Funko(FNKO) - 2021 Q3 - Quarterly Report

Part I – FINANCIAL INFORMATION Item 1. Financial Statements This section presents the unaudited condensed consolidated financial statements, including statements of operations, comprehensive income (loss), balance sheets, and cash flows, along with detailed notes explaining the company's organization, accounting policies, acquisitions, debt, tax agreements, commitments, segments, income taxes, stockholders' equity, and earnings per share Condensed Consolidated Statements of Operations (unaudited) This table presents the unaudited condensed consolidated statements of operations, detailing net sales, net income (loss), and earnings per share for the specified periods | Metric | Three Months Ended Sep 30, 2021 (in thousands) | Three Months Ended Sep 30, 2020 (in thousands) | Nine Months Ended Sep 30, 2021 (in thousands) | Nine Months Ended Sep 30, 2020 (in thousands) | | :--- | :--- | :--- | :--- | :--- | | Net sales | $267,733 | $191,229 | $693,020 | $426,028 | | Net income (loss) | $18,375 | $15,597 | $50,405 | $(5,144) | | Net income (loss) attributable to Funko, Inc. | $11,901 | $9,796 | $32,228 | $(4,915) | | Basic EPS | $0.30 | $0.28 | $0.85 | $(0.14) | | Diluted EPS | $0.28 | $0.27 | $0.80 | $(0.14) | Condensed Consolidated Statements of Comprehensive Income (Loss) (unaudited) This table presents the unaudited condensed consolidated statements of comprehensive income (loss), detailing net income (loss) and other comprehensive income (loss) for the specified periods | Metric | Three Months Ended Sep 30, 2021 (in thousands) | Three Months Ended Sep 30, 2020 (in thousands) | Nine Months Ended Sep 30, 2021 (in thousands) | Nine Months Ended Sep 30, 2020 (in thousands) | | :--- | :--- | :--- | :--- | :--- | | Net income (loss) | $18,375 | $15,597 | $50,405 | $(5,144) | | Other comprehensive income (loss) | $(1,266) | $1,647 | $(739) | $(896) | | Comprehensive income (loss) | $17,109 | $17,244 | $49,666 | $(6,040) | | Comprehensive income (loss) attributable to Funko, Inc. | $10,967 | $10,847 | $31,624 | $(5,462) | Condensed Consolidated Balance Sheets (unaudited) This table presents the unaudited condensed consolidated balance sheets, detailing total assets, liabilities, and stockholders' equity at the specified dates | Item | September 30, 2021 (in thousands) | December 31, 2020 (in thousands) | | :--- | :--- | :--- | | Total assets | $914,907 | $763,590 | | Total liabilities | $541,063 | $440,945 | | Total stockholders' equity | $373,874 | $322,445 | Condensed Consolidated Statements of Cash Flows (unaudited) This table presents the unaudited condensed consolidated statements of cash flows, detailing net cash provided by operating, investing, and financing activities for the specified periods | Activity | Nine Months Ended Sep 30, 2021 (in thousands) | Nine Months Ended Sep 30, 2020 (in thousands) | | :--- | :--- | :--- | | Net cash provided by operating activities | $78,792 | $60,345 | | Net cash used in investing activities | $(17,151) | $(14,704) | | Net cash used in financing activities | $(20,494) | $(39,662) | | Net increase in cash and cash equivalents | $40,990 | $6,666 | | Cash and cash equivalents at end of period | $93,245 | $31,895 | Notes to Unaudited Condensed Consolidated Financial Statements This section provides detailed explanations and disclosures supporting the unaudited condensed consolidated financial statements 1. Organization and Operations This note describes Funko, Inc.'s formation as a Delaware corporation for its IPO, its role as the sole managing member of FAH, LLC, and the consolidation of FAH, LLC's financial results. It also mentions a prior-year immaterial correction to net sales - Funko, Inc. was formed on April 21, 2017, for its IPO, becoming the sole managing member of FAH, LLC and consolidating its financial results, reporting a non-controlling interest for other FAH, LLC owners[24][25] - An immaterial error in Q3 2020 net sales was corrected, increasing Q3 2020 net sales by $2.7 million and decreasing Q4 2020 net sales by $2.7 million[27] 2. Significant Accounting Policies This note states that the unaudited condensed consolidated financial statements adhere to U.S. GAAP, requiring management