Funko(US:FNKO)2023-11-01 16:00markdown Part I [Item 1. Financial Statements](index=6&type=section&id=Item%201.%20Financial%20Statements) This section presents the unaudited condensed consolidated financial statements for Funko, Inc. and its subsidiaries, including statements of operations, comprehensive (loss) income, balance sheets, and cash flows, along with detailed notes explaining significant accounting policies, debt, tax receivable agreements, commitments, segments, income taxes, stockholders' equity, non-controlling interests, and earnings per share [Condensed Consolidated Statements of Operations (unaudited)](index=6&type=section&id=Condensed%20Consolidated%20Statements%20of%20Operations%20(unaudited)) For the three months ended September 30, 2023, Funko reported a **net loss** of **$16.2 million**, a **significant decline** from a **net income** of **$11.1 million** in the prior year period. Net sales **decreased** by **14.4%** to **$312.9 million**. For the nine months ended September 30, 2023, the company incurred a **net loss** of **$153.2 million**, compared to a **net income** of **$41.5 million** in the same period of 2022, with net sales **decreased** by **18.7%** to **$804.9 million** | Metric (in thousands) | 3 Months Ended Sep 30, 2023 | 3 Months Ended Sep 30, 2022 | 9 Months Ended Sep 30, 2023 | 9 Months Ended Sep 30, 2022 | | :-------------------- | :-------------------------- | :-------------------------- | :-------------------------- | :-------------------------- | | Net sales | $312,944 | $365,607 | $804,850 | $989,666 | | (Loss) income from operations | $(5,449) | $17,394 | $(100,427) | $46,140 | | Net (loss) income | $(16,224) | $11,149 | $(153,230) | $41,460 | | Net (loss) income attributable to Funko, Inc. | $(15,009) | $9,630 | $(143,318) | $34,184 | | Basic EPS | $(0.31) | $0.21 | $(3.01) | $0.78 | | Diluted EPS | $(0.31) | $0.19 | $(3.01) | $0.73 | [Condensed Consolidated Statements of Comprehensive (Loss) Income (unaudited)](index=7&type=section&id=Condensed%20Consolidated%20Statements%20of%20Comprehensive%20(Loss)%20Income%20(unaudited)) The company reported a comprehensive **loss** of **$19.1 million** for the three months ended September 30, 2023, compared to comprehensive **income** of **$7.5 million** in the prior year. For the nine months ended September 30, 2023, the comprehensive **loss** was **$153.6 million**, a **significant reversal** from comprehensive **income** of **$33.1 million** in the same period of 2022, primarily due to **net losses** and foreign currency translation **losses** | Metric (in thousands) | 3 Months Ended Sep 30, 2023 | 3 Months Ended Sep 30, 2022 | 9 Months Ended Sep 30, 2023 | 9 Months Ended Sep 30, 2022 | | :-------------------- | :-------------------------- | :-------------------------- | :-------------------------- | :-------------------------- | | Net (loss) income | $(16,224) | $11,149 | $(153,230) | $41,460 | | Foreign currency translation gain (loss), net of tax | $(2,839) | $(3,674) | $(391) | $(8,335) |\ | Comprehensive (loss) income | $(19,063) | $7,475 | $(153,621) | $33,125 | | Comprehensive (loss) income attributable to Funko, Inc. | $(17,613) | $6,354 | $(143,745) | $27,255 | [Condensed Consolidated Balance Sheets (unaudited)](index=8&type=section&id=Condensed%20Consolidated%20Balance%20Sheets%20(unaudited)) As of September 30, 2023, total assets **decreased** to **$880.0 million** from **$1,091.1 million** at December 31, 2022, primarily driven by a reduction in inventory and deferred tax assets. Total liabilities **increased** to **$421.7 million** from **$361.4 million**, mainly due to an **increase** in the line of credit. Total stockholders' equity **decreased significantly** to **$242.8 million** from **$389.7 million** | Metric (in thousands) | September 30, 2023 | December 31, 2022 | | :-------------------- | :----------------- | :---------------- | | Cash and cash equivalents | $31,885 | $19,200 | | Inventory | $162,062 | $246,429 | | Total current assets | $404,929 | $473,172 | | Total assets | $880,043 | $1,091,145 | | Line of credit | $141,000 | $70,000 | | Total current liabilities | $421,734 | $361,397 | | Liabilities under tax receivable agreement, net of current portion | $0 | $99,620 | | Total stockholders' equity | $242,766 | $389,689 | [Condensed Consolidated Statements of Cash Flows (unaudited)](index=9&type=section&id=Condensed%20Consolidated%20Statements%20of%20Cash%20Flows%20(unaudited)) For the nine months ended September 30, 2023, net cash used in operating activities **significantly decreased** to **$2.9 million** from **$64.7 million** in the prior year, primarily due to favorable changes in working capital, including a substantial reduction in inventory. Net cash used in investing activities **decreased** to **$35.6 million** from **$60.1 million**. Net cash provided by financing activities was **$51.3 million**, down from **$66.8 million** in 2022 | Metric (in thousands) | 9 Months Ended Sep 30, 2023 | 9 Months Ended Sep 30, 2022 | | :-------------------- | :-------------------------- | :-------------------------- | | Net cash used in operating activities | $(2,867) | $(64,682) | | Net cash used in investing activities | $(35,584) | $(60,097) | | Net cash provided by financing activities | $51,309 | $66,797 | | Net change in cash and cash equivalents | $12,685 | $(58,507) | | Cash and cash equivalents at end of period | $31,885 | $25,050 | [Notes to Unaudited Condensed Consolidated Financial Statements](index=10&type=section&id=Notes%20to%20Unaudited%20Condensed%20Consolidated%20Financial%20Statements) The notes provide detailed explanations for the financial statements, covering the company's organizational structure, significant accounting policies including a **$30.1 million** inventory write-down and a **$123.2 million** deferred tax asset valuation allowance, fair value measurements, debt facilities and amendments, changes in tax receivable agreement liability, various commitments and legal contingencies, segment information, income tax details, stockholders' equity changes, non-controlling interests, and earnings per share calculations [1. Organization and Operations](index=10&type=section&id=1.