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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q

☒QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2023
OR
☐TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____________to _____________
Commission file number: 001-38274

funkologo1aa01.jpg
FUNKO, INC.
(Exact name of registrant as specified in its charter)

Delaware35-2593276
(State or other jurisdiction of
incorporation or organization)		(I.R.S. Employer
Identification No.)

2802 Wetmore Avenue98201
EverettWashington
(Address of principal executive offices)(Zip Code)
(425) 783-3616
(Registrant’s telephone number, including area code)
N/A
(Former name, former address and former fiscal year, if changed since last report)
Securities registered pursuant to Section 12(b) of the Act:
Title of each classTrading Symbol(s)Name of each exchange on which registered
Class A Common Stock,
$0.0001 par value per share		FNKOThe Nasdaq Stock Market LLC
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ☒ No  ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes  ☒    No  ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer☒Accelerated Filer☐
Non-accelerated filer☐Smaller reporting company☐
Emerging growth company☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐ 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ☐    No  ☒
As of October 31, 2023, the registrant had 50,405,278 shares of Class A common stock, $0.0001 par value per share, and 2,276,507 shares of Class B common stock, $0.0001 par value per share, outstanding.


INDEX
Page
Item 1.
Item 2.
Item 3.
Item 4.
Item 1.
Item 1A.
Item 2.
Item 5.
Item 6.



SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. All statements contained in this Quarterly Report on Form 10-Q other than statements of historical fact, including statements regarding our future operating results and financial position, the expected impact of general economic and market conditions on our business, results of operations and financial condition, capital resources and our ability to generate cash to fund our operations, compliance with financial and negative covenants and related impacts to our business, our business strategy and plans, potential acquisitions, market growth and trends, demand for our products, inventory expectations, anticipated future expenses and payments and our objectives for future operations, are forward-looking statements. The words “believe,” “may,” “will,” “estimate,” “continue,” “anticipate,” “intend,” “expect,” “could,” “would,” “project,” “plan,” “potentially,” “preliminary,” “likely,” and similar expressions are intended to identify forward-looking statements. We have based these forward-looking statements largely on our current expectations and projections about future events and trends that we believe may affect our financial condition, results of operations, business strategy, short-term and long-term business operations and objectives, and financial needs. These forward-looking statements are subject to a number of risks, uncertainties, and assumptions, including the important factors described in this Quarterly Report on Form 10-Q under Part II. Item 1A. “Risk Factors,” and in our other filings with the Securities and Exchange Commission, that may cause our actual results, performance or achievements to differ materially and adversely from those expressed or implied by the forward-looking statements.
Any forward-looking statements made herein speak only as of the date of this Quarterly Report on Form 10-Q, and you should not rely on forward-looking statements as predictions of future events. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee that the future results, performance, or achievements reflected in the forward-looking statements will be achieved or occur. We undertake no obligation to update any of these forward-looking statements for any reason after the date of this Quarterly Report on Form 10-Q or to conform these statements to actual results or revised expectations.
1

Summary of Risk Factors
Our business is subject to numerous risks and uncertainties, including those described in Part II, Item 1A. "Risk Factors" in this Quarterly Report on Form 10-Q. Some of the factors that could materially and adversely affect our business, financial condition, results of operations or prospects include, but are not limited to, the following:
•We are subject to several risks related to the operation of our business, including, but not limited to, our ability to execute our business strategy, manage our growth and our inventories, and attract and retain qualified personnel.
•As a purveyor of licensed pop culture consumer products, we are largely dependent on content development and creation by third parties, and are subject to a number of related risks including, but not limited to, the market appeal of the properties we license and the products we create.
•We are subject to risks related to the retail industry including, but not limited to, potential negative impacts of global and regional economic downturns, changes in retail practices, and our ability to maintain and further develop relationships with our retail customers and distributors.
•We are subject to risks related to intellectual property, including our ability to obtain, protect and enforce our intellectual property rights and our ability to operate our business without violating the intellectual property rights of other parties.
•Our success is dependent on our ability to manage fluctuations in our business, including fluctuations in gross margin, seasonal impacts and fluctuations due to the timing and popularity of new product releases.
•Our substantial sales and manufacturing operations outside the United States subject us to risks associated with international operations, including, but not limited to, changes in the global trade markets, as well as fluctuations in foreign currency or tax rates.
•Our business depends in large part on our third-party vendors, manufacturers and outsourcers, and our reputation and ability to effectively operate our business may be harmed by actions taken by these third parties outside of our control.
•We are subject to potential legal risks including, but not limited to, ongoing securities class action litigation, future product liability suits or product recalls, or risks associated with failure to comply to the various laws and regulations to which we are subject, any of which could have a significant adverse effect on our financial condition and results of operations.
•We are subject to risks related to information technology including, but not limited to, risks related to the operation of our e-commerce business, our ability and the ability of third parties to operate our information systems and our compliance with laws related to privacy and the protection of data.
•Our indebtedness could adversely affect our financial health and competitive position, and we may not be able to secure additional financing on favorable terms, or at all, to meet our future capital needs.
•TCG has significant influence over us, and its interests may conflict with the interests of our other stockholders.
•There are risks related to our organizational structure, including the Tax Receivable Agreement, which confers certain benefits upon the Continuing Equity Owners that will not benefit Class A common stockholders to the same extent as it will benefit the Continuing Equity Owners.
•There are risks associated with the ownership of our Class A common stock including, but not limited to, potential dilution by future issuances and volatility in the price of our Class A common stock.
2

Part I – FINANCIAL INFORMATION
Item 1.
Financial Statements

FUNKO, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended September 30,Nine Months Ended September 30,
2023202220232022
(In thousands, except per share data)
Net sales$312,944 $365,607 $804,850 $989,666 
Cost of sales (exclusive of depreciation and amortization shown separately below)
208,936 237,728 581,258 649,974 
Selling, general, and administrative expenses93,992 97,930 279,685 259,043 
Depreciation and amortization15,465 12,555 44,334 34,509 
Total operating expenses318,393 348,213 905,277 943,526 
(Loss) income from operations(5,449)17,394 (100,427)46,140 
Interest expense, net7,601 2,977 20,551 5,854 
Loss on debt extinguishment— — 494 — 
Gain on tax receivable agreement liability adjustment— — (99,620)— 
Other expense, net98 926 519 1,758 
(Loss) income before income taxes(13,148)13,491 (22,371)38,528 
Income tax expense (benefit) 3,076 2,342 130,859 (2,932)
Net (loss) income(16,224)11,149 (153,230)41,460 
Less: net (loss) income attributable to non-controlling interests
(1,215)1,519 (9,912)7,276 
Net (loss) income attributable to Funko, Inc.$(15,009)$9,630 $(143,318)$34,184 
(Loss) earnings per share of Class A common stock:
Basic$(0.31)$0.21 $(3.01)$0.78 
Diluted$(0.31)$0.19 $(3.01)$0.73 
Weighted average shares of Class A common stock outstanding:
Basic48,237 46,874 47,641 43,670 
Diluted48,237 49,686 47,641 53,991 
See accompanying notes to the unaudited condensed consolidated financial statements.
3

FUNKO, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME
(Unaudited)
Three Months Ended September 30,Nine Months Ended September 30,
2023202220232022
(In thousands)
Net (loss) income$(16,224)$11,149 $(153,230)$41,460 
Other comprehensive (loss) income:
Foreign currency translation gain (loss), net of tax effect of $0 and $1,039 for the three months ended September 30, 2023 and 2022, respectively, and $688 and $2,198 for the nine months ended September 30, 2023 and 2022, respectively
(2,839)(3,674)(391)(8,335)
Comprehensive (loss) income(19,063)7,475 (153,621)33,125 
Less: Comprehensive (loss) income attributable to non-controlling interests
(1,450)1,121 (9,876)5,870 
Comprehensive (loss) income attributable to Funko, Inc.$(17,613)$6,354 $(143,745)$27,255 
See accompanying notes to the unaudited condensed consolidated financial statements.
4

FUNKO, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
September 30,
2023		December 31,
2022
(In thousands, except per share amounts)
Assets
Current assets:
Cash and cash equivalents$31,885 $19,200 
Accounts receivable, net166,934 167,895 
Inventory162,062 246,429 
Prepaid expenses and other current assets44,048 39,648 
Total current assets404,929 473,172 
Property and equipment, net95,389 102,232 
Operating lease right-of-use assets63,533 71,072 
Goodwill135,722 131,380 
Intangible assets, net171,261 181,284 
Deferred tax asset, net of valuation allowance— 123,893 
Other assets9,209 8,112 
Total assets$880,043 $1,091,145 
Liabilities and Stockholders’ Equity
Current liabilities:
Line of credit$141,000 $70,000 
Current portion of long-term debt, net of unamortized discount21,977 22,041 
Current portion of operating lease liabilities17,866 18,904 
Accounts payable70,178 67,651 
Income taxes payable1,136 871 
Accrued royalties61,857 69,098 
Accrued expenses and other current liabilities107,720 112,832 
Total current liabilities421,734 361,397 
Long-term debt, net of unamortized discount136,539 153,778 
Operating lease liabilities, net of current portion73,961 82,356 
Deferred tax liability385 382 
Liabilities under tax receivable agreement, net of current portion— 99,620 
Other long-term liabilities4,658 3,923 
Commitments and Contingencies (Note 6)
Stockholders’ equity:
Class A common stock, par value $0.0001 per share, 200,000 shares authorized; 48,727 and 47,192 shares issued and outstanding as of September 30, 2023 and December 31, 2022, respectively
5 5 
Class B common stock, par value $0.0001 per share, 50,000 shares authorized; 3,293 shares issued and outstanding as of September 30, 2023 and December 31, 2022, respectively
— — 
Additional paid-in-capital318,782 310,807 
Accumulated other comprehensive loss(3,030)(2,603)
(Accumulated deficit) retained earnings(83,303)60,015 
Total stockholders’ equity attributable to Funko, Inc.232,454 368,224 
Non-controlling interests10,312 21,465 
Total stockholders’ equity242,766 389,689 
Total liabilities and stockholders’ equity$880,043 $1,091,145 
See accompanying notes to the unaudited condensed consolidated financial statements.
5

FUNKO, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine Months Ended September 30,
20232022
(In thousands)
Operating Activities
Net (loss) income$(153,230)$41,460 
Adjustments to reconcile net income to net cash (used in) provided by operating activities:
Depreciation, amortization and other42,592 34,390 
Equity-based compensation7,521 11,999 
Amortization of debt issuance costs and debt discounts944 670 
Loss on debt extinguishment494 — 
Gain on tax receivable agreement liability adjustment(99,620)— 
Deferred tax expense 123,206 — 
Other(69)7,539 
Changes in operating assets and liabilities:
Accounts receivable, net1,314 (10,198)
Inventory84,797 (106,061)
Prepaid expenses and other assets8,244 (32,310)
Accounts payable2,536 32,349 
Income taxes payable268 (13,303)
Accrued royalties(7,240)10,942 
Accrued expenses and other liabilities(14,624)(42,159)
Net cash used in operating activities(2,867)(64,682)
Investing Activities
Purchases of property and equipment(30,861)(46,908)
Acquisitions of businesses and related intangible assets, net of cash acquired(5,274)(13,967)
Other551 778 
Net cash used in investing activities(35,584)(60,097)
Financing Activities
Borrowings on line of credit71,000 90,000 
Debt issuance costs(1,957)(405)
Payments of long-term debt(16,911)(13,500)
Distributions to Tax Receivable Agreement Parties(1,110)(10,507)
Proceeds from exercise of equity-based options287 1,209 
Net cash provided by financing activities51,309 66,797 
Effect of exchange rates on cash and cash equivalents(173)(525)
Net change in cash and cash equivalents12,685 (58,507)
Cash and cash equivalents at beginning of period19,200 83,557 
Cash and cash equivalents at end of period$31,885 $25,050 
See accompanying notes to the unaudited condensed consolidated financial statements.
6

FUNKO, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. Organization and Operations
The unaudited condensed consolidated financial statements include Funko, Inc. and its subsidiaries (together, the “Company”) and have been prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”). All intercompany balances and transactions have been eliminated.
The Company was formed as a Delaware corporation on April 21, 2017. The Company was formed for the purpose of completing an initial public offering (“IPO”) of its Class A common stock and related transactions in order to carry on the business of Funko Acquisition Holdings, L.L.C. (“FAH, LLC”) and its subsidiaries.
Funko, Inc. operates and controls all of FAH, LLC’s operations and, through FAH, LLC and its subsidiaries, conducts FAH, LLC’s business as the sole managing member. Accordingly, the Company consolidates the financial results of FAH, LLC and reports a non-controlling interest in its unaudited condensed consolidated financial statements representing the common units of FAH, LLC interests still held by other owners of FAH, LLC (collectively, the “Continuing Equity Owners”).
Interim Financial Information
In the opinion of management, all adjustments considered necessary for a fair presentation of the results as of the date of and for the interim periods presented have been included, and such adjustments consist of normal recurring adjustments. Certain prior-year amounts have been reclassified to conform the current year presentation. The unaudited condensed consolidated results of operations for the current interim period are not necessarily indicative of the results for the entire year ending December 31, 2023, due to seasonality and other factors. These unaudited condensed consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements and related notes included in its Annual Report on Form 10-K for the year ended December 31, 2022, filed with the Securities and Exchange Commission (“SEC”) on March 1, 2023.
2. Significant Accounting Policies
Use of Estimates
The preparation of the Company’s unaudited condensed consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements as well as the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates and assumptions.
Significant Accounting Policies
A description of the Company’s significant accounting policies is included in the audited consolidated financial statements within its Annual Report on Form 10-K for the year ended December 31, 2022.
During the nine months ended September 30, 2023, the Company approved an inventory reduction plan to improve U.S. warehouse operational efficiency. The Company recorded a $30.1 million one-time inventory write-down included in cost of sales as presented in the condensed consolidated statements of operations. The units were identified and recorded based on an estimate of product costs, associated capitalized freight, net of allocated inventory reserves of the identified units and an estimate of physical destruction costs, during the quarter ended March 31, 2023. The physical destruction plan was completed during the third quarter of 2023 and there were no changes to estimated destruction costs.
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During the nine months ended September 30, 2023, the Company determined that based on all the available evidence, including the Company’s three-year cumulative pre-tax loss position, it is not more likely than not that the results of operations will generate sufficient taxable income to realize its deferred tax assets. Consequently, the Company established a full valuation allowance of $123.2 million against its deferred tax assets, thus reducing the carrying balance to $0, and recognized a corresponding increase to tax expense in the consolidated statements of operations and comprehensive (loss) income in the nine months ended September 30, 2023. There was no change to that assessment as of September 30, 2023.
As a result of the full valuation allowance on the deferred tax assets, and projected inability to fully utilize all or part of the related tax benefits, the Company determined that certain payments to the TRA Parties related to unrealized tax benefits under the TRA are no longer probable and estimable. Based on this assessment, the Company reduced its TRA Liability as of June 30, 2023, to $9.6 million, and recognized a gain of $99.6 million within the accompanying consolidated statements of operations and comprehensive (loss) income for the nine months ended September 30, 2023. There was no change to that assessment as of September 30, 2023.
3. Fair Value Measurements
The Company’s financial instruments, other than those discussed below, include cash and cash equivalents, accounts receivable, accounts payable, and accrued liabilities. The carrying amount of these financial instruments approximate fair value due to the short-term nature of these instruments. For financial instruments measured at fair value on a recurring basis, the Company prioritizes the inputs used in measuring fair value according to a three-tier fair value hierarchy defined by U.S. GAAP. For a description of the methods and assumptions that the Company uses to estimate the fair value and determine the classification according to the fair value hierarchy for each financial instrument, see the Company’s audited consolidated financial statements and related notes included in its Annual Report on Form 10-K for the year ended December 31, 2022.
Cash equivalents. As of September 30, 2023 and December 31, 2022, cash equivalents included $10.8 million and $0.5 million, respectively, of highly liquid money market funds, which are classified as Level 1 within the fair value hierarchy.
Crypto asset safeguarding liability and corresponding asset. The crypto asset safeguarding liability and corresponding safeguarding asset are measured and recorded at fair value on a recurring basis using prices available in the market on a pooled basis the Company determines to be the principal market at the balance sheet date. As of September 30, 2023 and December 31, 2022, the estimated fair value of the crypto asset safeguarding liability and corresponding asset was $13.0 million and $11.3 million, respectively, classified at Level 2 within the fair value hierarchy.
Debt. The estimated fair value of the Company’s debt instruments, which are classified as Level 3 financial instruments, at September 30, 2023 and December 31, 2022, was approximately $160.6 million and $177.5 million, respectively. The carrying values of the Company’s debt instruments at September 30, 2023 and December 31, 2022, were $158.5 million and $175.8 million, respectively.
8