estimates. It refers to the company's Annual Report on Form 10-K for a comprehensive description of significant accounting policies - The preparation of financial statements requires management to make estimates and assumptions that affect reported amounts, and actual results could differ[28] - A detailed description of significant accounting policies is available in the Company's Annual Report on Form 10-K for the year ended December 31, 2020[29] 3. Acquisitions This note details the acquisition of a majority interest in TokenWave LLC on March 26, 2021, to expand into digital Non-Fungible Tokens (NFTs), noting that the transaction's financial impact was not material - On March 26, 2021, Funko acquired a majority of TokenWave LLC, developer of the TokenHead NFT app, to expand product offerings into digital NFTs; the acquisition's financial impact was not material[30] 4. Fair Value Measurements This note explains that most financial instruments' carrying amounts approximate fair value due to their short-term nature. It specifies that cash equivalents are classified as Level 1 and debt instruments as Level 3 within the fair value hierarchy | Instrument | September 30, 2021 (in thousands) | December 31, 2020 (in thousands) | Fair Value Hierarchy | | :--- | :--- | :--- | :--- | | Cash equivalents | $63,300 | $34,500 | Level 1 | | Debt instruments (estimated fair value) | $180,000 | $193,900 | Level 3 | | Debt instruments (carrying value) | $177,600 | $190,800 | N/A | 5. Debt This note outlines the company's debt structure, including the repayment of former credit facilities and the establishment of new credit facilities in September 2021, consisting of a $180.0 million term loan and a $100.0 million revolving credit facility. It details the terms, security, and compliance with covenants | Debt Component | September 30, 2021 (in thousands) | December 31, 2020 (in thousands) | | :--- | :--- | :--- | | Term loan facility | $180,000 | $193,875 | | Debt issuance costs | $(2,450) | $(3,105) | | Total term debt | $177,550 | $190,770 | | Less: current portion | $17,378 | $10,758 | | Long-term debt, net | $160,172 | $180,012 | - In September 2021, Funko repaid its $180.1 million Former Term Loan Facility, resulting in a $0.7 million loss on debt extinguishment from writing off unamortized deferred financing fees[41] - On September 17, 2021, Funko entered into new credit facilities: a $180.0 million New Term Loan Facility (maturing Sep 17, 2026) and a $100.0 million New Revolving Credit Facility, primarily used to repay former facilities[42][43] - As of September 30, 2021, Funko had $180.0 million outstanding under the New Term Loan Facility and $100.0 million available under the New Revolving Credit Facility, with no outstanding borrowings, and was in compliance with all covenants[45][46] 6. Liabilities under Tax Receivable Agreement This note details the Tax Receivable Agreement (TRA) with Continuing Equity Owners, obligating Funko to pay 85% of tax benefits realized from common unit redemptions or exchanges. It also presents the changes in the TRA liability and related deferred tax assets - The Tax Receivable Agreement (TRA) requires Funko to pay Continuing Equity Owners 85% of tax benefits realized from future redemptions or exchanges of common units of FAH, LLC[48] - For the nine months ended September 30, 2021, Funko recognized a $16.5 million increase in net deferred tax assets due to common unit exchanges[49] | Item | Three Months Ended Sep 30, 2021 (in thousands) | Nine Months Ended Sep 30, 2021 (in thousands) | | :--- | :--- | :--- | | Beginning balance | $80,500 | $62,317 | | Additional liabilities for exchanges | $1,890 | $20,079 | | Payments under tax receivable agreement | $0 | $(6) | | Ending balance | $82,390 | $82,390 | 7. Commitments and Contingencies This note outlines various contractual commitments, including license agreements, employment agreements, leases, and debt. It also details significant legal contingencies, such as ongoing securities class action lawsuits and shareholder derivative actions, and a reserve for royalty audits - Funko is involved in ongoing securities class action litigation (Ferreira v. Funko, Inc. et al.) and shareholder derivative