%20Organization%20and%20Operations) Funko, Inc. was formed in 2017 for its IPO and consolidates the financial results of FAH, LLC, reporting a non-controlling interest for units held by other owners. Interim financial results are not necessarily indicative of the full year due to seasonality - Funko, Inc. consolidates FAH, LLC's operations and reports **non-controlling interests** for common units held by other owners[25](index=25&type=chunk) - Interim results are not indicative of full-year performance due to seasonality and other factors[26](index=26&type=chunk) [2. Significant Accounting Policies](index=10&type=section&id=2.%20Significant%20Accounting%20Policies) Key accounting policies involve estimates affecting financial statements. During the nine months ended September 30, 2023, Funko recorded a **$30.1 million** one-time inventory write-down for operational efficiency and established a **full valuation allowance** of **$123.2 million** against deferred tax assets due to cumulative pre-tax **losses**, leading to a **$99.6 million** gain on tax receivable agreement liability adjustment - The Company recorded a **$30.1 million** one-time inventory write-down in cost of sales during the nine months ended September 30, 2023, to improve U.S. warehouse operational efficiency[29](index=29&type=chunk) - A **full valuation allowance** of **$123.2 million** was established against deferred tax assets due to the Company's three-year cumulative pre-tax **loss** position, reducing the carrying balance to **$0**[30](index=30&type=chunk) - The Tax Receivable Agreement (TRA) liability was **reduced** by **$99.6 million**, recognizing a gain, as payments related to unrealized tax benefits were no longer probable and estimable due to the deferred tax asset **valuation allowance**[31](index=31&type=chunk) [3. Fair Value Measurements](index=11&type=section&id=3.%20Fair%20Value%20Measurements) Funko's financial instruments, including cash equivalents, crypto asset safeguarding liability, and debt, are measured at fair value using a three-tier hierarchy. Cash equivalents, primarily money market funds, are Level 1. Crypto asset safeguarding liability and corresponding assets are Level 2, valued at **$13.0 million** as of September 30, 2023. Debt instruments are classified as Level 3, with an estimated fair value of **$160.6 million** compared to a carrying value of **$158.5 million** as of September 30, 2023 | Financial Instrument | Classification | September 30, 2023 (in thousands) | December 31, 2022 (in thousands) | | :------------------- | :------------- | :-------------------------------- | :-------------------------------- | | Cash equivalents | Level 1 | $10,800 | $500 | | Crypto asset safeguarding liability and asset | Level 2 | $13,000 | $11,300 | | Debt (estimated fair value) | Level 3 | $160,600 | $177,500 | | Debt (carrying value) | Level 3 | $158,500 | $175,800 | [4. Debt](index=12&type=section&id=4.%20Debt) Funko's debt includes a Revolving Credit Facility and a Term Loan Facility, totaling **$285.0 million** outstanding as of September 30, 2023, along with an Equipment Finance Loan of **$16.6 million**. The New Credit Agreement was amended in February 2023 (Third Amendment) to modify financial covenants, reduce the Revolving Credit Facility size, restrict draws, and **increase** interest margins during a 'Waiver Period' through December 31, 2023. The company was in **compliance** with modified covenants as of September 30, 2023 | Debt Type (in thousands) | September 30, 2023 | December 31, 2022 | | :----------------------- | :----------------- | :---------------- | | Revolving Credit Facility | $141,000 | $70,000 | | Term Loan Facility | $144,000 | $157,500 | | Equipment Finance Loan | $16,589 | $20,000 | | Total term debt | $158,516 | $175,819 | | Long-term debt, net | $136,539 | $153,778 | - The New Revolving Credit Facility was **reduced** from **$215.0 million** to **$180.0 million** (and to **$150.0 million** by December 31, 2023) and interest margins **increased** during the Waiver Period (through December 31, 2023)[38](index=38&type=chunk) - As of September 30, 2023, the Credit Agreement Parties were in **compliance** with the modified covenants[41](index=41&type=chunk) [5. Liabilities under Tax Receivable Agreement](index=14&type=section&id=5.%20Liabilities%20under%20Tax%20Receivable%20Agreement) The Tax Receivable Agreement (TRA) requires Funko to pay TRA Parties **85%** of realized tax benefits. The TRA liability was **significantly reduced** from **$109.2 million** at December 31, 2022, to **$9.6 million** as of September 30, 2023, due to the Company determining that future payments related to unrealized tax benefits are no longer probable and estimable after establishing a **full valuation allowance** on deferred tax assets | Metric (in thousands) | 3 Months Ended Sep 30, 2023 | 3 Months Ended Sep 30, 2022 | 9 Months Ended Sep 30, 2023 | 9 Months Ended Sep 30, 2022 | | :-------------------- | :-------------------------- | :-------------------------- | :-------------------------- | :-------------------------- | | Beginning balance | $9,562 | $112,733 | $109,187 | $82,884 | | Liability reduction | — | — | $(99,620) | — | | Ending balance | $9,562 | $112,746 | $9,562 | $112,746 | - The total obligation under the Tax Receivable Agreement, including accrued interest, was **$9.8 million** as of September 30, 2023, down from **$109.2 million** at December 31, 2022[49](index=49&type=chunk) - The reduction in TRA liability was due to the determination that payments related to unrealized tax benefits are no longer probable and estimable following the establishment of a **full valuation allowance** on deferred tax assets[49](index=49&type=chunk) [6. Commitments and Contingencies](index=15&type=section&id=6.