4. Debt
Debt consists of the following (in thousands):
September 30, 2023December 31, 2022
Revolving Credit Facility$141,000 $70,000 
Term Loan Facility$144,000 $157,500 
Equipment Finance Loan16,589 20,000 
Debt issuance costs(2,073)(1,681)
Total term debt158,516 175,819 
Less: current portion
21,977 22,041 
Long-term debt, net$136,539 $153,778 
New Credit Facilities
On September 17, 2021, FAH, LLC and certain of its material domestic subsidiaries from time to time (the “Credit Agreement Parties”) entered into a new credit agreement (as amended from time to time, the “New Credit Agreement”) with JPMorgan Chase Bank, N.A., PNC Bank, National Association, KeyBank National Association, Citizens Bank, N.A., Bank of the West, HSBC Bank USA, National Association, Bank of America, N.A., U.S. Bank National Association, MUFG Union Bank, N.A., and Wells Fargo Bank, National Association (collectively, the “Initial Lenders”) and JPMorgan Chase Bank, N.A. as administrative agent, providing for a term loan facility in the amount of $180.0 million (the “New Term Loan Facility”) and a revolving credit facility of $100.0 million (the “New Revolving Credit Facility”) (together the “New Credit Facilities”). Proceeds from the New Credit Facilities were primarily used to repay and terminate the Company’s former credit facilities. On April 26, 2022, the Credit Agreement Parties entered into Amendment No. 1 to the New Credit Agreement (the “First Amendment”) with the Initial Lenders and JPMorgan Chase Bank, N.A. as administrative agent, which allows for additional Restricted Payments (as defined in the First Amendment) using specified funding sources. On July 29, 2022, the Credit Agreement Parties entered into Amendment No. 2 to the New Credit Agreement (the “Second Amendment”) with the Initial Lenders and Goldman Sachs Bank USA (collectively, the “Lenders”) and JPMorgan Chase Bank, N.A. as administrative agent, which increased the New Revolving Credit Facility to $215.0 million and converted the New Credit Facility interest rate index from Borrower (as defined in the New Credit Agreement) option LIBOR to SOFR.
9

On February 28, 2023, the Credit Agreement Parties entered into an Amendment No. 3 (the “Third Amendment”) to the New Credit Agreement to, among other things, (i) modify the financial covenants under the New Credit Agreement for the period beginning on the date of the Third Amendment through the fiscal quarter ending December 31, 2023 (the “Waiver Period”), (ii) reduce the size of the New Revolving Credit Facility from $215.0 million to $180.0 million as of the date of the Third Amendment and thereafter to $150.0 million on December 31, 2023, which reduction shall be permanent after the Waiver Period, (iii) restrict the ability to draw on the New Revolving Credit Facility during the Waiver Period in excess of the amount outstanding on the date of the Third Amendment, (iv) increase the margin payable under the Credit Facilities during the Waiver Period to (a) 4.00% per annum with respect to any Term Benchmark Loan or RFR Loan (each as defined in the New Credit Agreement), and (b) 3.00% per annum with respect to any Canadian Prime Loan or ABR Loan (as defined in the New Credit Agreement), (v) allow that any calculation of Consolidated EBITDA (each as defined in the New Credit Agreement) that includes the fiscal quarters during the Waiver Period may include certain agreed upon amounts for certain addbacks, (vi) further limit our ability to make certain restricted payments, including the ability to pay dividends or make other distributions on equity interests, or redeem, repurchase or retire equity interests, incur additional indebtedness, incur additional liens, enter into sale and leaseback transactions or issue additional equity interests or securities convertible into or exchange for equity interests (other than the issuance of common stock) during the Waiver Period, (vii) require a minimum qualified cash requirement of at least $10.0 million and (viii) require a mandatory prepayment of the New Revolving Credit Facility during the Waiver Period with any qualified cash proceeds in excess of $25.0 million. Following the Waiver Period, beginning in the fiscal quarter ending March 31, 2024, the Third Amendment resets the maximum Net Leverage Ratio and the minimum Fixed Charge Coverage Ratio (each as defined in the New Credit Agreement) that must be maintained by the Credit Agreement Parties to 2.50:1.00 and 1.25:1.00, respectively, which were the ratios in effect under the New Credit Agreement prior to the Third Amendment.
The New Term Loan Facility matures on September 17, 2026 (the “Maturity Date”) and amortizes in quarterly installments in aggregate amounts equal to 2.50% of the original principal amount of the New Term Loan Facility, with any outstanding balance due and payable on the Maturity Date. The first amortization payment commenced with the quarter ending on December 31, 2021. The New Revolving Credit Facility also terminates on the Maturity Date and loans thereunder may be borrowed, repaid, and reborrowed up to such date.
Subject to the interest rates during the Waiver Period as described above, loans under the New Credit Facilities will, at the Borrowers’ option, bear interest at either (i) SOFR, EURIBOR, HIBOR, CDOR, Daily Simple SONIA and/or the Central Bank Rate, as applicable, plus (x) 4.00% per annum and (y) solely in the case of Term SOFR based loans 0.10% per annum or (ii) ABR or the Canadian prime rate, as applicable, plus 3.00%, in each case of clauses (i) and (ii), subject to two 0.25% step-downs based on the achievement of certain leverage ratios following February 28, 2023. Each of SOFR, EURIBOR, HIBOR, CDOR and Daily Simple SONIA rates are subject to a 0% floor. For loans based on ABR, the Central Bank Rate or the Canadian prime rate, interest payments are due quarterly. For loans based on Daily Simple SONIA, interest payments are due monthly. For loans based on SOFR, EURIBOR, HIBOR or CDOR, interest payments are due at the end of each applicable interest period.
The New Credit Facilities are secured by substantially all of the assets of FAH, LLC and any of its existing or future material domestic subsidiaries, subject to customary exceptions. As of September 30, 2023 the Credit Agreement Parties were in compliance with the modified covenants that were amended pursuant to the Third Amendment and within the Waiver Period and as of December 31, 2022, the Credit Agreement Parties were in compliance with all of the covenants in its New Credit Agreement.
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At September 30, 2023 and December 31, 2022, the Credit Agreement Parties had $144.0 million and $157.5 million, respectively, of borrowings outstanding under the New Term Loan Facility and $141.0 million and $70.0 million outstanding borrowings under the New Revolving Credit Facility, respectively. Outstanding borrowings under the New Revolving Credit Facility at September 30, 2023 are due within 30 days of the applicable draw. At September 30, 2023 and December 31, 2022, the Credit Agreement Parties had $0.0 million and $145.0 million available under the New Revolving Credit Facility, respectively.
There were no outstanding letters of credit as of September 30, 2023 and December 31, 2022.
Equipment Finance Loan
On November 25, 2022, Funko, LLC, Funko Games, LLC, Funko Acquisition Holdings, L.L.C., Funko Holdings LLC and Loungefly, LLC, (collectively, "Equipment Finance Credit Parties"), entered into a $20.0 million equipment finance agreement ("Equipment Finance Loan") with Wells Fargo Equipment Finance, Inc. The loan is to be repaid in 48 monthly equal installments starting January 15, 2023, utilizing an annual fixed interest rate of 5.71%.
The Equipment Finance Loan is secured by certain identified assets held within our Buckeye, Arizona warehouse.
At September 30, 2023 and December 31, 2022, the Company had $16.6 million and $20.0 million outstanding under the Equipment Finance Loan, respectively.
5. Liabilities under Tax Receivable Agreement
On November 1, 2017, the Company entered into a tax receivable agreement with FAH, LLC (the “Tax Receivable Agreement”) and each of the Continuing Equity Owners, and certain transferees of the Continuing Equity Owners have been joined as parties to the Tax Receivable Agreement (the parties entitled to payments under the Tax Receivable Agreement are referred to herein as the "TRA Parties") that provides for the payment by the Company to the TRA Parties of 85% of the amount of tax benefits, if any, that it realizes, or in some circumstances, is deemed to realize, as a result of (i) future redemptions funded by the Company or exchanges, or deemed exchanges in certain circumstances, of common units of FAH, LLC for Class A common stock of Funko, Inc. or cash, and (ii) certain additional tax benefits attributable to payments made under the Tax Receivable Agreement (the “TRA Payment”).
During both the three and nine months ended September 30, 2023 the Company acquired 0.1 million common units of FAH, LLC. During the three and nine months ended September 30, 2022 the Company acquired 0.0 million and 6.5 million common units of FAH, LLC, respectively. During the three and nine months ended September 30, 2023, the Company did not recognize an increase to its net deferred tax assets due to the full valuation allowance. As a result of the exchanges during the three and nine months ended September 30, 2022, the Company recognized an increase to its net deferred tax assets in the amount of $0.0 million and $30.0 million, respectively.
11

The following table summarizes changes in the amount of the Company’s Tax Receivable Agreement liability (in thousands):
Three Months Ended September 30,Nine Months Ended September 30,
2023202220232022
Beginning balance$9,562 $112,733 $109,187 $82,884 
Additional liabilities for exchanges— 13 — 29,862 
Liability reduction— — (99,620)— 
Payments under tax receivable agreement— — (5)— 
Ending balance $9,562 $112,746 $9,562 $112,746 
As of September 30, 2023, the Company’s total obligation under the Tax Receivable Agreement, including accrued interest, was $9.8 million, which was included in accrued expenses and other current liabilities on the unaudited condensed consolidated balance sheets. At December 31, 2022, the Company’s total obligation under the Tax Receivable Agreement, including accrued interest, was $109.2 million, of which $9.6 million was included in accrued expenses and other current liabilities on the condensed consolidated balance sheets. As reflected in Note 2. Significant Accounting Policies, the Company determined that payments to the TRA Parties related to unrealized tax benefits under the Tax Receivable Agreement are no longer probable and estimable. Based on this assessment, the Company reduced its Tax Receivable Agreement liability as of June 30, 2023.
6. Commitments and Contingencies
License Agreements
The Company enters into license agreements with various licensors of copyrighted and trademarked characters and design in connection with the products that it sells. The agreements generally require royalty payments based on product sales and in some cases may require minimum royalty and other related commitments.
Employment Agreements
The Company has employment agreements with certain officers. The agreements include, among other things, an annual bonus based on certain performance metrics of the Company, as defined by the board of directors, and up to one year’s severance pay beyond termination date.
Debt
The Company is party to a New Credit Agreement which includes a New Term Loan Facility and a New Revolving Credit Facility. The Company is also party to an Equipment Finance Loan. See Note 4, Debt.
Tax Receivable Agreement
The Company is party to the Tax Receivable Agreement that provides for the TRA Payment by the Company to the TRA Parties under certain circumstances. See Note 5, Liabilities under Tax Receivable Agreement.
12