actions, alleging misleading statements and breaches of fiduciary duties[58][60] - A Washington state court class action lawsuit (In re Funko, Inc. Securities Litigation) alleging Securities Act violations related to the IPO was dismissed by the trial court but reversed on appeal on November 1, 2021, and remanded for further proceedings[62] - As of September 30, 2021, Funko had a reserve of $11.3 million for ongoing and future royalty audits[173] 8. Segments This note clarifies that Funko operates as a single reportable segment, as its Chief Operating Decision Maker evaluates performance and allocates resources at a consolidated level. It provides a breakdown of net sales by product category and geographical region - Funko identifies and operates as a single segment because its Chief Operating Decision Maker reviews financial performance and allocates resources at a consolidated level[66] | Product Category | Three Months Ended Sep 30, 2021 | Three Months Ended Sep 30, 2020 | Nine Months Ended Sep 30, 2021 | Nine Months Ended Sep 30, 2020 | | :--- | :--- | :--- | :--- | :--- | | Figures | 76.9 % | 75.9 % | 78.5 % | 78.3 % | | Other | 23.1 % | 24.1 % | 21.5 % | 21.7 % | | Pop! Branded Products | 72.1 % | 71.5 % | 76.3 % | 77.0 % | | Loungefly Branded Products | 13.7 % | 14.1 % | 13.1 % | 12.5 % | | Other Branded Products | 14.2 % | 14.4 % | 10.6 % | 10.5 % | | Region | Three Months Ended Sep 30, 2021 (in thousands) | Three Months Ended Sep 30, 2020 (in thousands) | Nine Months Ended Sep 30, 2021 (in thousands) | Nine Months Ended Sep 30, 2020 (in thousands) | | :--- | :--- | :--- | :--- | :--- | | United States | $191,289 | $140,935 | $490,993 | $317,348 | | Europe | $58,873 | $35,538 | $150,683 | $71,677 | | Other International | $17,571 | $14,756 | $51,344 | $37,003 | | Total Net Sales | $267,733 | $191,229 | $693,020 | $426,028 | 9. Income Taxes This note explains Funko, Inc.'s tax treatment as a corporation, with income allocated from FAH, LLC (a pass-through entity). It provides the income tax expense/benefit for the periods and details the effective tax rate, which is influenced by non-controlling interests - Funko, Inc. is taxed as a corporation, paying federal, state, and local taxes on income allocated from FAH, LLC, which is treated as a pass-through partnership[70] | Period | Income Tax Expense (Benefit) (in thousands) | | :--- | :--- | | Three Months Ended Sep 30, 2021 | $5,939 | | Three Months Ended Sep 30, 2020 | $1,420 | | Nine Months Ended Sep 30, 2021 | $12,814 | | Nine Months Ended Sep 30, 2020 | $(1,139) | - The effective tax rate for the nine months ended September 30, 2021, was 20.3%, which is less than the statutory rate of 21% primarily due to earnings attributable to non-controlling interests not being subject to corporate income taxes[71] 10. Stockholders' Equity This note provides a reconciliation of changes in stockholders' equity for the three and nine months ended September 30, 2021 and 2020, detailing movements in Class A and Class B common stock, additional paid-in capital, accumulated other comprehensive income, retained earnings, and non-controlling interests | Item | September 30, 2021 (in thousands) | September 30, 2020 (in thousands) | | :--- | :--- | :--- | | Total stockholders' equity | $373,874 | $302,685 | 11. Non-controlling interests This note explains Funko, Inc.'s accounting for non-controlling interests, representing common units of FAH, LLC held by Continuing Equity Owners. It details Funko, Inc.'s economic ownership interest in FAH, LLC and the specific activities excluded from FAH, LLC's net income calculation - Funko, Inc. owned 76.8% economic interest in FAH, LLC as of September 30, 2021, an increase from 69.5% as of December 31, 2020[77] | Item | Three Months Ended Sep 30, 2021 (in thousands) | Three Months Ended Sep 30, 2020 (in thousands) | Nine Months Ended Sep 30, 2021 (in thousands) | Nine Months Ended Sep 30, 2020 (in thousands) | | :--- | :--- | :--- | :--- | :--- | | Equity-based compensation | $3,658 | $2,438 | $9,869 | $7,384 | | Income tax expense (benefit) | $5,257 | $911 | $11,050 | $(2,318) | 12. Earnings (loss) per Share This note provides the reconciliation of numerators and denominators used to compute basic and