%20Commitments%20and%20Contingencies) Funko is subject to various commitments and contingencies, including license agreements with royalty payments, employment agreements, debt obligations, and operating leases. The company recorded a **$6.2 million** charge for lease termination in the nine months ended September 30, 2023. Funko is also involved in several legal proceedings, including ongoing stockholder derivative actions and class action lawsuits, with some settlements in principle reached and others pending - The Company recorded a **$6.2 million** charge related to the termination of a lease agreement and related expenses during the three and nine months ended September 30, 2023[54](index=54&type=chunk) - Funko is involved in multiple stockholder derivative actions and class action lawsuits, with non-monetary settlements in principle reached for some cases (In re Funko, Inc. Derivative Litigation, Smith v. Mariotti, and Fletcher, et al. v. Mariotti)[56](index=56&type=chunk) - A class action lawsuit (In re Funko, Inc. Securities Litigation) alleging violations of the Securities Act of 1933 is ongoing in Washington state court, with discovery in progress and a class certification motion filed[59](index=59&type=chunk)[61](index=61&type=chunk) [7. Segments](index=18&type=section&id=7.%20Segments) Funko operates as a single segment, with its Chief Operating Decision Maker reviewing performance at a consolidated level. Product sales are categorized into Core Collectible (**74.5%** of sales for Q3 2023), Loungefly (**18.4%**), and Other (**7.1%**). Geographically, the United States remains the largest market, though sales **decreased** by **20.4%** in Q3 2023, while Europe saw a **6.6% increase** - Funko operates as a **single reportable segment**[65](index=65&type=chunk) | Product Category | 3 Months Ended Sep 30, 2023 | 3 Months Ended Sep 30, 2022 | 9 Months Ended Sep 30, 2023 | 9 Months Ended Sep 30, 2022 | | :--------------- | :-------------------------- | :-------------------------- | :-------------------------- | :-------------------------- | | Core Collectible | 74.5% | 77.2% | 73.4% | 76.3% | | Loungefly | 18.4% | 16.3% | 19.8% | 18.2% | | Other | 7.1% | 6.5% | 6.8% | 5.5% | | Geographical Net Sales (in thousands) | 3 Months Ended Sep 30, 2023 | 3 Months Ended Sep 30, 2022 | 9 Months Ended Sep 30, 2023 | 9 Months Ended Sep 30, 2022 | | :------------------------------------ | :-------------------------- | :-------------------------- | :-------------------------- | :-------------------------- | | United States | $208,895 | $262,316 | $557,899 | $725,677 | | Europe | $83,398 | $78,239 | $193,229 | $198,688 | | Other International | $20,651 | $25,052 | $53,722 | $65,301 | [8. Income Taxes](index=19&type=section&id=8.%20Income%20Taxes) Funko, Inc. is taxed as a corporation, with FAH, LLC as a pass-through entity. For the nine months ended September 30, 2023, the company recorded a **significant income tax expense** of **$130.9 million**, compared to a **$2.9 million benefit** in 2022. This **increase** is primarily due to recognizing a **full valuation allowance** on deferred tax assets, resulting in an effective tax rate of (**584.9%**) | Metric (in thousands) | 3 Months Ended Sep 30, 2023 | 3 Months Ended Sep 30, 2022 | 9 Months Ended Sep 30, 2023 | 9 Months Ended Sep 30, 2022 | | :-------------------- | :-------------------------- | :-------------------------- | :-------------------------- | :-------------------------- | | Income tax expense (benefit) | $3,076 | $2,342 | $130,859 | $(2,932) | - The effective tax rate for the nine months ended September 30, 2023, was (**584.9%**), primarily due to the establishment of a **full valuation allowance** against deferred tax assets[70](index=70&type=chunk) [9. Stockholders' Equity](index=20&type=section&id=9.%20Stockholders'%20Equity) Total stockholders' equity **decreased** from **$389.7 million** at December 31, 2022, to **$242.8 million** at September 30, 2023, primarily due to a **net loss** attributable to Funko, Inc. of **$143.3 million** for the nine months ended September 30, 2023. Class A common shares outstanding **increased** to **48.7 million**, while Class B common shares remained at **3.3 million** | Metric (in thousands) | September 30, 2023 | December 31, 2022 | | :-------------------- | :----------------- | :---------------- | | Total stockholders' equity | $242,766 | $389,689 | | Net (loss) income attributable to Funko, Inc. (9 months) | $(143,318) | $34,184 | | Class A common shares outstanding | 48,727 | 47,192 | | Class B common shares outstanding | 3,293 | 3,293 | [10. Non-controlling interests](index=21&type=section&id=10.%20Non-controlling%20interests) Funko, Inc. holds a **91.7%** economic ownership interest in FAH, LLC as of September 30, 2023, up from **91.6%** at December 31, 2022. Net loss and comprehensive loss are attributed based on this economic interest. Excluded from FAH, LLC's net income are equity-based compensation, income tax expense, and tax receivable agreement liability adjustments - Funko, Inc. owned **91.7%** economic interest in FAH, LLC as of September 30, 2023 (vs. **91.6%** at Dec 31, 2022)[76](index=76&type=chunk) | Excluded Activity (in thousands) | 3 Months Ended Sep 30, 2023 | 3 Months Ended Sep 30, 2022 | 9 Months Ended Sep 30, 2023 | 9 Months Ended Sep 30, 2022 | | :------------------------------- | :-------------------------- | :-------------------------- | :-------------------------- | :-------------------------- | | Equity-based (recapture of) compensation expense | $(916) | $4,677 | $7,521 | $11,999 | | Income tax expense (benefit) | $2,257 | $1,459 | $128,780 | $(5,216) | | Tax receivable agreement liability adjustment | — | — | $(99,620) | — | [11. Earnings per Share](index=22&type=section&id=11.