Leases
The Company has entered into non-cancellable operating leases for office, warehouse, and distribution facilities, with original lease periods expiring through 2032. Some operating leases also contain the option to renew for five-year periods at prevailing market rates at the time of renewal. In addition to minimum rent, certain of the leases require payment of real estate taxes, insurance, common area maintenance charges, and other executory costs. During the three and nine months ended, we recorded a $6.2 million charge related to the termination of a lease agreement and related expenses, for a lease that had not yet commenced.
Legal Contingencies
The Company is involved in claims and litigation in the ordinary course of business, some of which seek monetary damages, including claims for punitive damages, which are not covered by insurance. For certain pending matters, accruals have not been established because such matters have not progressed sufficiently through discovery, and/or development of important factual information and legal information is insufficient to enable the Company to estimate a range of possible loss, if any. An adverse determination in one or more of these pending matters could have an adverse effect on the Company’s consolidated financial position, results of operations or cash flows.
The Company is, and may in the future become, subject to various legal proceedings and claims that arise in or outside the ordinary course of business. For example, several stockholder derivative actions based on the Company’s earnings announcement and Quarterly Report on Form 10-Q for the quarter ended September 30, 2019 have been brought on behalf of the Company against certain of its directors and officers. Specifically, on April 23, June 5, and June 10, 2020, the actions captioned Cassella v. Mariotti et al., Evans v. Mariotti et al., and Igelido v. Mariotti et al., respectively, were filed in the United States District Court for the Central District of California. On July 6, 2020, these three actions were consolidated for all purposes into one action under the title In re Funko, Inc. Derivative Litigation, and on August 13, 2020, the consolidated action was stayed pending final resolution of the motion to dismiss in the Ferreira action. On May 9, 2022, another complaint, asserting substantially similar claims, was filed in the U.S. District Court for the Central District of California, captioned Smith v. Mariotti, et al. On July 5, 2022, two purported stockholders filed an additional derivative action in the Court of Chancery of the State of Delaware, captioned Fletcher, et al. v. Mariotti. The Company has reached a non-monetary settlement in principle in In re Funko, Inc. Derivative Litigation, Smith v. Mariotti, and Fletcher, et al. v. Mariotti and the actions are stayed pending finalization of the settlement.
On June 11, 2021, a purported stockholder filed a related derivative action, captioned Silverberg v. Mariotti, et al., in the Court of Chancery of the State of Delaware. The Company moved to dismiss the Silverberg complaint on April 3, 2023. Plaintiff responded on May 3, 2023, and briefing was completed on May 18, 2023. The motion remains pending before the Court of Chancery.
Additionally, between November 16, 2017 and June 12, 2018, seven purported stockholders of the Company filed putative class action lawsuits in the Superior Court of Washington in and for King County against the Company, certain of its officers and directors, ACON, Fundamental Capital, LLC and Funko International, LLC (collectively, “Fundamental”), the underwriters of its IPO, and certain other defendants.
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On July 2, 2018, the suits were ordered consolidated for all purposes into one action under the title In re Funko, Inc. Securities Litigation. On August 1, 2018, plaintiffs filed a consolidated complaint against the Company, certain of its officers and directors, ACON, Fundamental, and certain other defendants. The Company moved to dismiss twice, and the Court twice granted the Company's motions to dismiss, the second time with prejudice. Plaintiffs appealed, and on November 1, 2021, the Court of Appeals reversed the trial court’s dismissal decision in most respects. On May 4, 2022, the Washington State Supreme Court denied the Company’s petition, and the case was remanded to the Superior Court for further proceedings. The Company filed its answer on September 19, 2022 and discovery is currently ongoing. Plaintiffs filed a motion for class certification on July 7, 2023, and briefing was completed on the class certification motion on October 25, 2023.
On June 4, 2018, a putative class action lawsuit entitled Kanugonda v. Funko, Inc., et al. was filed in the United States District Court for the Western District of Washington against the Company, certain of its officers and directors, and certain other defendants. On January 4, 2019, a lead plaintiff was appointed in that case. On April 30, 2019, the lead plaintiff filed an amended complaint against the previously named defendants. The Company moved to dismiss the Complaint in the federal action, now captioned Berkelhammer v. Funko, Inc. et al., on June 14, 2023. Plaintiff filed an opposition on July 27, 2023, cross moving for an order voluntarily dismissing the action without prejudice so that he can pursue status as a class representative in In re Funko, Inc. Securities Litigation, or in the alternative, a court order denying defendants’ motion to dismiss. Briefing completed on August 18, 2023. On October 13, 2023, the District Court granted plaintiff’s motion for voluntary dismissal without prejudice, denied defendants’ motion to dismiss, and dismissed the action.
The case in Washington state court alleges that the Company violated Sections 11, 12, and 15 of the Securities Act of 1933, as amended, by making allegedly materially misleading statements in documents filed with the U.S. Securities and Exchange Commission in connection with the Company’s IPO and by omitting material facts necessary to make the statements made therein not misleading. The lawsuit seeks, among other things, compensatory statutory damages and rescissory damages in account of the consideration paid for the Company’s Class A common stock by the plaintiffs and members of the putative class, as well as attorneys’ fees and costs.
On January 18, 2022, a purported stockholder filed a putative class action lawsuit in the Court of Chancery of the State of Delaware, captioned Shumacher v. Mariotti, et al., relating to the Company’s corporate “Up-C” structure and bringing direct claims for breach of fiduciary duties against certain current and former officers and directors. On March 31, 2022, the defendants moved to dismiss the action. In response to defendants’ motion to dismiss. Plaintiff filed an Amended Complaint on May 25, 2022. The amendment did not materially change the claims at issue, and the Defendants again moved to dismiss on July 29, 2022. On December 15, 2022, Plaintiff opposed the Defendants’ motion to dismiss, and also moved for attorneys’ fees. Briefing on the motion to dismiss was completed on February 8, 2023; briefing on Plaintiff’s fee application was completed on April 6, 2023. The Court heard oral argument on both motions on July 24, 2023.
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On June 2, 2023, a purported stockholder filed a putative class action lawsuit in the United States District Court for the Western District of Washington, captioned Studen v. Funko, Inc., et al. The Complaint alleges that the Company and certain individual defendants violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as well as Rule 10b-5 promulgated thereunder by making allegedly materially misleading statements in documents filed with the SEC, as well as in earnings calls and presentations to investors, regarding a planned upgrade to its enterprise resource planning system and the relocation of a distribution center, as well as by omitting material facts about the same subjects necessary to make the statements made therein not misleading. The lawsuits seek, among other things, compensatory damages and attorneys’ fees and costs. On August 17, 2023, the Court appointed lead plaintiff, and on October 29, 2023, the parties submitted a joint stipulated scheduling order. Plaintiff’s amended complaint was filed October 19, 2023. The amendment adds additional allegations by including accounts from purported former employees and contractors. Plaintiff seeks to represent a putative class of investors who purchased or acquired Funko common stock between March 3, 2022 and March 1, 2023. Defendants’ motion to dismiss is due December 15, 2023, and the motion will be fully briefed by March 22, 2024.
The Company is party to additional legal proceedings incidental to its business. While the outcome of these additional matters could differ from management’s expectations, the Company does not believe that the resolution of such matters is reasonably likely to have a material effect on its results of operations or financial condition.
7. Segments
The Company identifies its segments according to how the business activities are managed and evaluated and for which discrete financial information is available and regularly reviewed by its Chief Operating Decision Maker (the “CODM”) to allocate resources and assess performance. Because its CODM reviews financial performance and allocates resources at a consolidated level on a regular basis, the Company has one segment.
The following table presents summarized product information as a percent of sales:
Three Months Ended September 30,Nine Months Ended September 30,
2023202220232022
Core Collectible74.5 %77.2 %73.4 %76.3 %
Loungefly 18.4 %16.3 %19.8 %18.2 %
Other7.1 %6.5 %6.8 %5.5 %
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The following tables present summarized geographical information (in thousands):
Three Months Ended September 30,Nine Months Ended September 30,
2023202220232022
Net sales:
United States$208,895 $262,316 $557,899 $725,677 
Europe83,398 78,239 193,229 198,688 
Other International20,651 25,052 53,722 65,301 
Total net sales$312,944 $365,607 $804,850 $989,666 
September 30, 2023December 31, 2022
Long-term assets:
United States$117,187 $131,549 
United Kingdom18,919 28,811 
Vietnam and China32,025 21,056 
Total long-lived assets$168,131 $181,416 
8. Income Taxes
Funko, Inc. is taxed as a corporation and pays corporate federal, state and local taxes on income allocated to it from FAH, LLC based upon Funko, Inc.’s economic interest held in FAH, LLC. FAH, LLC is treated as a pass-through partnership for income tax reporting purposes. FAH, LLC’s members, including the Company, are liable for federal, state and local income taxes based on their share of FAH, LLC’s pass-through taxable income.
The Company recorded income tax expense of $3.1 million and $130.9 million for the three and nine months ended September 30, 2023, respectively, and $2.3 million of income tax expense and $2.9 million of income tax benefit for the three and nine months ended September 30, 2022, respectively. The Company’s effective tax rate for the nine months ended September 30, 2023 was (584.9)%. The Company’s effective tax rate is less than the statutory rate of 21% primarily due to the establishment of the valuation allowance as of June 30, 2023.
The Company is party to the Tax Receivable Agreement that provides for the TRA Payment by the Company to the TRA Parties under certain circumstances. See Note 5, Liabilities under Tax Receivable Agreement.



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9. Stockholders’ Equity
The following is a reconciliation of changes in stockholders’ equity for the three and nine months ended September 30, 2023 and 2022:
Three Months Ended September 30,Nine Months Ended September 30,
2023202220232022
(In thousands)
Class A common stock
Beginning balance$5 $5 $5 $4 
Shares issued— — — 1 
Ending balance$5 $5 $5 $5 
Class B common stock
Beginning balance$— $— $— $1 
Redemption of common units of FAH, LLC— — — (1)
Ending balance$— $— $— $— 
Additional paid-in capital
Beginning balance$319,531 $304,258 $310,807 $252,505 
Equity-based compensation(916)4,677 7,521 11,999 
Shares issued for equity-based compensation awards— 650 287 1,209 
Redemption of common units of FAH, LLC167 21 167 37,922 
Recapitalization of common units of FAH, LLC— — — 5,873 
Establishment of liabilities under tax receivable agreement and related changes to deferred tax assets— 3 — 101 
Ending balance$318,782 $309,609 $318,782 $309,609 
Accumulated other comprehensive (loss) income
Beginning balance$(426)$(2,575)$(2,603)$1,078 
Foreign currency translation loss, net of tax(2,604)(3,276)(427)(6,929)
Ending balance$(3,030)$(5,851)$(3,030)$(5,851)
(Accumulated deficit) retained earnings
Beginning balance$(68,294)$92,604 $60,015 $68,050 
Net (loss) income attributable to Funko, Inc.(15,009)9,630 (143,318)34,184 
Ending balance$(83,303)$102,234 $(83,303)$102,234 
Non-controlling interests
Beginning balance$11,936 $25,671 $21,465 $74,920 
Distributions to TRA Parties(7)(283)(1,110)(10,507)
Redemption of common units of FAH, LLC(167)(21)(167)(37,922)
Recapitalization of common units of FAH, LLC— — — (5,873)
Foreign currency translation (loss) gain, net of tax(235)(398)36 (1,406)
Net (loss) income attributable to non-controlling interests(1,215)1,519 (9,912)7,276 
Ending balance$10,312 $26,488 $10,312 $26,488 
Total stockholders’ equity$242,766 $432,485 $242,766 $432,485 
17

The following is a reconciliation of changes in Class A and Class B common shares outstanding for the three and nine months ended September 30, 2023 and 2022:
Three Months Ended September 30,Nine Months Ended September 30,
2023202220232022
(In thousands)
Class A common shares outstanding
Beginning balance47,497 46,832 47,192 40,088 
Shares issued for equity-based compensation awards
1,170 259 1,475 507 
Redemption of common units of FAH, LLC60 4 60 6,500 
Ending balance48,727 47,095 48,727 47,095 
Class B common shares outstanding
Beginning balance3,293 3,293 3,293 10,691 
Redemption of common units of FAH, LLC— — — (6,488)
Recapitalization of Class B common shares— — — (910)
Ending balance3,293 3,293 3,293 3,293 
Total Class A and Class B common shares outstanding
52,020 50,388 52,020 50,388 
10. Non-controlling interests
Funko, Inc. is the sole managing member of FAH, LLC and as a result consolidates the financial results of FAH, LLC and reports a non-controlling interest representing the common units of FAH, LLC held by the Continuing Equity Owners. Changes in Funko, Inc.’s ownership interest in FAH, LLC while Funko, Inc. retains its controlling interest in FAH, LLC will be accounted for as equity transactions. As such, future redemptions or direct exchanges of common units of FAH, LLC by the Continuing Equity Owners will result in a change in ownership and reduce the amount recorded as non-controlling interest and increase or decrease additional paid-in capital when FAH, LLC has positive or negative net assets, respectively.
Net income (loss) and comprehensive (loss) income are attributed between Funko, Inc. and non-controlling interest holders based on each party’s relative economic ownership interest in FAH, LLC. As of September 30, 2023 and December 31, 2022, Funko, Inc. owned 48.7 million and 47.2 million of FAH, LLC common units, respectively, representing a 91.7% and 91.6% economic ownership interest in FAH, LLC, respectively.
18