diluted earnings (loss) per share of Class A common stock, detailing the impact of potentially dilutive securities and their exclusion if anti-dilutive | Metric | Three Months Ended Sep 30, 2021 | Three Months Ended Sep 30, 2020 | Nine Months Ended Sep 30, 2021 | Nine Months Ended Sep 30, 2020 | | :--- | :--- | :--- | :--- | :--- | | Net income (loss) attributable to Funko, Inc. | $11,901 | $9,796 | $32,228 | $(4,915) | | Basic EPS | $0.30 | $0.28 | $0.85 | $(0.14) | | Diluted EPS | $0.28 | $0.27 | $0.80 | $(0.14) | - For the three months ended September 30, 2021, 13.9 million potentially dilutive securities, including 12.3 million common units of FAH, LLC, were excluded from diluted EPS computation because their effect would have been anti-dilutive[80] Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations This section provides management's perspective on Funko's financial condition and operating results, covering an overview of the business, the impact of COVID-19, key performance indicators, detailed analysis of quarterly and year-to-date results, non-GAAP financial measures, liquidity, and critical accounting policies Overview This section provides an overview of Funko's business as a leading pop culture consumer products company, offering licensed products across various categories - Funko is a leading pop culture consumer products company, creating licensed products across various categories including figures, bags, apparel, and digital NFTs, available at accessible price points[84] COVID-19 This section discusses the ongoing impact of the COVID-19 pandemic on Funko's business, including demand, supply chain, and operational adjustments - The COVID-19 pandemic caused weakened demand, reduced customer shipments, and negative impacts on net sales and liquidity in 2020 due to business closures and social distancing[86] - Increased shipping container costs are expected to continue through early 2022 due to global supply chain issues, leading Funko to increase prices on certain products to offset these and inflationary pressures[87] - Funko shifted a greater amount of its production from China to Vietnam in response to sourcing delays and difficulties caused by the pandemic[87] Key Performance Indicators This section presents key financial performance indicators, including net sales, net income (loss), EBITDA, and Adjusted EBITDA, for the specified periods | Indicator | Three Months Ended Sep 30, 2021 (in thousands) | Three Months Ended Sep 30, 2020 (in thousands) | Nine Months Ended Sep 30, 2021 (in thousands) | Nine Months Ended Sep 30, 2020 (in thousands) | | :--- | :--- | :--- | :--- | :--- | | Net sales | $267,733 | $191,229 | $693,020 | $426,028 | | Net income (loss) | $18,375 | $15,597 | $50,405 | $(5,144) | | EBITDA | $36,353 | $31,779 | $99,918 | $35,885 | | Adjusted EBITDA | $40,181 | $36,191 | $111,009 | $47,012 | Results of Operations This section analyzes Funko's financial performance, comparing results for the three and nine months ended September 30, 2021, against the prior year Three Months Ended September 30, 2021 Compared to Three Months Ended September 30, 2020 This section compares Funko's financial performance for Q3 2021 against Q3 2020, showing a 40.0% increase in net sales and a 21.5% increase in net income attributable to Funko, Inc., driven by recovery from COVID-19 impacts and growth in specialty retail, e-commerce, and direct-to-consumer channels. Gross margin decreased due to higher shipping costs | Metric | Q3 2021 (in thousands) | Q3 2020 (in thousands) | Dollar Change (in thousands) | Percentage Change | | :--- | :--- | :--- | :--- | :--- | | Net sales | $267,733 | $191,229 | $76,504 | 40.0 % | | Cost of sales | $171,320 | $117,504 | $53,816 | 45.8 % | | Selling, general, and administrative expenses | $59,890 | $41,167 | $18,723 | 45.5 % | | Income from operations | $26,195 | $20,671 | $5,524 | 26.7 % | | Net income attributable to Funko, Inc. | $11,901 | $9,796 | $2,105 | 21.5 % | - Net sales increased 40.0% to $267.7 million in Q3 2021, primarily due to increased sales to specialty retailers, e-commerce sites, and direct-to-consumer customers, recovering from COVID-19 impacts in Q3 2020[94] - Gross margin (exclusive of depreciation and