%20Earnings%20per%20Share) Basic and diluted **loss** per share for Class A common stock were **$(0.31)** for the three months ended September 30, 2023, and **$(3.01)** for the nine months ended September 30, 2023, reflecting the **net loss** attributable to Funko, Inc. Potentially dilutive securities were excluded from diluted EPS calculations when their effect was **anti-dilutive** | Metric | 3 Months Ended Sep 30, 2023 | 3 Months Ended Sep 30, 2022 | 9 Months Ended Sep 30, 2023 | 9 Months Ended Sep 30, 2022 | | :----- | :-------------------------- | :-------------------------- | :-------------------------- | :-------------------------- | | Basic EPS | $(0.31) | $0.21 | $(3.01) | $0.78 | | Diluted EPS | $(0.31) | $0.19 | $(3.01) | $0.73 | - For the three and nine months ended September 30, 2023, **10.3 million** and **10.6 million** potentially dilutive securities, respectively, were excluded from diluted EPS computation due to their **anti-dilutive effect**[79](index=79&type=chunk) [Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations](index=24&type=section&id=Item%202.%20Management's%20Discussion%20and%20Analysis%20of%20Financial%20Condition%20and%20Results%20of%20Operations) This section provides management's perspective on Funko's financial condition and operational results, highlighting a **challenging retail environment**, **decreased** net sales, and **significant net losses** for both the three and nine months ended September 30, 2023. It also details liquidity, capital resources, debt covenant modifications, and critical accounting policies, including a substantial inventory write-down and deferred tax asset **valuation allowance** [Overview](index=25&type=section&id=Overview) Funko, a pop culture lifestyle brand, faces a **challenging retail environment** with slowed restocking, lower inventory levels, and order cancellations impacting net sales, gross margin, and **net income**. The company is exposed to global macroeconomic factors and has strategically adjusted inventory. Key performance indicators show **significant declines** in net sales and a shift from **net income** to **net loss** for the periods presented - Funko operates in a **challenging retail environment** characterized by slower inventory restocking, lower inventory levels, and order cancellations, impacting net sales, gross margin, and **net income**[85](index=85&type=chunk) | Metric (in thousands) | 3 Months Ended Sep 30, 2023 | 3 Months Ended Sep 30, 2022 | 9 Months Ended Sep 30, 2023 | 9 Months Ended Sep 30, 2022 | | :-------------------- | :-------------------------- | :-------------------------- | :-------------------------- | :-------------------------- | | Net sales | $312,944 | $365,607 | $804,850 | $989,666 | | Net (loss) income | $(16,224) | $11,149 | $(153,230) | $41,460 | | EBITDA | $9,918 | $29,023 | $42,514 | $78,891 | | Adjusted EBITDA | $25,394 | $35,697 | $3,745 | $103,701 | [Results of Operations](index=26&type=section&id=Results%20of%20Operations) Funko experienced a **significant decline** in net sales and a shift to **net loss** for both the three and nine months ended September 30, 2023, compared to the prior year. This was driven by **decreased** sales to retailers, higher inventory reserves, **increased** selling, general, and administrative expenses as a percentage of sales, and higher interest expenses. A **gain** on tax receivable agreement liability adjustment partially offset the nine-month **loss** [Three Months Ended September 30, 2023 Compared to Three Months Ended September 30, 2022](index=26&type=section&id=Three%20Months%20Ended%20September%2030%2C%202023%20Compared%20to%20Three%20Months%20Ended%20September%2030%2C%202022) Net sales **decreased** by **14.4%** to **$312.9 million**, primarily due to slower inventory restocking and a **challenging retail environment**. This led to a **net loss** of **$16.2 million**, compared to a **net income** of **$11.1 million** in the prior year. Gross margin **declined** to **33.2%** from **35.0%** due to **increased** inventory reserves and disposal costs. Interest expense **surged** by **155.3%** due to higher debt balances and rates | Metric (in thousands) | 2023 | 2022 | Dollar Change | Percentage Change | | :-------------------- | :---------- | :---------- | :------------ | :---------------- | | Net sales | $312,944 | $365,607 | $(52,663) | (14.4)% | | Cost of sales | $208,936 | $237,728 | $(28,792) | (12.1)% | | SG&A expenses | $93,992 | $97,930 | $(3,938) | (4.0)% | | Depreciation & amortization | $15,465 | $12,555 | $2,910 | 23.2% | | (Loss) income from operations | $(5,449) | $17,394 | $(22,843) | nm | | Interest expense, net | $7,601 | $2,977 | $4,624 | nm | | Net (loss) income | $(16,224) | $11,149 | $(27,373) | nm | - Gross margin (exclusive of depreciation and amortization) **decreased** to **33.2%** from **35.0%**, driven by **increased** inventory reserves and disposal of finished inventory[95](index=95&type=chunk) - Net sales in the United States **decreased** **20.4%** to **$208.9 million**, while Europe **increased** **6.6%** to **$83.4 million**[92](index=92&type=chunk) [Nine Months Ended September 30, 2023 Compared to Nine Months Ended September 30, 2022](index=29&type=section&id=Nine%20Months%20Ended%20September%2030%2C%202023%20Compared%20to%20Nine%20Months%20Ended%20September%2030%2C%202022) Net sales **decreased** by **18.7%** to **$804.9 million**, leading to a **net loss** of **$153.2 million**, a **significant reversal** from a **$41.5 million net income** in the prior year. Gross margin fell to **27.8%** from **34.3%** due to inventory write-downs and adjustments. Selling, general, and administrative expenses **increased** by **8.0%**, and interest expense **surged** by **251.1%**. A **$99.6 million gain** on tax receivable agreement liability adjustment partially mitigated the **loss** | Metric (in thousands) | 2023 | 2022 | Dollar Change | Percentage Change | | :-------------------- | :---------- | :---------- | :------------ | :---------------- | | Net sales | $804,850 | $989,666 | $(184,816) | (18.7)% | | Cost of sales | $581,258 | $649,974 | $(68,716) | (10.6)% | | SG&A expenses | $279,685 | $259,043 | $20,642 | 8.0% | | Depreciation & amortization | $44,334 | $34,509 | $9,825 | 28.5% | | (Loss) income from operations | $(100,427) | $46,140 | $(146,567) | nm | | Interest expense, net | $20,551 | $5,854 | $14,697 | nm | | Gain on tax receivable agreement liability | $(99,620) | — | $(99,620) | nm | | Net (loss) income | $(153,230) | $41,460 | $(194,690) | nm | - Gross margin (exclusive of depreciation and amortization) **decreased** to **27.8%** from **34.3%**, primarily due to **increased** inventory reserves and disposal of finished inventory[109](index=109&type=chunk) - Income tax expense **increased significantly** to **$130.9 million** from a **$2.9 million benefit**, mainly due to recognizing a **full valuation allowance** on deferred tax assets[116](index=116&type=chunk) [Non-GAAP Financial Measures](index=32&type=section&id=Non-GAAP%20Financial%20Measures) Funko uses non-GAAP financial measures like EBITDA, Adjusted EBITDA, Adjusted Net (Loss) Income, and Adjusted (Loss) Earnings per Diluted Share to evaluate performance, excluding non-cash charges and one-time items. For the nine months ended September 30, 2023, Adjusted EBITDA was **$3.7 million**, a **substantial decrease** from **$103.7 million** in 2022, and Adjusted **Loss** per Diluted Share was **$(0.88)** - Non-GAAP measures (EBITDA, Adjusted EBITDA, Adjusted Net (Loss) Income, Adjusted (Loss) EPS) are used to assess performance by removing non-core operational impacts[119](index=119&type=chunk)[120](index=120&type=chunk) | Metric (in thousands, except per share data) | 3 Months Ended Sep 30, 2023 | 3 Months Ended Sep 30, 2022 | 9 Months Ended Sep 30, 2023 | 9 Months Ended Sep 30, 2022 | | :------------------------------------------- | :-------------------------- | :-------------------------- | :-------------------------- | :-------------------------- | | Adjusted net income | $1,746 | $15,124 | $(45,855) | $47,503 | | Adjusted earnings (loss) per diluted share | $0.03 | $0.28 | $(0.88) | $0.88 | | EBITDA | $9,918 | $29,023 | $42,514 | $78,891 | | Adjusted EBITDA | $25,394 | $35,697 | $3,745 | $103,701 | [Liquidity and Financial Condition](index=36&type=section&id=Liquidity%20and%20Financial%20Condition) Funko's liquidity is primarily driven by working capital, inventory management, capital expenditures, and debt service. Net cash used in operating activities **decreased significantly** to **$2.9 million** for the nine months ended September 30, 2023, largely due to improved working capital from inventory reduction. The company's credit facilities were amended to modify covenants and reduce the revolving credit facility size, with **compliance** maintained as of September 30, 2023. Future liquidity needs include tax distributions and potential TRA payments [Introduction](index=36&type=section&id=Introduction) Funko's liquidity needs are primarily for working capital, inventory, capital expenditures, debt service, and general corporate purposes. The company believes current liquidity sources will be sufficient for the next 12 months, but acknowledges potential needs for additional financing if cash flows are insufficient - **Primary liquidity requirements** include working capital, inventory management, capital expenditures, debt service, and general corporate needs[133](index=133&type=chunk) - The company believes current liquidity sources will be **sufficient for the next 12 months** but **may need additional financing** if cash flows are insufficient[134](index=134&type=chunk)[135](index=135&type=chunk) [Liquidity and Capital Resources](index=36&type=section&id=Liquidity%20and%20Capital%20Resources) Net cash used in operating activities **decreased** to **$2.9 million** for the nine months ended September 30, 2023, from **$64.7 million** in 2022, driven by a **$236.0 million increase** in cash from working capital changes, particularly a **$190.9 million increase** from inventory. Net cash used in investing activities was **$35.6 million**, and net cash provided by financing activities was **$51.3 million** | Cash Flow Activity (in thousands) | 9 Months Ended Sep 30, 2023 | 9 Months Ended Sep 30, 2022 | | :-------------------------------- | :-------------------------- | :-------------------------- | | Net cash used in operating activities | $(2,867) | $(64,682) | | Net cash used in investing activities | $(35,584) | $(60,097) | | Net cash provided by financing activities | $51,309 | $66,797 | | Net change in cash and cash equivalents | $12,685 | $(58,507) | | Cash and cash equivalents at end of period | $31,885 | $25,050 | - The **decrease** in net cash used in operating activities was primarily due to a **$236.0 million increase** in cash from working capital changes, including a **$190.9 million increase** from inventory[137](index=137&type=chunk) - Financing activities included a **$71.0 million** draw on the New Revolving Credit Facility and **$16.9 million** in debt payments[140](index=140&type=chunk) [Credit Facilities](index=37&type=section&id=Credit%20Facilities) Funko's New Credit Facilities, including a Term Loan Facility and Revolving Credit Facility, were amended in February 2023 (Third Amendment). This amendment modified financial covenants, reduced the Revolving Credit Facility size, restricted draws, and **increased** interest margins during a 'Waiver Period' through December 31, 2023. The company was in **compliance** with these modified covenants as of September 30, 2023, but faces risks if operating results do not improve after the waiver period - The Third Amendment to the New Credit Agreement modified financial covenants, **reduced** the New Revolving Credit Facility to **$180.0 million** (and **$150.0 million** by Dec 31, 2023), restricted draws, and **increased** interest margins during the Waiver Period (through Dec 31, 2023)[143](index=143&type=chunk) - As of September 30, 2023, Funko had **$144.0 million** outstanding under the New Term Loan Facility and **$141.0 million** outstanding under the New