Net (loss) income and comprehensive (loss) income of FAH, LLC excludes certain activity attributable to Funko, Inc., including equity-based (recapture of) compensation expense for share-based compensation awards issued by Funko, Inc., income tax expense (benefit) for corporate, federal, state and local taxes attributable to Funko, Inc. and tax receivable agreement liability adjustments. The following represents the amounts excluded from the computation of net (loss) income and comprehensive (loss) income of FAH, LLC for the three and nine months ended September 30, 2023 and 2022:
Three Months Ended September 30,Nine Months Ended September 30,
2023202220232022
(In thousands)
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
Basic (loss) earnings per share of Class A common stock is computed by dividing net (loss) income attributable to Funko, Inc. by the weighted-average number of shares of Class A common stock outstanding during the period. Diluted (loss) earnings per share of Class A common stock is computed by dividing net (loss) income attributable to Funko, Inc. by the weighted-average number of shares of Class A common stock outstanding adjusted to give effect to potentially dilutive securities.
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The following table sets forth reconciliations of the numerators and denominators used to compute basic and diluted (loss) earnings per share of Class A common stock (in thousands, except shares and per share amounts):
Three Months Ended September 30,Nine Months Ended September 30,
2023202220232022
Numerator:
Net (loss) income$(16,224)$11,149 $(153,230)$41,460 
Less: net (loss) income attributable to
  non-controlling interests
(1,215)1,519 (9,912)7,276 
Net (loss) income attributable to Funko, Inc. — basic and diluted$(15,009)$9,630 $(143,318)$34,184 
Add: Reallocation of net (loss) income attributable to non-controlling interests from the assumed exchange of common units of FAH, LLC for Class A common stock
— — — 5,397 
Net (loss) income attributable to Funko, Inc. — diluted$(15,009)$9,630 $(143,318)$39,581 
Denominator:
Weighted-average shares of Class A common stock outstanding — basic48,236,867 46,874,285 47,640,974 43,670,297 
Add: Dilutive common units of FAH, LLC that are convertible into Class A common stock
— 146,109 — 8,005,100 
Add: Dilutive Funko, Inc. equity compensation awards
— 2,665,985 — 2,315,109 
Weighted-average shares of Class A common stock outstanding — diluted48,236,867 49,686,379 47,640,974 53,990,506 
(Loss) earnings per share of Class A common stock — basic$(0.31)$0.21 $(3.01)$0.78 
(Loss) earnings per share of Class A common stock — diluted$(0.31)$0.19 $(3.01)$0.73 
For the three months ended September 30, 2023 and 2022, an aggregate of 10.3 million and 6.0 million, respectively, and for the nine months ended September 30, 2023 and 2022, an aggregate of 10.6 million and 1.9 million, respectively, of potentially dilutive securities were excluded from the weighted-average in the computation of diluted (loss) earnings per share of Class A common stock because the effect would have been anti-dilutive. For the three months ended September 30, 2023 and 2022, anti-dilutive securities included 4.4 million and 4.3 million, respectively, and for the nine months ended September 30, 2023 and 2022, anti-dilutive securities included 4.4 million and 0.0 million, respectively, common units of FAH, LLC that are convertible into Class A common stock, but were excluded from the computations of diluted (loss) earnings per share because the effect would have been anti-dilutive under the if-converted method.
Shares of the Company’s Class B common stock do not participate in the earnings or losses of the Company and are therefore not participating securities. As such, separate presentation of basic and diluted earnings per share of Class B common stock under the two-class method has not been presented.
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Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
You should read the following discussion and analysis of our financial condition and results of operations together with our unaudited condensed consolidated financial statements and related notes included elsewhere in this Quarterly Report on Form 10-Q, as well as our audited consolidated financial statements and related notes as disclosed in our Annual Report on Form 10-K filed with the Securities and Exchange Commission (“SEC”) on March 1, 2023. This discussion and analysis contains forward-looking statements based upon current plans, expectations and beliefs involving risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of various important factors, including those set forth under “Risk Factors” included in this Quarterly Report on Form 10-Q.
As used in this Quarterly Report on Form 10-Q, unless the context otherwise requires, references to:
•“we,” “us,” “our,” the “Company,” “Funko” and similar references refer: Funko, Inc., and, unless otherwise stated, all of its direct and indirect subsidiaries, including FAH, LLC.
•“ACON” refers to ACON Funko Investors, L.L.C., a Delaware limited liability company, and certain funds affiliated with ACON Funko Investors, L.L.C. (including each of the Former Equity Owners).
•“ACON Sale” refers to the sale by ACON and certain of its affiliates to TCG of an aggregate of 12,520,559 shares of our Class A common stock pursuant to a Stock Purchase Agreement, dated as of May 3, 2022, by and among ACON, certain affiliates of ACON and TCG.
•“Continuing Equity Owners” refers collectively to ACON Funko Investors, L.L.C., Fundamental, the Former Profits Interests Holders, certain former warrant holders and certain current and former executive officers, employees and directors and each of their permitted transferees, in each case, that owned common units in FAH, LLC after our initial public offering ("IPO") and who may redeem at each of their options, their common units for, at our election, cash or newly-issued shares of Funko, Inc.’s Class A common stock.
•“FAH, LLC” refers to Funko Acquisition Holdings, L.L.C., a Delaware limited liability company.
•“FAH LLC Agreement” refers to FAH, LLC’s second amended and restated limited liability company agreement, as amended from time to time.
•“Former Equity Owners” refers to those Original Equity Owners affiliated with ACON who transferred their indirect ownership interests in common units of FAH, LLC for shares of Funko, Inc.’s Class A common stock (to be held by them either directly or indirectly) in connection with our IPO.
•“Former Profits Interests Holders” refers collectively to certain of our directors and certain current executive officers and employees, in each case, who held existing vested and unvested profits interests in FAH, LLC pursuant to FAH, LLC’s prior equity incentive plan and received common units of FAH, LLC in exchange for their profits interests (subject to any common units received in exchange for unvested profits interests remaining subject to their existing time-based vesting requirements) in connection with our IPO.
•“Fundamental” refers collectively to Fundamental Capital, LLC and Funko International, LLC.
•“Original Equity Owners” refers to the owners of ownership interests in FAH, LLC, collectively, prior to the IPO, which include ACON, Fundamental, the Former Profits Interests Holders and certain current and former executive officers, employees and directors.
•“Tax Receivable Agreement” refers to a tax receivable agreement entered into between Funko, Inc., FAH, LLC and each of the Continuing Equity Owners and certain transferees.
•“TCG" refers to TCG 3.0 Fuji, LP.
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Overview
Funko is a leading pop culture lifestyle brand. Our business is built on the principle that almost everyone is a fan of something and the evolution of pop culture is leading to increasing opportunities for fan loyalty. We create whimsical, fun and unique products that enable fans to express their affinity for their favorite “something”—whether it is a movie, TV show, video game, musician or sports team. We infuse our distinct designs and aesthetic sensibility into one of the industry’s largest portfolios of licensed content over a wide variety of product categories, including figures, plush, accessories, apparel, homewares, vinyl record, poster or digital NFT.
We sell our products in numerous countries across North America, Europe, Latin America, Asia and Africa, with approximately 31% of our net sales generated outside of the United States. We also source and procure inventory, primarily out of China, Vietnam and Mexico. As such, we are exposed to and impacted by global macroeconomic factors. Current macroeconomic factors remain very dynamic, such as greater political unrest or instability in Central and Eastern Europe (including the ongoing Russia-Ukraine War), the Middle East (including the Israel–Hamas War), and certain Southeast Asia regions as well as financial instability, rising interest rates and heightened inflation could reduce our net sales or have impacts to our gross margin, net income and cash flows.
In addition, we have been and continue to be operating in a challenging retail environment where retailers have slowed their restocking, prioritized lower inventory levels and, in some cases, have canceled their orders. This has had an impact across our brands and geographies of reducing our net sales, gross margin and net income. We have strategically adjusted our inventory buy-in to focus on core products and help mitigate this impact.
Key Performance Indicators
We consider the following metrics to be key performance indicators to evaluate our business, develop financial forecasts, and make strategic decisions.
Three Months Ended September 30,Nine Months Ended September 30,
2023202220232022
(amounts in thousands)
Net sales$312,944 $365,607 $804,850 $989,666 
Net (loss) income$(16,224)$11,149 $(153,230)$41,460 
EBITDA (1)
$9,918 $29,023 $42,514 $78,891 
Adjusted EBITDA (1)
$25,394 $35,697 $3,745 $103,701 
(1)Earnings before interest, taxes, depreciation and amortization (“EBITDA”) and Adjusted EBITDA are financial measures not calculated in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”). For a reconciliation of EBITDA and Adjusted EBITDA to net (loss) income, the most closely comparable U.S. GAAP financial measure, see “Non-GAAP Financial Measures” below.

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Results of Operations
Three Months Ended September 30, 2023 Compared to Three Months Ended September 30, 2022
The following table sets forth information comparing the components of net (loss) income for the three months ended September 30, 2023 and 2022:
Three Months Ended September 30,Period over Period Change
20232022DollarPercentage
(amounts in thousands, except percentages)
Net sales$312,944 $365,607 $(52,663)(14.4)%
Cost of sales (exclusive of depreciation and amortization shown separately below)208,936 237,728 (28,792)(12.1)%
Selling, general, and administrative expenses93,992 97,930 (3,938)(4.0)%
Depreciation and amortization15,465 12,555 2,910 23.2 %
Total operating expenses318,393 348,213 (29,820)(8.6)%
(Loss) income from operations(5,449)17,394 (22,843)nm
Interest expense, net7,601 2,977 4,624 nm
Other expense, net98 926 (828)nm
(Loss) income before income taxes(13,148)13,491 (26,639)nm
Income tax expense 3,076 2,342 734 31.3 %
Net (loss) income(16,224)11,149 (27,373)nm
Less: net (loss) income attributable to non-controlling interests
(1,215)1,519 (2,734)nm
Net (loss) income attributable to Funko, Inc.$(15,009)$9,630 $(24,639)nm
Net Sales
Net sales were $312.9 million for the three months ended September 30, 2023, a decrease of 14.4%, compared to $365.6 million for the three months ended September 30, 2022. The decrease in net sales was due primarily to decreased sales to e-commerce sites, mass-market retailer and distributor customers for the three months ended September 30, 2023 compared to the three months ended September 30, 2022, primarily as a result of slower inventory restocking and an overall challenging retail environment.
For the three months ended September 30, 2023, the number of active properties decreased 1.2% to 753 as compared to 762 for the three months ended September 30, 2022, and the average net sales per active property decreased 13.4% for the three months ended September 30, 2023 as compared to the three months ended September 30, 2022. An active property is a licensed property from which we generate sales of products during a given period. We expect that the number of active properties and the average sales per active property will fluctuate from quarter to quarter based on what is relevant in pop culture at that time, the types of properties we are producing against and general economic trends.
On a geographical basis, net sales in the United States decreased 20.4% to $208.9 million in the three months ended September 30, 2023 as compared to $262.3 million in the three months ended September 30, 2022. Net sales in Europe increased 6.6% to $83.4 million in the three months ended September 30, 2023 as compared to $78.2 million in the three months ended September 30, 2022 and net sales in other international locations decreased 17.6% to $20.7 million in the three months ended September 30, 2023 as compared to $25.1 million in the three months ended September 30, 2022.
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On a branded product basis, net sales of Core Collectible branded products decreased 17.4% to $233.3 million in the three months ended September 30, 2023 as compared to $282.4 million in the three months ended September 30, 2022, Loungefly branded products decreased 3.6% to $57.4 million in the three months ended September 30, 2023 as compared to $59.6 million in the three months ended September 30, 2022, and net sales of other branded products decreased 5.9% to $22.2 million in the three months ended September 30, 2023 as compared to $23.6 million in the three months ended September 30, 2022.
Cost of Sales and Gross Margin (exclusive of depreciation and amortization)
Cost of sales (exclusive of depreciation and amortization) was $208.9 million for the three months ended September 30, 2023, a decrease of 12.1%, compared to $237.7 million for the three months ended September 30, 2022. Cost of sales (exclusive of depreciation and amortization) decreased primarily as a result of decreased sales, as discussed above, partially offset by higher costs as a percentage of net sales as described below.
Gross margin (exclusive of depreciation and amortization), calculated as net sales less cost of sales as a percentage of net sales, was 33.2% for the three months ended September 30, 2023, compared to 35.0% for the three months ended September 30, 2022. The decrease in gross margin (exclusive of depreciation and amortization) for the three months ended September 30, 2023 compared to the three months ended September 30, 2022 was driven primarily by an increase in inventory reserves and other inventory adjustments, including disposal of finished inventory held at offshore factories during the three months ended September 30, 2023.
Selling, General, and Administrative Expenses
Selling, general, and administrative expenses were $94.0 million for the three months ended September 30, 2023, a decrease of 4.0%, compared to $97.9 million for the three months ended September 30, 2022. The decrease was driven primarily by a $9.5 million decrease to personnel and related costs (including salary and related taxes/benefits, commissions, equity-based compensation and variable warehouse labor and third party logistics expenses), and a $1.1 million decrease to product development, offset by a $6.8 million increase in professional fees, which include consulting fees and one-time charges related to the termination of a lease agreement and related expenses.
Selling, general and administrative expenses were 30.0% and 26.8% of net sales for the three months ended September 30, 2023 and 2022, respectively. The increase in selling, general and administrative expenses as a percentage of net sales was due to initiatives to streamline Company operations, including one-time charges for reduction-in-force and the termination of a lease agreement and related expenses.
Depreciation and Amortization
Depreciation and amortization expense was $15.5 million for the three months ended September 30, 2023, an increase of 23.2%, compared to $12.6 million for the three months ended September 30, 2022, primarily related to the type and timing of assets placed in service.
Interest Expense, Net
Interest expense, net was $7.6 million for the three months ended September 30, 2023, an increase of 155.3%, compared to $3.0 million for the three months ended September 30, 2022. The increase in interest expense, net was due primarily to a higher average balance on debt outstanding at higher interest rates, including $141.0 million outstanding on the revolving line of credit during the three months ended September 30, 2023 as compared to $80.8 million for the three months ended September 30, 2022.
24

Other expense, net
Other expense, net was $0.1 million and $0.9 million for the three months ended September 30, 2023 and 2022, respectively. The decrease in other expense, net for the three months ended September 30, 2023 from the three months ended September 30, 2022 was primarily related to foreign currency gains and losses relating to transactions denominated in currencies other than the U.S. dollar.
Income tax expense
Income tax expense was $3.1 million and $2.3 million for the three months ended September 30, 2023 and 2022, respectively. The increase for the three months ended September 30, 2023 from the three months ended September 30, 2022 was primarily related to return to provision adjustments related to the 2022 tax return.
Net (loss) income
Net loss was $16.2 million for the three months ended September 30, 2023, compared to net income of $11.1 million for the three months ended September 30, 2022. The decrease in net income was primarily due to cost of sales (exclusive of depreciation and amortization) and selling, general and administrative expenses for the three months ended September 30, 2023 outpacing the net sales decrease as compared to the three months ended September 30, 2022, as discussed above.
25

Nine Months Ended September 30, 2023 Compared to Nine Months Ended September 30, 2022
The following table sets forth information comparing the components of net (loss) income for the nine months ended September 30, 2023 and 2022:
Nine Months Ended September 30,Period over Period Change
20232022DollarPercentage
(amounts in thousands, except percentages)
Net sales$804,850 $989,666 $(184,816)(18.7)%
Cost of sales (exclusive of depreciation and amortization shown separately below)581,258 649,974 (68,716)(10.6)%
Selling, general, and administrative expenses279,685 259,043 20,642 8.0 %
Depreciation and amortization44,334 34,509 9,825 28.5 %
Total operating expenses905,277 943,526 (38,249)(4.1)%
(Loss) income from operations(100,427)46,140 (146,567)nm
Interest expense, net20,551 5,854 14,697 nm
Gain on tax receivable agreement liability(99,620)— (99,620)nm
Loss on debt extinguishment494 — 494 nm
Other expense, net519 1,758 (1,239)(70.5)%
(Loss) income before income taxes(22,371)38,528 (60,899)nm
Income tax expense (benefit) 130,859 (2,932)133,791 nm
Net (loss) income(153,230)41,460 (194,690)nm
Less: net (loss) income attributable to non-controlling interests(9,912)7,276 (17,188)nm
Net (loss) income attributable to Funko, Inc.$(143,318)$34,184 $(177,502)nm
Net Sales
Net sales were $804.9 million for the nine months ended September 30, 2023, a decrease of 18.7%, compared to $989.7 million for the nine months ended September 30, 2022. The decrease in net sales was due primarily to decreased sales to mass-market retailers, e-commerce sites and specialty retailer customers for the nine months ended September 30, 2023 compared to the nine months ended September 30, 2022.
For the nine months ended September 30, 2023, the number of active properties decreased 3.2% to 869 as compared to 898 for the nine months ended September 30, 2022, and the average net sales per active property decreased 16.0% for the nine months ended September 30, 2023 as compared to the nine months ended September 30, 2022.
On a geographical basis, net sales in the United States decreased 23.1% to $557.9 million in the nine months ended September 30, 2023 as compared to $725.7 million in the nine months ended September 30, 2022. Net sales in Europe decreased 2.7% to $193.2 million in the nine months ended September 30, 2023 as compared to $198.7 million in the nine months ended September 30, 2022 and net sales in other international locations decreased 17.7% to $53.7 million in the nine months ended September 30, 2023 as compared to $65.3 million in the nine months ended September 30, 2022.
26

On a branded product basis, net sales of Core Collectible branded products decreased 21.8% to $590.4 million in the nine months ended September 30, 2023 as compared to $755.1 million in the nine months ended September 30, 2022, Loungefly branded products decreased 11.1% to $159.6 million in the nine months ended September 30, 2023 as compared to $179.6 million in the nine months ended September 30, 2022 and net sales of other branded products decreased 0.2% to $54.8 million in the nine months ended September 30, 2023 as compared to $54.9 million in the nine months ended September 30, 2022.
Cost of Sales and Gross Margin (exclusive of depreciation and amortization)
Cost of sales (exclusive of depreciation and amortization) was $581.3 million for the nine months ended September 30, 2023, a decrease of 10.6%, compared to $650.0 million for the nine months ended September 30, 2022. Cost of sales (exclusive of depreciation and amortization) decreased primarily as a result of decreased sales, as discussed above, partially offset by higher costs as a percentage of net sales as described below.
Gross margin (exclusive of depreciation and amortization), calculated as net sales less cost of sales as a percentage of net sales, was 27.8% for the nine months ended September 30, 2023, compared to 34.3% for the nine months ended September 30, 2022. The decrease in gross margin (exclusive of depreciation and amortization) for the nine months ended September 30, 2023 compared to the nine months ended September 30, 2022 was driven primarily by an increase in inventory reserves and other inventory adjustments, including disposal of finished inventory held at domestic and offshore factories during the nine months ended September 30, 2023.
Selling, General, and Administrative Expenses
Selling, general, and administrative expenses were $279.7 million for the nine months ended September 30, 2023, an increase of 8.0%, compared to $259.0 million for the nine months ended September 30, 2022. The increase was driven primarily by a $8.3 million increase in rent, facilities and warehouse support, primarily related to the Buckeye, Arizona warehouse, a $7.2 million increase to personnel and related costs (including salary and related taxes/benefits, commissions, equity-based compensation and variable warehouse labor and third party logistics expenses), and a $4.8 million increase in professional fees, which include consulting and legal fees. Selling, general and administrative expenses were 34.7% and 26.2% of net sales for the nine months ended September 30, 2023 and 2022, respectively. The increase in selling, general and administrative expenses as a percentage of net sales was due to initiatives to streamline Company operations, including one-time charges for reduction-in-force and the termination of a lease agreement and related expenses.
Depreciation and Amortization
Depreciation and amortization expense was $44.3 million for the nine months ended September 30, 2023, an increase of 28.5%, compared to $34.5 million for the nine months ended September 30, 2022, primarily related to the type and timing of assets placed in service.
Interest Expense, Net
Interest expense, net was $20.6 million for the nine months ended September 30, 2023, an increase of 251.1%, compared to $5.9 million for the nine months ended September 30, 2022. The increase in interest expense, net was due primarily to a higher average balance on debt outstanding, at higher interest rates, during the nine months ended September 30, 2023 as compared to the nine months ended September 30, 2022.
27

Loss on debt extinguishment
As a result of the debt refinancing in February 2023, a $0.5 million loss on debt extinguishment was recorded for the nine months ended September 30, 2023 as unamortized debt financing fees were written-off.

