with new IP-driven rides, towns, and displays.
Product Segments:
Funko operates in three key product segments:
1. Core Collectible: This segment includes Funko's core line of pop culture figures and other collectibles. In the six months ended June 30, 2024, net sales of Core Collectible products accounted for approximately 74.2% of the company's total net sales, representing Funko's largest and most established product category.
2. Loungefly: The Loungefly segment includes the company's line of Loungefly-branded bags, wallets, apparel, and other accessories. In the six months ended June 30, 2024, net sales of Loungefly products accounted for 17.7% of total net sales. Loungefly was acquired by Funko in 2018 and has become an important part of the company's product offering, targeting younger consumers with fashion-forward pop culture-inspired accessories and bags.
3. Other: The Other segment includes a variety of Funko's other product lines, such as games, digital collectibles, and other miscellaneous items. In the six months ended June 30, 2024, net sales of products in the Other category accounted for 8.1% of total net sales.
Geographic Markets:
Funko generates approximately 34% of its net sales outside the United States, with key international markets including Europe and certain emerging markets in the Middle East. This international presence provides the company with diversification and growth opportunities beyond its core U.S. market.
Outlook and Guidance:
For the third quarter of 2024, Funko provided guidance for net sales between $282 million and $297 million, gross margin between 38% and 39%, SG&A expense of $90 million to $95 million, adjusted net income between $0.5 million ($0.01 per diluted share) and $3 million ($0.06 per diluted share), and adjusted EBITDA between $21 million and $25 million.
For the full year 2024, Funko is reiterating its guidance range for net sales of $1.047 billion to $1.103 billion and adjusted EBITDA of $65 million to $85 million. The company expects its fourth quarter to be stronger than the third quarter due to its higher mix of DTC sales and the giftable nature of product lines like Pop! Yourself and Bitty Pop!.
It's worth noting that Funko beat their Q2 2024 guidance, reporting net sales of $247.7 million and adjusted EBITDA of $27.9 million, both of which were higher than their guidance ranges. The Q3 guidance reflects a pull-forward of approximately $9 million in net sales from Q3 to Q2.
Challenges and Risks:
Funko faces several risks and challenges in the current environment. The company's heavy reliance on licensed content from third-party providers exposes it to the success or failure of those properties. The rapidly evolving consumer preferences and the competitive landscape also pose ongoing challenges, requiring Funko to continuously innovate and adapt its product offerings.
Additionally, Funko's international operations, particularly in Asia, where most of its products are manufactured, expose the company to risks such as currency fluctuations, supply chain disruptions, and geopolitical tensions. The company's ability to manage these risks will be crucial to its long-term success.
Short Reports and Scandals:
In 2019, Funko's subsidiary, Loungefly, was found to have historically underpaid certain duties owed to U.S. Customs. The company promptly notified the authorities, conducted an internal investigation, and paid the outstanding duties along with a $1 million penalty. This incident highlighted the importance of robust compliance and risk management practices within Funko's operations.
More recently, in July 2023, Funko's then-CEO, Brian Mariotti, took a six-month sabbatical, and the company appointed Michael Lunsford as Interim CEO. In September 2023, Mariotti resigned from the board and the company, and entered into an advisory agreement. This leadership transition was met with some uncertainty among investors, but in May 2024, the company announced the appointment of Cynthia Williams as the new permanent CEO, a move that has been generally well-received by the market.
Conclusion:
Funko's journey as a pop culture lifestyle brand has been marked by both successes and challenges. The company's ability to adapt to the evolving retail landscape, diversify its product offerings, and strengthen its direct-to-consumer channels will be crucial in navigating the current market environment. With new leadership in place and a focus on stabilizing the business, Funko is poised to leverage its strong brand recognition and loyal fan base to drive future growth and profitability. The company's recent financial performance, particularly in Q2 2024, shows signs of improvement, but continued execution on its strategic initiatives will be key to maintaining this positive momentum.