Revolving Credit Facility, with **$0.0 million** available under the latter[151](index=151&type=chunk) - The company was in **compliance** with all covenants as of September 30, 2023, but **future compliance is uncertain** if economic conditions worsen[149](index=149&type=chunk)[144](index=144&type=chunk) [Form S-3 Registration Statement](index=40&type=section&id=Form%20S-3%20Registration%20Statement) Funko filed an **effective Form S-3** shelf registration statement on July 26, 2022, allowing it to offer and sell up to **$100.0 million** of various securities for its own account and certain selling stockholders to sell **17,318,008 shares** of Class A common stock. This provides **flexibility for future capital needs**, with specific terms to be determined at the time of any offering - An **effective Form S-3** allows Funko to offer and sell up to **$100.0 million** of securities and certain selling stockholders to sell **17,318,000 shares** of Class A common stock[152](index=152&type=chunk) - The Form S-3 provides **flexibility for future capital needs**, with offering terms to be established at the time of sale[153](index=153&type=chunk) [Future Sources and Uses of Liquidity](index=40&type=section&id=Future%20Sources%20and%20Uses%20of%20Liquidity) Primary sources of liquidity are operating cash flows and credit facilities. As of September 30, 2023, cash and cash equivalents were **$31.9 million**, with working capital at **$(16.8) million**. Future uses include working capital, inventory, capital expenditures, debt service, and potential **significant payments** under the Tax Receivable Agreement if deferred tax assets become realizable | Metric (in millions) | September 30, 2023 | December 31, 2022 | | :------------------- | :----------------- | :---------------- | | Cash and cash equivalents | $31.9 | $19.2 | | Working capital | $(16.8) | $111.8 | - Future liquidity needs include tax distributions, redemptions by Continuing Equity Owners, payments under the Tax Receivable Agreement, and capital expenditures for WMS integration and new facilities[157](index=157&type=chunk) - If deferred tax assets become realizable, the company will record a **significant liability** related to the Tax Receivable Agreement[157](index=157&type=chunk) [Seasonality](index=41&type=section&id=Seasonality) Funko historically experiences moderate seasonality, with **over 50%** of net sales occurring in the third and fourth quarters due to holiday inventory build-up. The first quarter typically has the **lowest volume** of shipments and sales, and is the **least profitable**. Rapid growth in recent years may have masked the full effects of seasonality, which could have a greater impact in future periods - Historically, **over 50%** of net sales occur in the third and fourth quarters (August-November) due to holiday season inventory build-up[158](index=158&type=chunk) - The first quarter typically represents the **lowest volume** of shipments and sales, and is the **least profitable**[158](index=158&type=chunk) - Rapid growth may have masked full seasonal effects, suggesting seasonality could have a greater impact in future periods[158](index=158&type=chunk) [Critical Accounting Policies and Estimates](index=41&type=section&id=Critical%20Accounting%20Policies%20and%20Estimates) Critical accounting policies include revenue recognition, royalties, inventory, goodwill, intangible assets, and income taxes. The company established a **full valuation allowance** of **$123.2 million** against deferred tax assets due to a three-year cumulative pre-tax **loss**, impacting the Tax Receivable Agreement liability. **No significant changes** to critical accounting policies were reported since the 2022 Annual Report on Form 10-K - Critical accounting policies and estimates include revenue recognition, sales allowances, royalties, inventory, goodwill and intangible assets, and income taxes[160](index=160&type=chunk) - A **full valuation allowance** of **$123.2 million** was established against deferred tax assets due to the Company's three-year cumulative pre-tax **loss** position, leading to a **$99.6 million gain** on the Tax Receivable Agreement liability adjustment[161](index=161&type=chunk)[163](index=163&type=chunk) [Item 3. Quantitative and Qualitative Disclosures About Market Risk](index=42&type=section&id=Item%203.%20Quantitative%20and%20Qualitative%20Disclosures%20About%20Market%20Risk) Funko is exposed to market risks from changes in interest rates, foreign currency, and inflation, which arise in the normal course of business. There have been **no material changes** to these market risks since the disclosure in the Annual Report on Form 10-K for the year ended December 31, 2022 - Funko is exposed to market risks from changes in interest rates, foreign currency, and inflation[165](index=165&type=chunk) - **No material changes** in market risk have occurred since the previous annual report[165](index=165&type=chunk) [Item 4. Controls and Procedures](index=43&type=section&id=Item%204.%20Controls%20and%20Procedures) Funko's management concluded that its disclosure controls and procedures were **not effective** as of September 30, 2023, due to previously identified **material weaknesses** in internal control over financial reporting. **Remediation efforts** are ongoing, focusing on risk assessment, control design, user access, system change approvals, and personnel expertise, with **full remediation** expected to continue throughout 2023 [Limitations on Effectiveness of Disclosure Controls and Procedures](index=43&type=section&id=Limitations%20on%20Effectiveness%20of%20Disclosure%20Controls%20and%20Procedures) Management acknowledges that disclosure controls and procedures can only provide **reasonable assurance** of achieving control objectives, given resource constraints and the need for judgment in evaluating benefits versus costs - Disclosure controls and procedures provide only **reasonable assurance** due to inherent limitations