amortization) decreased to 36.0% in Q3 2021 from 38.6% in Q3 2020, driven by higher shipping and inbound freight costs due to global supply chain capacity constraints[100] - The number of active properties increased 12.7% to 806, and average net sales per active property increased 24.2% in Q3 2021 compared to Q3 2020[95] Nine Months Ended September 30, 2021 Compared to Nine Months Ended September 30, 2020 This section compares Funko's financial performance for the nine months ended September 30, 2021, against the same period in 2020, showing a 62.7% increase in net sales and a significant shift from a net loss to a net income attributable to Funko, Inc. This growth was driven by recovery from the COVID-19 pandemic and increased sales across all channels, with a slight decrease in gross margin due to freight costs | Metric | YTD 2021 (in thousands) | YTD 2020 (in thousands) | Dollar Change (in thousands) | Percentage Change | | :--- | :--- | :--- | :--- | :--- | | Net sales | $693,020 | $426,028 | $266,992 | 62.7 % | | Cost of sales | $425,929 | $261,103 | $164,826 | 63.1 % | | Selling, general, and administrative expenses | $166,032 | $127,590 | $38,442 | 30.1 % | | Income from operations | $70,281 | $3,388 | $66,893 | nm | | Net income (loss) attributable to Funko, Inc. | $32,228 | $(4,915) | $37,143 | nm | - Net sales increased 62.7% to $693.0 million for the nine months ended September 30, 2021, primarily due to increased sales to specialty retailers, e-commerce sites, and direct-to-consumer customers, recovering from COVID-19 impacts in 2020[109] - Gross margin (exclusive of depreciation and amortization) decreased slightly to 38.5% in YTD 2021 from 38.7% in YTD 2020, mainly due to higher shipping and freight costs, partially offset by improved global product margins[115] - Selling, general, and administrative expenses as a percentage of net sales decreased to 24.0% in YTD 2021 from 29.9% in YTD 2020, as net sales growth outpaced the increase in expenses[116] Non-GAAP Financial Measures This section defines and reconciles non-GAAP financial measures used by management to assess business performance, such as Adjusted EBITDA and Adjusted Net Income - Funko uses non-GAAP financial measures (EBITDA, Adjusted EBITDA, Adjusted Net Income, Adjusted Earnings per Diluted Share) to evaluate business performance, develop forecasts, and make strategic decisions, as they remove the impact of items not directly resulting from core operations[124][125] - Non-GAAP measures have limitations, such as not reflecting cash expenditures, working capital needs, debt service requirements, or future asset replacement costs[128] | Metric | Three Months Ended Sep 30, 2021 (in thousands) | Three Months Ended Sep 30, 2020 (in thousands) | Nine Months Ended Sep 30, 2021 (in thousands) | Nine Months Ended Sep 30, 2020 (in thousands) | | :--- | :--- | :--- | :--- | :--- | | Net income (loss) attributable to Funko, Inc. | $11,901 | $9,796 | $32,228 | $(4,915) | | Adjusted net income | $21,106 | $16,072 | $55,732 | $3,633 | | Adjusted earnings per diluted share | $0.39 | $0.31 | $1.04 | $0.07 | | EBITDA | $36,353 | $31,779 | $99,918 | $35,885 | | Adjusted EBITDA | $40,181 | $36,191 | $111,009 | $47,012 | Liquidity and Financial Condition This section analyzes Funko's liquidity and capital resources, including cash flow activities, debt structure, and future liquidity needs Introduction This introduction outlines Funko's primary liquidity and capital requirements, including working capital, inventory management, capital expenditures, debt service, and general corporate needs, and expresses confidence in sufficient liquidity for the next 12 months - Funko's primary liquidity and capital requirements are for working capital, inventory management, capital expenditures, debt service, and general corporate needs[131] - The company believes its sources of liquidity and capital will be sufficient to finance continued operations, growth strategy, planned capital expenditures, and public company expenses for at least the next 12 months[132] Liquidity and Capital Resources This section summarizes Funko's cash flow activities for the nine months ended September 30, 2021 and 2020, detailing net cash provided by