Gain on tax receivable agreement liability adjustment
As a result of recognizing a full valuation allowance related to the Company’s deferred tax assets, the Company determined as of June 30, 2023 that no future tax benefits were expected to be realized under the Tax Receivable Agreement. The long-term portion of the tax receivable agreement liability was reduced and we recorded a gain of $99.6 million during the nine months ended September 30, 2023.
Other expense, net
Other expense, net was $0.5 million and $1.8 million for the nine months ended September 30, 2023 and 2022, respectively. Other expense, net for the nine months ended September 30, 2023 and 2022 was primarily related to foreign currency gains and losses relating to transactions denominated in currencies other than the U.S. dollar.
Income tax expense (benefit)
Income tax expense was $130.9 million and income tax benefit was $2.9 million for the nine months ended September 30, 2023 and 2022, respectively. The increase in income tax expense for the nine months ended September 30, 2023 from the nine months ended September 30, 2022 was related to recognizing a full valuation allowance on the Company’s deferred tax assets.
Net (loss) income
Net loss was $153.2 million for the nine months ended September 30, 2023, compared to net income of $41.5 million for the nine months ended September 30, 2022. The decrease in net income for the nine months ended September 30, 2023 as compared to the nine months ended September 30, 2022 was primarily due to the decrease in net sales and certain increases in cost of sales (exclusive of depreciation and amortization), and selling, general and administrative expenses and tax impact related to recognizing a deferred tax asset valuation allowance, partially offset by a gain on the tax receivable agreement liability adjustment, as discussed above.