and resource constraints[166](index=166&type=chunk) [Evaluation of Disclosure Controls and Procedures](index=43&type=section&id=Evaluation%20of%20Disclosure%20Controls%20and%20Procedures) As of September 30, 2023, management, including the Interim CEO and CFO, concluded that disclosure controls and procedures were **not effective** due to **material weaknesses** in internal control over financial reporting previously reported in the 2022 Annual Report on Form 10-K - Disclosure controls and procedures were **not effective** as of September 30, 2023, due to **material weaknesses** in internal control over financial reporting[167](index=167&type=chunk) [Remediation Efforts to Address the Material Weaknesses](index=43&type=section&id=Remediation%20Efforts%20to%20Address%20the%20Material%20Weaknesses) **Remediation efforts** are ongoing throughout 2023 and include rigorous risk assessment, enhancing control design, improving user access privileges, reviewing changes to IT systems, and investing in training and hiring personnel with appropriate expertise. **Full remediation** requires controls to operate effectively for a sufficient period and management's conclusion through testing - Performing rigorous scoping and risk assessment - Utilizing a SOX Steering Committee for risk analysis and reporting to the Audit Committee - Enhancing control activities design for precision and improving documentation retention - Designing and implementing controls for user access privilege review and segregation of duties - Designing and implementing controls for review and approval of changes to key financial IT systems - Investing in training and hiring personnel with expertise for timely and thorough monitoring of internal controls - **Remediation efforts** are **ongoing** throughout 2023, and **material weaknesses** will **not be considered fully remediated** until controls operate effectively for a sufficient period and are tested[168](index=168&type=chunk) [Changes in Internal Control over Financial Reporting](index=44&type=section&id=Changes%20in%20Internal%20Control%20over%20Financial%20Reporting) Aside from **ongoing remediation efforts** for identified **material weaknesses**, there were **no other changes** in Funko's internal control over financial reporting during the quarter ended September 30, 2023, that materially affected or are reasonably likely to materially affect these controls - **No material changes** in internal control over financial reporting occurred during Q3 2023, other than **ongoing remediation efforts** for previously identified **material weaknesses**[169](index=169&type=chunk) Part II [Item 1. Legal Proceedings](index=44&type=section&id=Item%201.%20Legal%20Proceedings) This section refers to Note 6, 'Commitments and Contingencies - Legal Contingencies,' in the financial statements for a detailed discussion of Funko's **material legal proceedings** - Details on **material legal proceedings** are provided in Note 6, 'Commitments and Contingencies - Legal Contingencies,' of the unaudited condensed consolidated financial statements[170](index=170&type=chunk) [Item 1A. Risk Factors](index=44&type=section&id=Item%201A.%20Risk%20Factors) Funko's business faces numerous **significant risks**, including those related to executing its business strategy, managing inventory, dependence on third-party content and licenses, competitive pressures, macroeconomic downturns, and operational challenges. Organizational structure risks involve TCG's **influence** and potential conflicts of interest, while ownership risks include potential dilution and stock price volatility. General risks encompass foreign currency fluctuations, cybersecurity threats, and **compliance** with evolving regulations [BUSINESS, ECONOMIC, MARKET AND OPERATING RISKS](index=44&type=section&id=BUSINESS%2C%20ECONOMIC%2C%20MARKET%20AND%20OPERATING%20RISKS) Funko's business faces risks from its ability to execute strategy, manage inventory, and adapt to rapidly changing consumer preferences in pop culture. Dependence on short-term license agreements, global economic downturns, and intense competition pose **significant threats**. Operational challenges include reliance on third-party manufacturers, supply chain disruptions, and the impact of climate change and ESG initiatives. Changes in leadership and the highly seasonal nature of the business also contribute to operational volatility - Inability to execute business strategy, manage growth, and attract/retain qualified personnel - Dependence on third-party content development and market appeal of licensed properties - Risks related to the retail industry, including economic downturns and changes in retail practices - Challenges in obtaining, protecting, and enforcing intellectual property rights - Fluctuations in gross margin, seasonal impacts, and timing/popularity of new product releases - Risks from international operations, including trade markets, currency, and tax rate fluctuations - Reliance on third-party vendors, manufacturers, and outsourcers - Potential legal risks, including ongoing litigation, product liability, and regulatory non-compliance - The company incurred a **$30.1 million** inventory write-down and **$8.6 million** in disposal costs for unfinished/finished goods in the nine months ended September 30, 2023, due to operational efficiency initiatives and customer order cancellations[177](index=177&type=chunk) - Changes in leadership, including the resignation of the former CEO, could **materially impact** relationships with licensors and overall business operations[182](index=182&type=chunk)[222](index=222&type=chunk) [ORGANIZATIONAL STRUCTURE RISKS](index=75&type=section&id=ORGANIZATIONAL%20STRUCTURE%20RISKS) Funko's organizational structure presents risks due to TCG's **significant influence** over stockholder decisions and potential conflicts of interest with other stockholders, particularly regarding the Tax Receivable Agreement (TRA). The TRA requires **substantial cash payments** for tax benefits, which may **not be fully realized**, and obligations can accelerate under certain circumstances, potentially exceeding actual tax savings and **negatively impacting liquidity** - TCG has **significant influence** over stockholder decisions, including mergers, asset sales, and director elections, potentially **conflicting with other stockholders' interests**[292](index=292&type=chunk)[294](index=294&type=chunk) - The Tax Receivable Agreement (TRA) requires Funko to make **cash payments** to TRA Parties equal to **85%** of realized tax benefits, which could be **significant** and may **not be fully realized**[303](index=303&type=chunk) - TRA payments can **accelerate upon certain events** (e.g., change of control, material breach), potentially requiring immediate **substantial cash payments** that may **exceed actual tax benefits** and **negatively impact liquidity**[304](index=304&type=chunk)[305](index=305&type=chunk) [OWNERSHIP OF OUR CLASS A COMMON STOCK RISKS](index=82&type=section&id=OWNERSHIP%20OF%20OUR%20CLASS%20A%20COMMON%20STOCK%20RISKS) Risks associated with Class A common stock ownership include potential dilution from future issuances (e.g., incentive plans, acquisitions, or Form S-3 offerings) and stock price volatility due to various factors, including operating performance, market expectations, and external events. The company does **not intend to pay dividends** in the foreseeable future, and Delaware law and corporate provisions may prevent stockholder-initiated changes in direction or management. **Material weaknesses** in internal control over financial reporting also pose risks to accurate financial reporting and investor confidence - Future issuances of Class A common stock (e.g., from incentive plans, acquisitions, or Form S-3 offerings) could **dilute existing stockholders' ownership**[310](index=310&type=chunk)[312](index=312&type=chunk) - The company does **not intend to pay dividends** on Class A common stock for the foreseeable future, **retaining earnings for business growth and debt repayment**[313](index=313&type=chunk) - **Material weaknesses** in internal control over financial reporting could lead to **errors in financial statements**, restatements, **failure to meet reporting obligations**, and a **decline in stock price**[323](index=323&type=chunk)[324](index=324&type=chunk) [GENERAL RISKS](index=87&type=section&id=GENERAL%20RISKS) General risks include the **significant impact** of foreign currency exchange rate changes on reported financial performance, the potential for business disruption and harm from compromised electronic data due to cyberattacks or security incidents, and the adverse effects of non-compliance with anti-corruption, anti-bribery, and data privacy laws. Additionally, a new **1%** U.S. federal excise tax on stock repurchases could **increase costs**, and impairment in goodwill or other assets could **negatively affect financial condition** - Changes in foreign currency exchange rates can **significantly impact reported financial performance**, with **depreciation in key currencies negatively affecting sales and earnings**[326](index=326&type=chunk) - Compromised electronic data from cyberattacks or security incidents could **disrupt operations**, **harm customers**, **damage reputation**, and lead to **litigation or regulatory actions**[328](index=328&type=chunk)[329](index=329&type=chunk) - Failure to comply with anti-corruption, anti-bribery (e.g., FCPA, U.K. Bribery Act), and data privacy laws (e.g., GDPR, CCPA) could result in **fines, criminal penalties, negative publicity, and adverse financial effects**[337](index=337&type=chunk)[339](index=339&type=chunk)[340](index=340&type=chunk) [Item 2. Unregistered Sales of Equity Securities, Use of Proceeds, and Issuer Purchases of Equity Securities](index=91&type=section&id=Item%202.%20Unregistered%20Sales%20of%20Equity%20Securities%2C%20Use%20of%20Proceeds%2C%20and%20Issuer%20Purchases%20of%20Equity%20Securities) This section states that there were **no unregistered sales** of equity securities, use of proceeds, or issuer purchases of equity securities during the reporting period - **No unregistered sales** of equity securities, use of proceeds, or issuer purchases of equity securities occurred[342](index=342&type=chunk) [Item 5. Other Information](index=92&type=section&id=Item%205.%20Other%20Information) Several executive officers, including the Chief Commercial Officer, Chief Legal Officer, and President, adopted Rule 10b5-1(c) trading plans in September 2023 to sell a specified number of Class A common stock shares between January and December 2024 - Andy Oddie (Chief Commercial Officer) adopted a trading plan to sell up to **218,768 shares** between January 2, 2024, and December 31, 2024 - Tracy Daw (Chief Legal Officer) adopted a trading plan to sell up to **219,110 shares** between January 2, 2024, and June 28, 2024 - Andrew Perlmutter (President) adopted a trading plan to sell up to **289,022 shares** between January 2, 2024, and June 3, 2024 [Item 6. Exhibits](index=92&type=section&id=Item%206.%20Exhibits) This section lists all exhibits filed with the Form 10-Q, including organizational documents, employment agreements, certifications, and XBRL interactive data files - The exhibits include organizational documents (Amended and Restated Certificate of Incorporation, Bylaws), employment agreements (e.g., with Andrew Perlmutter, Brian Mariotti, Michael Lunsford), certifications (Interim CEO, CFO), and XBRL interactive data files[345](index=345&type=chunk)[348](index=348&type=chunk) [SIGNATURES](index=94&type=section&id=SIGNATURES) The report was signed by Steve Nave, Chief Financial Officer and Chief Operating Officer of Funko, Inc., on November 2, 2023, certifying compliance with the Securities Exchange Act of 1934 - The report was signed by Steve Nave, Chief Financial Officer and Chief Operating Officer, on November 2, 2023[350](index=350&type=chunk)