operating activities and net cash used in investing and financing activities. It highlights the increase in operating cash flow driven by net income growth | Activity | Nine Months Ended Sep 30, 2021 (in thousands) | Nine Months Ended Sep 30, 2020 (in thousands) | | :--- | :--- | :--- | | Net cash provided by operating activities | $78,792 | $60,345 | | Net cash used in investing activities | $(17,151) | $(14,704) | | Net cash used in financing activities | $(20,494) | $(39,662) | | Net increase in cash and cash equivalents | $40,990 | $6,666 | - Net cash provided by operating activities increased to $78.8 million for YTD 2021 from $60.3 million for YTD 2020, primarily due to a $50.9 million increase in net income (excluding non-cash adjustments), partially offset by a $32.4 million decrease from changes in working capital[133][134] Credit Facilities This section details the new credit agreement established on September 17, 2021, which includes a $180.0 million term loan and a $100.0 million revolving credit facility, used to refinance former facilities. It outlines the maturity, interest rates, security, and restrictive covenants, confirming compliance as of September 30, 2021 - On September 17, 2021, Funko entered into new credit facilities, including a $180.0 million New Term Loan Facility (maturing Sep 17, 2026) and a $100.0 million New Revolving Credit Facility, primarily used to repay former facilities and secured by substantially all company assets[138][141][145] - Loans under the New Credit Facilities bear interest at LIBOR/EURIBOR/etc. plus 2.50% or ABR/Canadian prime plus 1.50%, subject to step-downs based on leverage ratios[142] - As of September 30, 2021, Funko was in compliance with all covenants in its New Credit Agreement, including a maximum Net Leverage Ratio of 2.50:1.00 and a minimum fixed charge coverage ratio of 1.25:1.00[143][144] Form S-3 Registration Statement This section describes the effective Form S-3 shelf registration statement, which allows Funko to offer and sell up to $100.0 million of various securities and permits certain selling stockholders to offer and sell 27,884,185 shares of Class A common stock - An effective Form S-3 shelf registration statement allows Funko to offer and sell up to $100.0 million of various securities and permits certain selling stockholders to offer and sell 27,884,185 shares of Class A common stock[147] Future Sources and Uses of Liquidity This section identifies Funko's primary future liquidity sources as operating activities and credit facilities. It outlines future uses, including public company costs, tax distributions, payments under the Tax Receivable Agreement, and capital expenditures for new systems and facilities | Item | September 30, 2021 (in thousands) | December 31, 2020 (in thousands) | | :--- | :--- | :--- | | Cash and cash equivalents | $93,245 | $52,255 | | Working capital | $167,800 | $120,700 | - Future liquidity needs include public company costs, tax distributions, payments under the Tax Receivable Agreement, and general cash requirements for operations and capital expenditures (e.g., ERP system, direct-to-consumer platforms, new leased facilities)[152] Seasonality This section discusses the moderate seasonality of Funko's business, with over 50% of net sales historically occurring in the third and fourth quarters, primarily from August through November, driven by inventory build-up for the holiday season - Historically, over 50% of Funko's net sales occur in the third and fourth quarters (August through November) as customers build inventories for the holiday season, making this period critical for sales and working capital[153] Contractual Obligations This section highlights changes in Funko's term debt commitments due to the New Credit Facilities, with the New Term Loan Facility maturing on September 17, 2026, and amortizing in quarterly installments. It also notes ongoing growth initiatives through additional leases - The New Term Loan Facility matures on September 17, 2026, and amortizes in quarterly installments equal to 2.50% of the original principal amount, with the first payment commencing in Q4 2021[154] Critical Accounting Policies and Estimates This section describes the critical accounting policies and estimates that require significant management judgment and affect the reported financial results - Critical accounting policies and estimates, which require significant management judgment, include revenue recognition and sales allowances, royalties, inventory, goodwill and intangible assets, and income taxes[157] - There have been no significant changes to Funko's critical accounting policies and estimates from those disclosed in its Annual Report on Form 10-K for the year ended December 31, 2020[158] Item 3. Quantitative and Qualitative Disclosures About Market Risk This section discusses Funko's primary market risks, which stem from changes in interest rates and foreign currency. It notes the company's use of short-term foreign currency forward exchange contracts to hedge foreign currency risk, with immaterial gains or losses - Funko is primarily exposed to market risk from changes in interest rates and foreign currency, arising in the normal course of business without speculative trading[159] - In the nine months ended September 30, 2021, Funko entered into additional short-term foreign currency forward exchange contracts to economically hedge foreign currency risk, with immaterial unrealized and realized gains/losses[159] Item 4. Controls and Procedures This section reports that Funko's management, including the CEO and CFO, concluded that the company's disclosure controls and procedures were effective at a reasonable assurance level as of September 30, 2021. No material changes in internal control over financial reporting were identified during the quarter - Management, with CEO and CFO participation, concluded that Funko's disclosure controls and procedures were effective at the reasonable assurance level as of September 30, 2021[162] - No material changes in internal control over financial reporting were identified during the quarter ended September 30, 2021[163] Part II – OTHER INFORMATION Item 1. Legal Proceedings This section refers to Note 7, 'Commitments and Contingencies - Legal Contingencies,' within the financial statements for a detailed discussion of Funko's material legal proceedings - Material legal proceedings are discussed in Note 7 'Commitments and Contingencies - Legal Contingencies' in the Notes to Unaudited Condensed Consolidated Financial Statements[164] Item 1A. Risk Factors This section details significant risks and uncertainties that could materially affect Funko's business, financial condition, and results of operations. It categorizes risks into business, economic, market, operating, organizational structure, ownership of Class A common stock, and general risks BUSINESS, ECONOMIC, MARKET AND OPERATING RISKS This section outlines various risks related to Funko's business operations, market conditions, and economic factors, including supply chain and competition - The COVID-19 pandemic continues to pose significant risks, including potential adverse impacts on business, financial condition, and results of operations due to new variants, supply chain disruptions, and market volatility[166][167][168][169] - Funko's business is highly dependent on short-term license agreements (typically 2-3 years), with its top ten licensors collectively accounting for approximately 77% of sales for the nine months ended September 30, 2021, and Disney-affiliated licensors accounting for 43%[171][172] - The industry is highly competitive with low barriers to entry; competitors can obtain licenses for the same properties, potentially on more favorable terms, and some licensors reserve rights to sell directly competing products[187][188] - Gross margin may fluctuate due to factors such as changes in product mix, increased costs (e.g., shipping and inbound freight), price competition, and the inability to meet minimum guaranteed royalties[192][193][194] - Effective inventory management is crucial; excess inventory (e.g., 94% increase in Q3 2021 due to longer transit times) or insufficient inventory can adversely affect demand, sales, and profitability[203][204] - Funko relies on third-party manufacturers (primarily in Vietnam, China, and Mexico), which exposes it to risks such as loss of manufacturers, non-compliance with product safety or labor requirements, and geopolitical factors affecting international operations[220][221][223] ORGANIZATIONAL STRUCTURE RISKS This section addresses risks associated with Funko's organizational structure, including ACON's influence and obligations under the Tax Receivable Agreement - ACON holds significant influence (approximately 31.1% of combined voting power as of November 2, 2021) over stockholder decisions, and its interests, along with other Continuing Equity Owners, may conflict with those of other Class A common stockholders[265] - Funko is a holding company dependent on distributions from FAH, LLC to pay taxes and expenses, including significant obligations under the Tax Receivable Agreement, which may be subject to various limitations and restrictions[272][273] - The Tax Receivable Agreement requires Funko to make significant cash payments to Continuing Equity Owners (85% of tax benefits), which could be accelerated in certain circumstances and may exceed the actual tax benefits realized, potentially impacting liquidity[276][277] OWNERSHIP OF OUR CLASS A COMMON STOCK RISKS This section details risks related to the ownership of Funko's Class A common stock, such as potential dilution and dividend policies - Future issuances of Class A common stock, including those from incentive plans, acquisitions, or redemptions of FAH, LLC common units by Continuing Equity Owners, could dilute existing stockholders and potentially depress the stock price[288][289][290] - Funko does not intend to pay dividends on its Class A common stock for the foreseeable future, opting to retain all available funds and future earnings for business development, growth, and debt repayment[291] - Delaware law and provisions in Funko's amended certificate of incorporation and bylaws, such as a classified board and advance notice requirements for stockholder proposals, may prevent or delay efforts by stockholders to change the company's direction or management[292][293][294] GENERAL RISKS This section covers broader risks, including those related to being an 'emerging growth company,' public company compliance, and foreign currency exchange rate fluctuations - As an 'emerging growth company,' Funko takes advantage of reduced disclosure requirements, which may make its Class A common stock less attractive to some investors[297] - Operating as a public company requires significant resources and management attention for compliance, potentially diverting focus from business operations, increasing costs, and posing risks if internal controls are ineffective[312][313][314] - Changes in foreign currency exchange rates can significantly impact Funko's reported financial performance due to its global operations, potentially leading to negative impacts on sales and earnings as reported in U.S. dollars[303] - The Class A common stock price may be volatile and decline regardless of operating performance due to various factors, including market expectations, industry conditions, strategic actions, and global economic or political events[308][309][310] Item 2. Unregistered Sales of Equity Securities and Use of Proceeds This section states that there were no unregistered sales of equity securities or use of proceeds to report for the period - No unregistered sales of equity securities or use of proceeds were reported for the period[321] Item 5. Other Information This section indicates that there is no other information to report for the period - No other information was reported for the period[322] Item 6. Exhibits This section provides an index of exhibits filed with the Form 10-Q, including organizational documents, credit agreements, and certifications, indicating whether they are incorporated by reference or filed/furnished herewith - The report includes exhibits such as the Amended and Restated Certificate of Incorporation, Bylaws, Credit Agreement, and CEO/CFO certifications, with details on their filing status[325] SIGNATURES Signatures Details This section contains the required signatures for the Form 10-Q, certifying its submission on behalf of Funko, Inc. by its Chief Financial Officer - The report is signed on behalf of Funko, Inc. by Jennifer Fall Jung, Chief Financial Officer, on November 4, 2021[328]