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Non-GAAP Financial Measures
EBITDA, Adjusted EBITDA, Adjusted Net (Loss) Income and Adjusted (Loss) Earnings per Diluted Share (collectively the “Non-GAAP Financial Measures”) are supplemental measures of our performance that are not required by, or presented in accordance with, U.S. GAAP. The Non-GAAP Financial Measures are not measurements of our financial performance under U.S. GAAP and should not be considered as an alternative to net (loss) income, (loss) earnings per share or any other performance measure derived in accordance with U.S. GAAP. We define EBITDA as net (loss) income before interest expense, net, income tax (benefit) expense, depreciation and amortization. We define Adjusted EBITDA as EBITDA further adjusted for non-cash charges related to equity-based compensation programs, loss on debt extinguishment, acquisition transaction costs and other expenses, certain severance, relocation and related costs, foreign currency transaction gains and losses, one-time inventory write-down, tax receivable agreement liability adjustments, one-time disposal costs for unfinished and finished goods held at offshore factories and other unusual or one-time items. We define Adjusted Net (Loss) Income as net (loss) income attributable to Funko, Inc. adjusted for the reallocation of income attributable to non-controlling interests from the assumed exchange of all outstanding common units and options in FAH, LLC for newly issued-shares of Class A common stock of Funko, Inc. and further adjusted for the impact of certain non-cash charges and other items that we do not consider in our evaluation of ongoing operating performance. These items include, among other things, non-cash charges related to equity-based compensation programs, loss on debt extinguishment, acquisition transaction costs and other expenses, certain severance, relocation and related costs, foreign currency transaction gains and losses, one-time inventory write-down, tax receivable agreement liability adjustments, one-time disposal costs for unfinished and finished goods held at offshore factories and the income tax expense effect of these adjustments. We define Adjusted (Loss) Earnings per Diluted Share as Adjusted Net (Loss) Income divided by the weighted-average shares of Class A common stock outstanding, assuming (1) the full exchange of all outstanding common units and options in FAH, LLC for newly issued-shares of Class A common stock of Funko, Inc. and (2) the dilutive effect of stock options and unvested common units, if any. We caution investors that amounts presented in accordance with our definitions of the Non-GAAP Financial Measures may not be comparable to similar measures disclosed by our competitors, because not all companies and analysts calculate the Non-GAAP Financial Measures in the same manner. We present the Non-GAAP Financial Measures because we consider them to be important supplemental measures of our performance and believe they are frequently used by securities analysts, investors, and other interested parties in the evaluation of companies in our industry. Management believes that investors’ understanding of our performance is enhanced by including these Non-GAAP Financial Measures as a reasonable basis for comparing our ongoing results of operations.
Management uses the Non-GAAP Financial Measures:
•as a measurement of operating performance because they assist us in comparing the operating performance of our business on a consistent basis, as they remove the impact of items not directly resulting from our core operations;
•for planning purposes, including the preparation of our internal annual operating budget and financial projections;
•as a consideration to assess incentive compensation for our employees;
•to evaluate the performance and effectiveness of our operational strategies; and
•to evaluate our capacity to expand our business.
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By providing these Non-GAAP Financial Measures, together with reconciliations, we believe we are enhancing investors’ understanding of our business and our results of operations, as well as assisting investors in evaluating how well we are executing our strategic initiatives. The Non-GAAP Financial Measures have limitations as analytical tools, and should not be considered in isolation, or as an alternative to, or a substitute for net income or other financial statement data presented in our unaudited condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q as indicators of financial performance. Some of the limitations are:
•such measures do not reflect our cash expenditures, or future requirements for capital expenditures or contractual commitments;
•such measures do not reflect changes in, or cash requirements for, our working capital needs;
•such measures do not reflect the interest expense, or the cash requirements necessary to service interest or principal payments on our debt;
•although depreciation and amortization are non-cash charges, the assets being depreciated and amortized will often have to be replaced in the future and such measures do not reflect any cash requirements for such replacements; and
•other companies in our industry may calculate such measures differently than we do, limiting their usefulness as comparative measures.
Due to these limitations, Non-GAAP Financial Measures should not be considered as measures of discretionary cash available to us to invest in the growth of our business. We compensate for these limitations by relying primarily on our U.S. GAAP results and using these non-GAAP measures only supplementally. As noted in the table below, the Non-GAAP Financial Measures include adjustments for non-cash charges related to equity-based compensation programs, loss on debt extinguishment, acquisition transaction costs and other expenses, certain severance, relocation and related costs, foreign currency transaction gains and losses, one-time inventory write-down, tax receivable agreement liability adjustments, one-time disposal costs for unfinished and finished goods held at offshore factories and other unusual or one-time items. It is reasonable to expect that certain of these items will occur in future periods. However, we believe these adjustments are appropriate because the amounts recognized can vary significantly from period to period, do not directly relate to the ongoing operations of our business and complicate comparisons of our internal operating results and operating results of other companies over time. Each of the normal recurring adjustments and other adjustments described herein and in the reconciliation table below help management with a measure of our core operating performance over time by removing items that are not related to day-to-day operations.
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The following tables reconcile the Non-GAAP Financial Measures to the most directly comparable U.S. GAAP financial performance measure, which is net income, for the periods presented:
Three Months Ended September 30,Nine Months Ended September 30,
2023202220232022
(In thousands, except per share data)
Net (loss) income attributable to Funko, Inc.$(15,009)$9,630 $(143,318)$34,184 
Reallocation of net income attributable to non-controlling interests from the assumed exchange of common units of FAH, LLC for Class A common stock (1)
(1,215)1,519 (9,912)7,276 
Equity-based compensation (2)
(916)4,677 7,521 11,999 
Loss on debt extinguishment (3)
— — 494 — 
Acquisition transaction costs and other expenses (4)
5,467 — 6,921 2,850 
Certain severance, relocation and related costs (5)
3,703 1,070 5,784 8,203 
Foreign currency transaction loss (6)
1,074 927 1,495 1,758 
One-time inventory write-down (7)
— — 30,084 — 
Tax receivable agreement liability adjustments (8)
— — (99,620)— 
One-time disposal costs for unfinished goods held at offshore factories (9)
— — 2,404 — 
One-time disposal costs for finished goods held at offshore factories (10)
6,148 — 6,148 
Income tax expense (benefit) (11)
2,494 (2,699)146,144 (18,767)
Adjusted net income$1,746 $15,124 $(45,855)$47,503 
Weighted-average shares of Class A common stock outstanding-basic
48,237 46,874 47,641 43,670 
Equity-based compensation awards and common units of FAH, LLC that are convertible into Class A common stock
4,443 7,150 4,430 10,321 
Adjusted weighted-average shares of Class A stock outstanding - diluted
52,680 54,024 52,071 53,991 
Adjusted earnings (loss) per diluted share$0.03 $0.28 $(0.88)$0.88 
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Three Months Ended September 30,Nine Months Ended September 30,
2023202220232022
(amounts in thousands)
Net (loss) income$(16,224)$11,149 $(153,230)$41,460 
Interest expense, net7,601 2,977 20,551 5,854 
Income tax expense (benefit) 3,076 2,342 130,859 (2,932)
Depreciation and amortization15,465 12,555 44,334 34,509 
EBITDA
$9,918 $29,023 $42,514 $78,891 
Adjustments:
Equity-based compensation (2)
$(916)$4,677 $7,521 $11,999 
Loss on debt extinguishment (3)
— — 494 — 
Acquisition transaction costs and other expenses (4)
5,467 — 6,921 2,850 
Certain severance, relocation and related costs (5)
3,703 1,070 5,784 8,203 
Foreign currency transaction (gain) loss (6)
1,074 927 1,495 1,758 
One-time inventory write-down (7)
— — 30,084 — 
Tax receivable agreement liability adjustments (8)
— — (99,620)— 
One-time disposal costs for unfinished goods held at offshore factories (9)
— — 2,404 — 
One-time disposal costs for finished goods held at offshore factories (10)
6,148 — 6,148 
Adjusted EBITDA
$25,394 $35,697 $3,745 $103,701 
(1)Represents the reallocation of net income attributable to non-controlling interests from the assumed exchange of common units of FAH, LLC for Class A common stock in periods in which income was attributable to non-controlling interests.
(2)Represents non-cash charges (recapture of charges) related to equity-based compensation programs, which vary from period to period depending on the timing of awards and forfeitures.
(3)Represents write-off of unamortized debt financing fees for the nine months ended September 30, 2023.
(4)For the three and nine months ended September 30, 2023, includes costs related to the termination of a lease agreement and related expenses, partially offset by acquisition-related benefits. For the nine months ended September 30, 2022, includes acquisition-related costs related to investment banking and due diligence fees.
(5)For the three and nine months ended September 30, 2023, includes charges to remove leasehold improvements and return multiple Washington-based warehouses, and charges related to severance and benefit costs for a reduction-in-force. For the three and nine months ended September 30, 2022, includes charges related to one-time relocation costs for U.S. warehouse personnel and inventory in connection with the opening of a new warehouse and distribution facility in Buckeye, Arizona.
(6)Represents both unrealized and realized foreign currency gains and losses on transactions denominated other than in U.S. dollars, including derivative gains and losses on foreign currency forward exchange contracts.
(7)For the nine months ended September 30, 2023, represents a one-time inventory write-down to improve U.S. warehouse operational efficiency.
(8)Represents reduction of the tax receivable agreement liability as a result of recognizing a full valuation allowance of the Company’s deferred tax assets and anticipated inability to realize future tax benefits.
(9)For the nine months ended September 30, 2023, represents one-time disposal costs related to unfinished goods held at offshore factories.
(10)For the three and nine months ended September 30, 2023, represents one-time disposal costs related to finished goods held at offshore factories primarily due to customer order cancellations.
(11)Represents the income tax expense effect of the above adjustments, except for the tax liability receivable adjustment. This adjustment uses an effective tax rate of 25% for all periods presented. For the nine months ended September 30, 2023, this also includes $123.2 million recognized valuation allowance on the Company’s deferred tax assets. For the nine months ended September 30, 2022, this also includes the $11.0 million discrete benefit from the release of a valuation allowance on the outside basis deferred tax asset.
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Liquidity and Financial Condition
Introduction
Our primary requirements for liquidity and capital are working capital, inventory management, capital expenditures, debt service and general corporate needs.
Notwithstanding our obligations under the Tax Receivable Agreement between Funko, Inc., FAH, LLC and each of the Continuing Equity Owners, and certain transferees of the Continuing Equity Owners have been joined as parties to the Tax Receivable Agreement (the parties entitled to payments under the Tax Receivable Agreement are referred to herein as the "TRA Parties"), we believe that our sources of liquidity and capital will be sufficient to finance our continued operations, growth strategy, our planned capital expenditures and the additional expenses we expect to incur for at least the next 12 months.
However, we cannot assure you that our cash provided by operating activities, cash and cash equivalents or cash available under our Revolving Credit Facility will be sufficient to meet our future needs. If we are unable to generate sufficient cash flows from operations in the future, and if availability under our Revolving Credit Facility is not sufficient, we may have to obtain additional financing. If we obtain additional capital by issuing equity, the interests of our existing stockholders will be diluted. If we incur additional indebtedness, that indebtedness may contain significant financial and other covenants that may significantly restrict our operations. We cannot assure you that we could obtain refinancing or additional financing on favorable terms or at all.
Liquidity and Capital Resources
The following table shows summary cash flow information for the nine months ended September 30, 2023 and 2022 (in thousands):
Nine Months Ended September 30,
20232022
Net cash used in operating activities$(2,867)$(64,682)
Net cash used in investing activities(35,584)(60,097)
Net cash provided by financing activities51,309 66,797 
Effect of exchange rates on cash and cash equivalents(173)(525)
Net change in cash and cash equivalents$12,685 $(58,507)
Operating Activities. Net cash used in operating activities was $2.9 million for the nine months ended September 30, 2023, compared to $64.7 million for the nine months ended September 30, 2022. Changes in net cash used in operating activities result primarily from cash received from net sales and cash payments for product costs and royalty expenses paid to our licensors. Other drivers of the changes in net cash used in operating activities include shipping and freight costs, selling, general and administrative expenses (including personnel expenses and commissions and rent and facilities costs) and interest payments made for our short-term borrowings and long-term debt. Our accounts receivable typically are short term and settle in approximately 30 to 90 days.
The decrease in net cash used in operating activities for the nine months ended September 30, 2023 compared to the nine months ended September 30, 2022 was primarily due to changes in working capital that increased cash provided by operating activities by $236.0 million. The working capital increase was primarily due to increases in inventory of $190.9 million, prepaid expenses and other assets of $40.6 million and decreases in accrued expense and other current liabilities of $27.5 million, offset by increases in accounts payable of $29.8 million and accrued royalties of $18.2 million.
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Investing Activities. Our net cash used in investing activities primarily consists of purchases of property and equipment. For the nine months ended September 30, 2023, net cash used in investing activities was $35.6 million, primarily related to purchases of tooling and molds used in production for our product lines and warehouse equipment for the U.S. consolidated warehouse and distribution center. In addition, we used $5.3 million in net cash for the acquisition of MessageMe, Inc. (d/b/a HipDot). For the nine months ended September 30, 2022, net cash used in investing activities was $60.1 million and was primarily related to purchases of tooling and molds used in our production product lines and for the acquisition of Mondo.
Financing Activities. Our financing activities primarily consist of proceeds from the issuance of long-term debt, net of debt issuance costs, the repayment of long-term debt, payments and borrowings under our line of credit facility, distributions to the TRA Parties and proceeds from the exercise of equity-based options.
For the nine months ended September 30, 2023, net cash provided by financing activities was $51.3 million, primarily related to a draw of $71.0 million on the New Revolving Credit Facility (as defined below), offset by payments of $16.9 million on the Company’s New Term Loan Facility (as defined below) and equipment finance loan and distributions to the TRA Parties of $1.1 million. For the nine months ended September 30, 2022, net cash used in financing activities was $66.8 million, primarily related to a draw of $90.0 million on the New Revolving Credit Facility, offset by payments of $13.5 million on the Company’s New Term Loan Facility and distributions to the TRA Parties of $10.5 million.
Credit Facilities
On September 17, 2021, FAH, LLC and certain of its material domestic subsidiaries from time to time (the “Credit Agreement Parties”) entered into a new credit agreement (as amended from time to time, the “New Credit Agreement”) with JPMorgan Chase Bank, N.A., PNC Bank, National Association, KeyBank National Association, Citizens Bank, N.A., Bank of the West, HSBC Bank USA, National Association, Bank of America, N.A., U.S. Bank National Association, MUFG Union Bank, N.A., and Wells Fargo Bank, National Association (collectively, the “Initial Lenders”) and JPMorgan Chase Bank, N.A. as administrative agent, providing for a term loan facility in the amount of $180.0 million (the “New Term Loan Facility”) and a revolving credit facility of $100.0 million (the “New Revolving Credit Facility”) (together the “New Credit Facilities”). Proceeds from the New Credit Facilities were primarily used to repay the Company’s former credit facilities. On April 26, 2022, the parties to the New Credit Agreement entered into Amendment No. 1 to the New Credit Agreement (the “First Amendment”) with the Initial Lenders and JPMorgan Chase Bank, N.A. as administrative agent, which allows for additional Restricted Payments (as defined in the First Amendment) using specified funding sources. On July 29, 2022, the parties to the New Credit Agreement entered into Amendment No. 2 to the New Credit Agreement (the “Second Amendment”) with the Initial Lenders and Goldman Sachs Bank USA (collectively, the “Lenders”) and JPMorgan Chase Bank, N.A. as administrative agent, which increases the New Revolving Credit Facility to $215.0 million and converts the New Credit Facility interest rate index from Borrower (as defined in the New Credit Agreement) option LIBOR to SOFR.
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On February 28, 2023, the Credit Agreement Parties entered into Amendment No. 3 (the “Third Amendment”) to the New Credit Agreement to, among other things, (i) modify the financial covenants under the New Credit Agreement for the period beginning on the date of the Third Amendment through the fiscal quarter ending December 31, 2023 (the “Waiver Period”), (ii) reduce the size of the New Revolving Credit Facility from $215.0 million to $180.0 million as of the date of the Third Amendment and thereafter to $150.0 million on December 31, 2023, which reduction shall be permanent after the Waiver Period, (iii) restrict the ability to draw on the New Revolving Credit Facility during the Waiver Period in excess of the amount outstanding on the date of the Third Amendment, (iv) increase the margin payable under the Credit Facilities during the Waiver Period to (a) 4.00% per annum with respect to any Term Benchmark Loan or RFR Loan (each as defined in the New Credit Agreement), and (b) 3.00% per annum with respect to any Canadian Prime Loan or ABR Loan (as defined in the New Credit Agreement), (v) allow that any calculation of Consolidated EBITDA (each as defined in the New Credit Agreement) that includes the fiscal quarters during the Waiver Period may include certain agreed upon amounts for certain addbacks, (vi) further limit our ability to make certain restricted payments, including the ability to pay dividends or make other distributions on equity interests, or redeem, repurchase or retire equity interests, incur additional indebtedness, incur additional liens, enter into sale and leaseback transactions or issue additional equity interests or securities convertible into or exchange for equity interests (other than the issuance of common stock) during the Waiver Period, (vii) require a minimum qualified cash requirement of at least $10.0 million and (viii) require a mandatory prepayment of the New Revolving Credit Facility during the Waiver Period with any qualified cash proceeds in excess of $25.0 million. Following the Waiver Period, beginning in the fiscal quarter ending March 31, 2024, the Third Amendment will reset the maximum Net Leverage Ratio and the minimum Fixed Charge Coverage Ratio (each as defined in the New Credit Agreement) that must be maintained by the Credit Agreement Parties to 2.50:1.00 and 1.25:1.00, respectively, which were the ratios in effect under the New Credit Agreement prior to the Third Amendment. We cannot assure you that we will be able to maintain compliance with our financial covenants as amended after the Waiver Period, or that we will be able to further amend the New Credit Agreement should similar circumstances arise in the future. As of February 28, 2023, the Company had $141.0 million in borrowings outstanding under the New Revolving Credit Facility.
If our operating results fail to improve or if we are otherwise unable to maintain compliance with the financial or other covenants under the New Credit Agreement, our lenders could, among other things, continue to refuse to permit any additional borrowings under the New Revolving Credit Facility, terminate all outstanding commitments thereunder and accelerate all outstanding borrowings and other obligations, which would require us to seek additional financing. Even in the absence of such event, if we are unable to generate sufficient cash flows from operations in the future, and if availability under our Revolving Credit Facility is not sufficient after the Waiver Period, we may have to obtain additional financing. If we obtain additional capital by issuing equity, the interests of our existing stockholders will be diluted. If we incur additional indebtedness, that indebtedness may contain significant financial and other covenants that may significantly restrict our operations. We cannot assure you that we could obtain refinancing or additional financing on favorable terms or at all, particularly during the Waiver Period.
The New Term Loan Facility matures on September 17, 2026 (the “Maturity Date”) and amortizes in quarterly installments in aggregate amounts equal to 2.50% of the original principal amount of the New Term Loan Facility, with any outstanding balance due and payable on the Maturity Date. The first amortization payment commenced with the quarter ending on December 31, 2021. The New Revolving Credit Facility also terminates on the Maturity Date and loans thereunder may be borrowed, repaid, and reborrowed, to the extent consistent with the Third Amendment, up to such date.
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Subject to the interest rates during the Waiver Period as described above, loans under the New Credit Facilities will, at the Borrowers’ option, bear interest at either (i) Term SOFR, EURIBOR, HIBOR, CDOR, SONIA and/or the Central Bank Rate, as applicable, plus (x) 4.00% per annum and (y) solely in the case of Term SOFR based loans, 0.10% per annum or (ii) ABR or the Canadian prime rate, as applicable, plus 3.00% per annum, in each case of clauses (i) and (ii), subject to two 0.25% per annum step-downs based on the achievement of certain leverage ratios. Each of Term SOFR, EURIBOR, HIBOR, CDOR and Daily Simple SONIA rates are subject to a 0% floor. For loans based on ABR, the Central Bank Rate or the Canadian prime rate, interest payments are due quarterly. For loans based on SONIA, interest payments are due monthly. For loans based on Term SOFR, EURIBOR, HIBOR or CDOR, interest payments are due at the end of each applicable interest period.
The New Credit Agreement contains a number of covenants that, among other things and subject to certain exceptions, restrict our ability to:
•incur additional indebtedness;
•incur certain liens;
•consolidate, merge or sell or otherwise dispose of our assets;
•make investments, loans, advances, guarantees and acquisitions;
•pay dividends or make other distributions on equity interests, or redeem, repurchase or retire equity interests;
•enter into transactions with affiliates;
•enter into sale and leaseback transactions in respect to real property;
•enter into swap agreements;
•enter into agreements restricting our subsidiaries’ ability to pay dividends;
•issue or sell equity interests or securities convertible into or exchangeable for equity interests;
•redeem, repurchase or refinance other indebtedness; and
•amend or modify our governing documents.
These limitations are also more restrictive during the Waiver Period as described herein. In addition, the New Credit Agreement requires FAH, LLC and its subsidiaries to comply on a quarterly basis with a maximum Net Leverage Ratio and a minimum fixed charge coverage ratio (in each case, measured on a trailing four-quarter basis) other than during the Waiver Period. The maximum Net Leverage Ratio and the minimum fixed charge coverage ratio for the fiscal quarter ended December 31, 2022 were 2.50:1.00 and 1.25:1.00, respectively, and such ratios will apply again commencing after the Waiver Period for the fiscal quarter ending March 31, 2024.
As of September 30, 2023 and December 31, 2022, we were in compliance with all covenants in our respective credit agreements in effect at such time. Subsequent to the Third Amendment, we expect to maintain compliance with our covenants for at least one year from the issuance of these financial statements based on our current expectations and forecasts. If economic conditions worsen, such as due to the COVID-19 pandemic or international conflict, and negatively impact the Company’s earnings and operating cash flows, this could impact our ability to regain compliance with our amended financial covenants and require the Company to seek additional amendments to our New Credit Agreement.
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The New Credit Agreement also contains certain customary representations and warranties and affirmative covenants, and certain reporting obligations. In addition, the lenders under the New Credit Facilities will be permitted to accelerate all outstanding borrowings and other obligations, terminate outstanding commitments and exercise other specified remedies upon the occurrence of certain events of default (subject to certain grace periods and exceptions), which include, among other things, payment defaults, breaches of representations and warranties, covenant defaults, certain cross-defaults and cross-accelerations to other indebtedness, certain events of bankruptcy and insolvency, certain material monetary judgments and changes of control. The New Credit Agreement defines “change of control” to include, among other things, any person or group other than ACON and its affiliates becoming the beneficial owner of more than 35% of the voting power of the equity interests of Funko, Inc.
As of September 30, 2023, we had $144.0 million of indebtedness outstanding under our New Term Loan Facility (net of unamortized discount of $2.1 million) and $141.0 million outstanding borrowings under our New Revolving Credit Facility, leaving $0.0 million available under our New Revolving Credit Facility.
Form S-3 Registration Statement
On July 15, 2022, we filed a preliminary shelf registration statement on Form S-3 with the SEC. The Form S-3 was declared effective by the SEC on July 26, 2022 and will remain effective until through July 25, 2025. The Form S-3 allows us to offer and sell from time-to-time up to $100.0 million of Class A common stock, preferred stock, debt securities, warrants, purchase contracts or units comprised of any combination of these securities for our own account and allows certain selling stockholders to offer and sell 17,318,008 shares of Class A common stock in one or more offerings.
The Form S-3 is intended to provide us flexibility to conduct registered sales of our securities, subject to market conditions and our future capital needs. The terms of any future offering under the shelf registration statement will be established at the time of such offering and will be described in a prospectus supplement filed with the SEC prior to the completion of any such offering.
Future Sources and Uses of Liquidity
As of September 30, 2023, we had $31.9 million of cash and cash equivalents and $(16.8) million of working capital, compared with $19.2 million of cash and cash equivalents and $111.8 million of working capital as of December 31, 2022. Working capital is impacted by the seasonal trends of our business and the timing of new product releases, as well as our current portion of long-term debt and draw downs on New Revolving Credit Facility.
Sources
As noted above, historically, our primary sources of cash flows have been cash flows from operating activities and borrowings under our credit facilities. We expect these sources of liquidity to continue to be our primary sources of liquidity. For a discussion of our credit facilities, see “Credit Facilities” above and Note 5, Debt. In addition, as described above, on July 15, 2022, we filed a preliminary shelf registration statement on Form S-3 with the SEC, which was declared effective by the SEC on July 26, 2022. The terms of any offering under the shelf registration statement will be established at the time of such offering and will be described in a prospectus supplement filed with the SEC prior to the completion of any such offering.
Uses
As noted above, our primary requirements for liquidity and capital are working capital, inventory management, capital expenditures, debt service and general corporate needs. There have been no material changes to our liquidity and capital commitments as described in our Annual Report on Form 10-K for the year ended December 31, 2022.
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Additional future liquidity needs may include tax distributions, the redemption right held by the Continuing Equity Owners that they may exercise from time to time (should we elect to exchange their common units for a cash payment), payments under the Tax Receivable Agreement and general cash requirements for operations and capital expenditures (including integration of our warehouse management system (WMS), additional platforms to support our direct-to-consumer experience, and capital build out of new leased warehouse and office space). The Continuing Equity Owners may exercise their redemption right for as long as their common units remain outstanding. If utilization of the deferred tax assets subject to the Tax Receivable Agreement becomes more likely than not in the future, the Company will record a liability related to the Tax Receivable Agreement and, if that occurs, we expect that the payments we will be required to make to the TRA Parties will be significant. Any payments made by us to the TRA Parties under the Tax Receivable Agreement will generally reduce the amount of overall cash flow that might have otherwise have been available to us or to FAH, LLC and, to the extent that we are unable to make payments under the Tax Receivable Agreement for any reason, the unpaid amounts generally will be deferred and will accrue interest until paid by us; provided however, that nonpayment for a specified period may constitute a material breach under the Tax Receivable Agreement and therefore may accelerate payments due under the Tax Receivable Agreement.
Seasonality
While our customers in the retail industry typically operate in highly seasonal businesses, we have historically experienced only moderate seasonality in our business. Historically, over 50% of our net sales are made in the third and fourth quarters, primarily in the period from August through November, as our customers build up their inventories in anticipation of the holiday season. Historically, the first quarter of the year has represented the lowest volume of shipment and sales in our business and in the retail and toy industries generally and it is also the least profitable quarter due to the various fixed costs of the business. However, the rapid growth we have experienced in recent years may have masked the full effects of seasonal factors on our business to date, and as such, seasonality may have a greater effect on our results of operations in future periods.
Critical Accounting Policies and Estimates
Discussion and analysis of our financial condition and results of operations are based on our unaudited condensed consolidated financial statements which have been prepared in accordance with U.S. GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets and liabilities and related disclosures of contingent assets and liabilities, revenue and expenses at the date of the unaudited condensed consolidated financial statements. We base our estimates on historical experience and on various other assumptions in accordance with U.S. GAAP that we believe to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions.
Critical accounting policies and estimates are those that we consider the most important to the portrayal of our financial condition and operating results and require management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. Our critical accounting policies and estimates include those related to revenue recognition and sales allowances, royalties, inventory, goodwill and intangible assets, and income taxes. Changes to these policies and estimates could have a material adverse effect on our results of operations and financial condition.
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The Company applies the provisions of Accounting Standards Codification (“ASC”) Topic No. 740, “Income Taxes” (“ASC 740”). Under ASC 740, deferred tax assets and liabilities are determined based on differences between the financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. The Company reviews its deferred tax assets for recoverability every quarter and valuation allowances are established when management determines, based on all the available evidence, that it is more likely than not that a deferred asset will not be realized. In reviewing all the available evidence management looks at historical pre-tax income or losses, projected future taxable income or loss, and the expected timing of the reversals of existing temporary differences, as deemed appropriate. In addition, all other available positive and negative evidence is taken into consideration for purposes of determining the proper balances of such valuation allowances. As a result of this review, the Company determined that based on all the available evidence, including the Company’s three-year cumulative pre-tax loss position as of June 30, 2023, it is not more likely than not that the results of operations will generate sufficient taxable income to realize its deferred tax assets. Consequently, the Company established a full valuation allowance of $123.2 million against its deferred tax assets, thus reducing the carrying balance to $0, and recognized a corresponding increase to tax expense in the consolidated statements of operations and comprehensive (loss) income for the nine months ended September 30, 2023. There was no change to that assessment as of September 30, 2023. Future changes to the balances of these valuation allowances, as a result of this continued review and analysis by the Company, could impact the financial statements within the period of change.
Pursuant to the Tax Receivable Agreement, the Company is required to make cash payments to the TRA Parties equal to 85% of the tax benefits, if any, that the Company realizes. Amounts payable under the Tax Receivable Agreement are contingent upon, among other things, (i) generation of taxable income over the term of the Tax Receivable Agreement and (ii) changes in tax laws. If the Company does not generate sufficient taxable income in the aggregate over the term of the Tax Receivable Agreement to utilize the tax benefits, then the Company would not be required to make the related Tax Receivable Agreement Payments, and this would reduce the liability under the Tax Receivable Agreement (“TRA Liability”) accordingly.
As a result of the full valuation allowance on the deferred tax assets, and projected inability to fully utilize all or part of the related tax benefits, the Company determined that certain payments to the TRA Parties related to unrealized tax benefits under the Tax Receivable Agreement are no longer probable and estimable. Based on this assessment, the Company reduced its TRA Liability as of June 30, 2023, to $9.6 million, and recognized a gain of $99.6 million within the accompanying consolidated statements of operations and comprehensive (loss) income for the nine months ended September 30, 2023. There was no change to that assessment as of September 30, 2023. If utilization of the deferred tax assets subject to the Tax Receivable Agreement becomes more likely than not in the future, the Company will record a liability related to the Tax Receivable Agreement, which would be recognized as pre-tax expense within the consolidated statements of operations and comprehensive (loss) income.
There have been no significant changes to our critical accounting policies to our disclosure reported in “Critical Accounting Policies and Estimates” in our Annual Report on Form 10-K for the year ended December 31, 2022.

Item 3.Quantitative and Qualitative Disclosures about Market Risk.
We are exposed to market risk from changes in interest rates, foreign currency and inflation. All of these market risks arise in the normal course of business, as we do not engage in speculative trading activities. There have been no material changes in our market risk from the disclosure included under “Quantitative and Qualitative Disclosures of Market Risk” in the Annual Report on Form 10-K for the year ended December 31, 2022.
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Item 4.Controls and Procedures.
Limitations on Effectiveness of Disclosure Controls and Procedures.
In designing and evaluating our disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures must reflect that there are resource constraints and that management is required to apply judgment in evaluating the benefits of possible controls and procedures relative to their costs.
Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our Interim Chief Executive Officer and Chief Financial Officer, has concluded, based on its evaluation as of September 30, 2023, that our “disclosure controls and procedures” (as such term is defined in Rules 13a–15(e) and 15d–15(e) under the Securities and Exchange Act of 1934, as amended (the “Exchange Act”)), were not effective at the reasonable assurance level as of such date because of the material weaknesses in our internal control over financial reporting previously described in Item 9A. “Controls and Procedures” of our 2022 Annual Report on Form 10-K.
Remediation Efforts to Address the Material Weaknesses
Our remediation efforts to address the above material weaknesses are ongoing and include:
•performing a rigorous scoping and risk assessment process to identify and analyze risk across the various levels of the Company;
•utilizing the SOX Steering Committee to identify and analyze risks, communicate and emphasize the importance of internal control, and to report regularly to the Company’s Audit Committee;
•enhancing the design of control activities to operate at a level of precision to identify all potentially material errors, and training control owners to improve required retention of documentation evidencing their operation;
•designing and implementing controls that review, approve, and periodically re-evaluate the user access privileges for all system users and the business purpose for allowing access for each authorized user to address segregation of duties;
•designing and implementing controls that require review and approval of changes to key financial information technology systems and reports utilized in the performance of internal controls used in financial reporting; and
•investing in training and hiring personnel with appropriate expertise to plan and perform more timely and thorough monitoring activities for internal controls over financial reporting.
We anticipate that our remediation efforts will continue throughout 2023 however, we cannot provide assurance as to when our remediation measures will be fully complete, and the material weaknesses cannot be considered fully remediated until the applicable controls have operated for a sufficient period of time and management has concluded, through testing, that these controls are operating effectively.


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Changes in Internal Control over Financial Reporting
Other than management’s continuing efforts to remediate the material weaknesses discussed above, there were no changes in our internal control over financial reporting during the quarter ended September 30, 2023, that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II – OTHER INFORMATION
Item 1.Legal Proceedings.
See Note 6 “Commitments and Contingencies - Legal Contingencies” in the Notes to Unaudited Condensed Consolidated Financial Statements included in this Form 10-Q for a discussion of material legal proceedings.
Item 1A.Risk Factors.
Our business faces significant risks and uncertainties. Certain important factors may have a material adverse effect on our business prospects, financial condition and results of operations, and they should be carefully considered. Accordingly, in evaluating our business, we encourage you to consider the following discussion of risk factors in its entirety, in addition to other information contained in or incorporated by reference into this Quarterly Report on Form 10-Q and our other public filings with the Securities and Exchange Commission (“SEC”). Other events that we do not currently anticipate or that we currently deem immaterial may also affect our business, prospects, financial condition and results of operations.
BUSINESS, ECONOMIC, MARKET AND OPERATING RISKS
Our success depends on our ability to execute our business strategy.
Our net sales and profitability have generally grown rapidly in the last several years; however, this should not be considered indicative of our future performance. Our future growth, profitability and cash flows depend upon our ability to successfully manage our operations and execute our business strategy, which is dependent upon a number of factors, including our ability to:
•expand our market presence in existing sales channels and enter additional sales channels;
•anticipate, gauge and respond to rapidly changing consumer preferences and pop culture trends;
•acquire or enter into new licenses in existing product categories or in new product categories and renew existing licenses;
•expand our geographic presence to take advantage of opportunities outside of the United States;
•enhance and maintain favorable brand recognition for our Company and product offerings;
•maintain and expand margins through sales growth and efficiency initiatives;
•effectively manage our relationships with third-party manufacturers;
•effectively manage our debt, working capital and capital investments to maintain and improve the generation of cash flow; and
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•execute any acquisitions quickly and efficiently and integrate businesses successfully.
There can be no assurance that we can successfully execute our business strategy in the manner or time period that we expect, particularly in light of the macroeconomic pressures impacting the global economy and consumer demand. Further, achieving these objectives will require investments that may result in short-term costs without generating any current sales or countervailing cost savings and, therefore, may be dilutive to our earnings, at least in the short term. In addition, we have in the past decided and may in the future decide to divest or discontinue certain brands or products or streamline operations and incur other costs or special charges in doing so. We may also decide to discontinue certain programs or sales to certain retailers based on anticipated strategic benefits. The failure to realize the anticipated benefits from our business strategy could have a material adverse effect on our prospects, business, financial condition and results of operations.
Our success depends, in part, on our ability to successfully manage our inventories.
We must maintain sufficient inventory levels to operate our business successfully, but we must also avoid accumulating excess inventory, which increases working capital needs and lowers gross margin. We obtain substantially all of our inventory from third-party manufacturers located outside the United States and must typically order products well in advance of the time these products will be offered for sale to our customers. As a result, it may be difficult to respond to changes in consumer preferences and market conditions, which, for pop culture products, can change rapidly. If we do not accurately anticipate the popularity of certain products, then we may not have sufficient inventory to meet demand. Alternatively, if demand or future sales do not reach forecasted levels, we could have excess inventory that we may need to hold for a long period of time, write down, sell at prices lower than expected or discard.
In addition, we may face difficulties processing inventory through our distribution centers, which could cause us to hold inventory for an extended period of time. If market conditions, demand for our products or consumer preferences shift or we face distribution challenges prior to the sales of the inventory, we may have excess inventory that we may need to hold for a long period of time, write down, and/or sell at prices lower than expected or discard.
We may also be negatively affected by changes in retailers’ inventory policies and practices, including as a result of macroeconomic factors. As a result of the desire of retailers to more closely manage inventory levels, we are required to more closely anticipate demand and this could require us to carry additional inventory. Policies and practices of individual retailers may adversely affect us as well, including those relating to access to and time on shelf space, price demands, payment terms and favoring the products of our competitors. Our retail customers make no binding long-term commitments to us regarding purchase volumes and make all purchases by delivering purchase orders. Any retailer can therefore freely reduce its overall purchase of our products, including the number and variety of our products that it carries, and reduce the shelf space allotted for our products. We have recently experienced canceled orders and if demand or future sales do not reach forecasted levels, we could have excess inventory that we may need to hold for a long period of time, write down, sell at prices lower than expected or discard. For example, during the nine months ended September 30, 2023, we incurred a one-time inventory write-down of $30.1 million due to our decision to increase operational efficiency and reduce storage costs and $8.6 million in unfinished and finished goods held at offshore factories, which contributed to the Company’s net loss for the period. If we are not successful in managing our inventory, our business, financial condition and results of operations could be adversely affected.
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If we fail to manage our growth effectively, our financial performance may suffer.
We have generally experienced rapid growth over the last several years, which has placed a strain on our managerial, operational, product design and development, sales and marketing, administrative and financial infrastructure. For example, we increased our total number of full-time employees from 702 as of December 31, 2018 to 1,293 as of September 30, 2023. We also lease distribution centers in the U.S. and the United Kingdom and utilize third party distribution centers in the U.S. and the Netherlands. Our success depends in part upon our ability to manage our growth effectively. To do so, we must continue to increase the productivity of our existing employees and to hire, train and manage new employees as needed, which we may not be able to do successfully or without compromising our corporate culture. See “Our success is critically dependent on the efforts and dedication of our officers and other employees, and the loss of one or more key employees, or our inability to attract and retain qualified personnel and maintain our corporate culture, could adversely affect our business.” To manage domestic and international growth of our operations and personnel, we have invested and continue to invest in the development of warehouse management systems, additional platforms to support our direct-to-consumer experience, and capital build out of new leased warehouse and office spaces. In August 2022, we announced that we were delaying the remaining steps for implementation of our enterprise resource planning software to 2023, which has caused us to incur increased costs and adversely impacted our financial results. At December 31, 2022, we determined the enterprise resource planning project was not feasible for its intended use and abandoned the cloud computing arrangement and incurred a write down of $32.5 million. We will need to continue to improve our product development, supply chain, financial and management controls and our reporting processes and procedures to support our infrastructure and new business initiatives. These additional investments will increase our operating costs, which will make it more difficult for us to offset any future revenue shortfalls by reducing expenses in the short term. Moreover, if we fail to scale our operations or manage our growth successfully, our business, financial condition and operating results could be adversely affected.
Our business is dependent upon our license agreements, which involve certain risks.
Products from which we generate substantially all of our net sales are produced under license agreements which grant us the right to use certain intellectual property in such products. These license agreements typically have short terms (between two and three years), are not automatically renewable, and, in some cases, give the licensor the right to terminate the license agreement at will.
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Our license agreements typically provide that our licensors own the intellectual property rights in the products we design and sell under the license. As a result, upon termination of the license, we would no longer have the right to sell these products, while our licensors could engage a competitor to do so. We believe our ability to retain our license agreements depends, in large part, on the strength of our relationships with our licensors. Any events or developments adversely affecting those relationships, or changes in our management team, could adversely affect our ability to maintain and renew our license agreements on similar terms or at all. In July 2023, we announced that Brian Mariotti, our then-Chief Executive Officer, would take a six-month sabbatical and that he would be replaced by a member of our Board of Directors, Michael Lunsford, as our Interim Chief Executive Officer. In September 2023, we announced that Mr. Mariotti resigned from the Board of Directors and entered into an Advisor Agreement with the Company. No assurance can be made that this change in our leadership will not have a material adverse impact on our relationships with licensors, and if we fail to manage our licensor relationships successfully, our business, financial condition or results of operations could be adversely affected. Our top ten licensors collectively accounted for approximately 68% and 76% of our sales for the nine months ended September 30, 2023 and 2022, respectively. Moreover, while we have separate licensing arrangements with Disney, LucasFilm and Marvel, these parties are all under common ownership by Disney and collectively these licensors accounted for approximately 38% and 46% of our sales for the nine months ended September 30, 2023 and 2022, respectively. The termination or failure to renew one or more of our license agreements, or the renewal of a license agreement on less favorable terms, could have a material adverse effect on our business, financial condition and results of operations. While we may enter into additional license agreements in the future, the terms of such license agreements may be less favorable than the terms of our existing license agreements.
Our license agreements are complex, and typically grant our licensors the right to audit our compliance with the terms and conditions of such agreements. Any such audit could result in a dispute over whether we have paid the proper royalties and a requirement that we pay additional royalties, the amounts of which could be material. As of September 30, 2023, we had a reserve of $23.3 million on our balance sheet related to ongoing and future royalty audits, based on estimates of the costs we expect to incur. In addition to royalty payments, these agreements as a whole impose numerous other obligations on us, including, among other things, obligations to:
•maintain the integrity of the applicable intellectual property;
•obtain the licensor’s approval of the products we develop under the license prior to making any sales;
•permit the licensor’s involvement in, or obtain the licensor’s approval of, advertising, packaging and marketing plans;
•maintain minimum sales levels or make minimum guaranteed royalty payments;
•actively promote the sale of the licensed product and maintain the availability of the licensed product throughout the license term;
•spend a certain percentage of our sales of the licensed product on marketing and advertising for the licensed product;
•sell the products we develop under the license only within a specified territory or within specified sales channels;
•indemnify the licensor in the event of product liability or other claims related to the licensed product and advertising or other materials used to promote the licensed product;
•sell the licensed products to the licensor at a discounted price or at the lowest price charged to our customers;
•obtain the licensor’s consent prior to assigning or sub-licensing to third parties; and
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•provide notice to, obtain approval from, or, in limited circumstances, make certain payments to the licensor in connection with certain changes in control.
If we breach any of these obligations or any other obligations set forth in any of our license agreements, we could be subject to monetary penalties and our rights under such license agreements could be terminated, either of which could have a material adverse effect on our business, financial condition and results of operations.
Our success is also partially dependent on the reputation of our licensors and the goodwill associated with their intellectual property, and their ability to protect and maintain the intellectual property rights that we use in connection with our products, all of which may be harmed by factors outside our control. See also “If we are unable to obtain, maintain and protect our intellectual property rights, in particular trademarks and copyrights, or if our licensors are unable to maintain and protect their intellectual property rights that we use in connection with our products, our ability to compete could be negatively impacted.”
Global and regional economic downturns that negatively impact the retail and credit markets, or that otherwise damage the financial health of our retail customers and consumers, can harm our business and financial performance.
We design, manufacture and market a wide variety of consumer products worldwide for sale to our retail customers and directly to consumers. Our financial performance is impacted by the level of discretionary consumer spending in the markets in which we operate. Recessions, credit crises and other economic downturns, or disruptions in credit markets, in the United States and in other markets in which our products are sold can result in lower levels of economic activity, lower employment levels, less consumer disposable income, and lower consumer confidence. The retail industry is subject to volatility, especially during uncertain economic conditions. A downturn in the retail industry in particular may disproportionately affect us because a substantial majority of our net sales are to retail customers. In addition, our business is subject to significant pressure on costs and pricing caused by general inflationary pressures as well as inflation caused by constrained sourcing capacity, the availability of qualified labor and related wage inflation, as well as inflationary pressures to increase commissions and benefits expenses, and associated changes in consumer demand. Significant increases in the costs of other products which are required by consumers, such as gasoline, home heating fuels, or groceries, may reduce household spending on our products. Such cost increases and weakened economic conditions may result from any number of factors, including pandemics, terrorist attacks, wars and other conflicts, natural disasters, increases in critical commodity prices or labor costs, sovereign debt defaults or the prospect of such events. General inflation in the United States, Europe and other geographies has recently risen to levels not experienced in decades. Such a weakened economic and business climate, as well as consumer uncertainty created by such a climate, has adversely impacted and could in the future materially harm our sales and profitability. Similarly, reductions in the value of key assets held by consumers, such as their homes or stock market investments, can lower consumer confidence and consumer spending power. Any of these factors can reduce the amount which consumers spend on the purchase of our products. This, in turn, can reduce our sales and harm our financial performance and profitability.
In addition to experiencing potentially lower sales of our products during times of economic difficulty, in an effort to maintain sales during such times, we may need to increase our promotional spending or sales allowances, or take other steps to encourage retailer and consumer purchases of our products. Those steps may lower our net sales or increase our costs, thereby decreasing our operating margins and lowering our profitability. As a result of increased inflation or supply constraints, like we are currently facing, we have increased prices of certain products, and may in the future need to increase our prices further in order to cover increased costs of goods sold, which may reduce demand for our products and may not fully offset our increased costs.
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The Company maintains the majority of its cash and cash equivalents in accounts with major U.S. and multi-national financial institutions, and our deposits at certain of these institutions exceed insured limits. Market conditions can impact the viability of these institutions. In the event of failure of any of the financial institutions where we maintain our cash and cash equivalents, there can be no assurance that we will be able to access uninsured funds in a timely manner or at all.
Changes in the retail industry and markets for consumer products affecting our retail customers or retailing practices could negatively impact our business, financial condition and results of operations.
Our products are primarily sold to consumers through retailers that are our direct customers or customers of our distributors. As such, trends and changes in the retail industry can negatively impact our business, financial condition and results of operations. For example, in 2022 and the first three quarters of 2023, the retail industry faced reductions in sales due to macroeconomic uncertainty which adversely impacted our sales.
Due to the challenging environment for traditional “brick-and-mortar” retail locations caused by declining in-store traffic, many retailers have closed physical stores, and some traditional retailers have engaged in significant reorganizations, filed for bankruptcy and gone out of business. In addition to furthering consolidation in the retail industry, such a trend could have a negative effect on the financial health of our retail customers and distributors, potentially causing them to experience difficulties in fulfilling their payment obligations to us or our distributors, reduce the amount of their purchases, seek extended credit terms or otherwise change their purchasing patterns, alter the manner in which they promote our products or the resources they devote to promoting and selling our products or cease doing business with us or our distributors. If any of our retail customers were to file for bankruptcy, we could be unable to collect amounts owed to us and could even be required to repay certain amounts paid to us prior to the bankruptcy filing. The occurrence of any of these events would have an adverse effect on our business, cash flows, financial condition and results of operations.
If we do not effectively maintain and further develop our relationships with retail customers and distributors, our growth prospects, business and results of operations could be harmed.
Historically, a majority of all of our net sales have been derived from our retail customers and distributors, upon which we rely to reach the consumers who are the ultimate purchasers of our products. In the United States, we primarily sell our products directly to specialty retailers, mass-market retailers and e-commerce sites. In international markets, we sell our products directly to similar retailers, primarily in Europe, through our subsidiary Funko UK, Ltd. We also sell our products to distributors for sale to retailers in the United States and in certain countries internationally, typically in those countries in which we do not currently have a direct presence. Our top ten customers represented approximately 41% and 44% of our sales for the nine months ended September 30, 2023 and 2022, respectively.
We depend on retailers to provide adequate and attractive space for our products and point of purchase displays in their stores. We further depend on our retail customers to employ, educate and motivate their sales personnel to effectively sell our products. If our retail customers do not adequately display our products or choose to promote competitors’ products or their own private label products over ours, our sales could decrease, and our business could be harmed. Similarly, we depend on our distributors to reach retailers in certain market segments in the United States and to reach international retailers in countries where we do not have a direct presence. Our distributors generally offer products from several different companies, including our competitors. Accordingly, we are at risk that these distributors may give higher priority to selling other companies’ products. If we were to lose the services of a distributor, we might need to find another distributor in that area, and there can be no assurance of our ability to do so in a timely manner or on favorable terms.
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In addition, our business could be adversely affected if any of our retail customers or distributors were to reduce purchases of our products, as has occurred in recent periods. Our retail customers and distributors generally build inventories in anticipation of future sales and will decrease the size of their future product orders if sales do not occur as rapidly as they anticipate. Our customers make no long-term commitments to us regarding purchase volumes and can therefore freely reduce their purchases of our products, and as a result we may have excess inventory. Any reduction in purchases of our products by our retail customers and distributors, or the loss of any key retailer or distributor, could adversely affect our net sales, operating results and financial condition. As a result of the COVID-19 pandemic and recent macroeconomic trends, we have had certain of our retail customers reduce and, in some instances, cancel purchase orders as a result of store closures or a shift of purchasing to focus only on essential consumer products.
Furthermore, consumer preferences have shifted, and may continue to shift in the future, to sales channels other than traditional retail, including e-commerce, in which we have more limited experience, presence and development. In addition, our entry into new product categories and geographies has exposed, and may continue to expose, us to new sales channels in which we have less expertise. If we are not successful in developing our e-commerce channel and other new sales channels, our net sales and profitability may be adversely affected.
The COVID-19 pandemic adversely impacted our business. Ongoing impacts from COVID-19 could materially adversely impact our business, financial condition and results of operations going forward.
We and certain of our suppliers and the manufacturers of certain of our products have in the past been adversely impacted by COVID-19. We faced delays and difficulty sourcing products, and significant increases in shipping costs, which have negatively affected our business and financial results. If such supplier and manufacturer challenges continue or recur, the impact on our supply chain and manufacturing could negatively affect our financial results for future reporting periods. Even if we are able to find alternate sources for such products, they may cost more, which could adversely impact our profitability and financial condition.
During the nine months ended September 30, 2023, our business did not experience a material effect from COVID-19, however, any renewed surge that leads to the curtailment of activities by businesses and consumers in much of the world, including as a result of restrictions imposed by governments and others to limit the spread of the disease and its variants such as through business and transportation shutdowns and restrictions on people’s movement and congregation, would adversely affect our business, financial position and results of operations going forward. Other pandemics or health crises may have similar adverse impacts.
Additionally, concerns over the economic impact of the COVID-19 pandemic have previously caused extreme volatility in financial and capital markets and may continue to do so in the future, which may materially adversely impact our stock price and our ability to access capital markets.
Our industry is highly competitive and the barriers to entry are low. If we are unable to compete effectively with existing or new competitors, our sales, market share and profitability could decline.
Our industry is, and will continue to be, highly competitive. We compete with toy companies in many of our product categories, some of which have substantially more resources than us, stronger name recognition, longer operating histories and greater economies of scale. We also compete with numerous smaller domestic and foreign collectible product designers and manufacturers. Across our business, we face competitors who are constantly monitoring and attempting to anticipate consumer tastes and trends, seeking ideas that will appeal to consumers and introducing new products that compete with our products for consumer acceptance and purchase.
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In addition to existing competitors, the barriers to entry for new participants in our industry are low, and the increasing use of digital technology, social media and the internet to spark consumer interest has further increased the ability for new participants to enter our markets and has broadened the array of companies against which we compete. New participants can gain access to retail customers and consumers and become a significant source of competition for our products in a very short period of time. Additionally, since we do not have exclusive rights to any of the properties we license or the related entertainment brands, our competitors, including those with more resources and greater economies of scale, can obtain licenses to design and sell products based on the same properties that we license, potentially on more favorable terms. Any of these competitors may be able to bring new products to market more quickly, respond more rapidly than us to changes in consumer preferences and produce products of higher quality or that can be sold at more accessible price points. To the extent our competitors’ products achieve greater market acceptance than our products, our business, financial condition and results of operations will be adversely affected.
In addition, certain of our licensors have reserved the rights to manufacture, distribute and sell identical or similar products to those we design and sell under our license agreements. These products could directly compete with our products and could be sold at lower prices than those at which our products are sold, resulting in higher margins for our customers compared to our products, potentially lessening our customers’ demand for our products and adversely affecting our sales and profitability.
Furthermore, competition for access to the properties we license is intense, and we must vigorously compete to obtain licenses to the intellectual property we need to produce our products. This competition could lessen our ability to secure, maintain, and renew our existing licenses, or require us to pay licensors higher royalties and higher minimum guaranteed payments in order to obtain new licenses or retain our existing licenses. To the extent we are unable to license properties on commercially reasonable terms, or on terms at least as favorable as our competitors, our competitive position and demand for our products will suffer. Because our ability to compete for licensed properties is based largely on our ability to increase fan engagement and generate royalty revenues for our licensors, any reduction in the demand for and sales of our products will further inhibit our ability to obtain licenses on commercially reasonable terms or at all. As a result, any such reduction in the demand for and sales of our products could have a material adverse effect on our business, financial condition and results of operations.
We also increasingly compete with toy companies and other product designers for shelf space at specialty, mass-market and other retailers. Our retail customers will allocate shelf space and promotional resources based on the margins of our products for our customers, as well as their sales volumes. If toy companies or other competitors produce higher margin or more popular merchandise than our products, our retail customers may reduce purchases of our products and, in turn, devote less shelf space and resources to the sale of our products, which could have a material adverse effect on our sales and profitability.
Our gross margin may not be sustainable and may fluctuate over time.
Our gross margin has historically fluctuated, primarily as a result of changes in product mix, changes in our costs, price competition and acquisitions. For the nine months ended September 30, 2023 and 2022, our gross margins (exclusive of depreciation and amortization) were 27.8% and 34.3%, respectively. Our current or historical gross margins may not be sustainable or predictive of future gross margins, and our gross margin may decrease over time. A decrease in gross margin can be the result of numerous factors, including, but not limited to:
•changes in customer, geographic, or product mix;
•introduction of new products, including our expansion into additional product categories;
•increases in the royalty rates under our license agreements;
•inability to meet minimum guaranteed royalties;
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•increases in, or our inability to reduce, our costs, including as a result of inflation;
•entry into new markets or growth in lower margin markets;
•increases in raw materials, labor or other manufacturing- and inventory-related costs;
•increases in transportation costs, including the cost of fuel, and increased shipping costs to meet customer demand;
•increased price competition;
•changes in the dynamics of our sales channels, including those affecting the retail industry and the financial health of our customers;
•inability to increase prices in order to meet increased costs;
•increases in sales discounts and allowances provided to our customers;
•acquisitions of companies with a lower gross margin than ours; and
•overall execution of our business strategy and operating plan.
If any of these factors, or other factors unknown to us at this time, occur, then our gross margin could be adversely affected, which could have a material adverse effect on our business, financial condition and results of operations.
Our business is largely dependent on content development and creation by third parties.
We spend considerable resources in designing and developing products in conjunction with planned movie, television, video game, music and other content releases by various third-party content providers. The timing of the development and release, and the ultimate consumer interest in and success of, such content depends on the efforts of these third parties, as well as conditions in the media and entertainment industry generally. We do not control when or if any particular project will be greenlit, developed or released, and the creators of such projects may change their plans with respect to release dates or cancel development altogether. This can make it difficult for us to successfully develop and market products in conjunction with a given content release, given the lead times involved in product development and successful marketing efforts. Additionally, unforeseen factors in the media and entertainment industry, including labor strikes and unforeseen developments with talent such as accusations of a star’s wrongdoing, may also delay or cancel the release of such projects. For example, in the summer of 2023, both the Writers’ Guild of America and Screen Actors Guild – American Federation of Television and Radio Artists (“SAG-AFTRA”) voted to authorize strikes by their respective members and the SAG-AFTRA strike remains ongoing. These strikes have resulted in projects that were originally scheduled for 2023 release dates to be delayed into 2024, and may delay further development and production of new and ongoing productions. