Why did gross margin shrink from 42.0% to 32.1% and what specific cost drivers contributed?

Answer

The headline numbers show that Funko’s gross margin fell sharply from 42.0 % in Q2 2024 to 32.1 % in Q2 2025. A gross‑margin decline of roughly 10 percentage points can be traced to two inter‑related components that are disclosed in the release:

Because gross margin is calculated as Gross profit ÷ Net sales, the decline can be explained by the fact that gross profit fell far faster than net sales. In other words, the cost of goods sold (COGS) rose as a share of revenue.

1. What drove the margin compression?

1. Higher cost of goods sold (COGS) relative to revenue

   • Gross profit dropped $42 M (≈ 40 %) while net sales fell only $54 M (≈ 21 %).
     
   • This asymmetry tells us that the per‑unit cost of producing Funko’s licensed collectibles, figures, and other pop‑culture items increased in Q2 2025. The higher COGS ate into the profit generated from each dollar of sales, pulling the gross‑margin ratio down from 42 % to 32 %.

2. Potential cost‑driver categories (typical for a licensed‑goods business)
   
   While the release does not item‑detail the COGS, the most common cost levers for a company like Funko are:

• Licensing fees & royalties – Funko’s products are based on a wide array of entertainment IPs (movies, TV shows, comics, video games, etc.). If royalty rates or licensing fee structures were more onerous in 2025 (e.g., new agreements, higher percentage‑based royalties, or escalator clauses tied to sales volume), the cost per unit would increase.
• Manufacturing & material costs – The pop‑culture market has been subject to commodity‑price volatility (plastics, vinyl, packaging materials). A rise in raw‑material prices or higher production‑line labor rates would directly lift COGS.
• Supply‑chain & logistics – Shipping, freight, and warehousing costs have been elevated industry‑wide due to carrier capacity constraints and fuel price spikes. If Funko absorbed a larger share of these expenses in 2025, the cost per unit would climb.
• Inventory write‑downs or obsolescence – If the company held more unsold inventory at the end of the quarter (e.g., slower‑moving licensed lines) it may have had to book higher cost of inventory, which would be reflected in a higher COGS figure.
• Production‑capacity adjustments – Scaling up or down production to meet fluctuating demand can affect unit‑cost efficiency. Under‑utilized capacity often leads to higher per‑unit overhead allocation.

1. SG&A expense increase (from $77.9 M to $82.3 M)
   
   • SG&A rose modestly (+5.6 %). Although SG&A is not part of gross margin, the increase signals higher overall cost pressure on the business (e.g., marketing pushes, higher staffing, or expanded distribution support). Some of those SG&A activities—such as intensified promotional campaigns—could have indirectly pressured gross margin by prompting the company to accept lower‑margin sales or to accelerate inventory turnover at higher cost.

2. Bottom‑line interpretation

• Margin compression is primarily a cost‑of‑goods issue. The company’s COGS grew faster than its revenue, turning a healthy 42 % gross margin into a mid‑30 % range.
• The specific cost drivers are not itemised in the press release, but based on Funko’s business model the most plausible contributors are:
  • Higher licensing/royalty payouts,
  • Rising material and manufacturing expenses,
  • Increased freight and logistics costs, and
  • Potential inventory‑valuation impacts.
• SG&A expense growth adds another layer of cost pressure, though it does not directly affect gross margin; it does, however, reduce overall profitability.

3. What to watch for in future releases

• COGS breakdown – Future earnings calls or filings that detail “cost of goods sold” by component (licensing, manufacturing, freight, inventory) will confirm which driver(s) were most material.
• Gross‑margin guidance – Management may provide a target margin range for upcoming quarters, indicating whether they expect the cost pressures to be temporary (e.g., supply‑chain normalization) or structural (e.g., higher royalty rates).
• SG&A trends – If SG&A continues to rise faster than sales, the company may need to re‑allocate resources to protect operating margins.

In short: The shrinkage of Funko’s gross margin from 42.0 % to 32.1 % is driven by a disproportionate rise in cost of goods sold relative to a modest decline in net sales. While the press release does not spell out the exact cost components, the most likely contributors are higher licensing royalties, increased manufacturing and material costs, and elevated logistics expenses—all of which reduced the profitability of each dollar of sales.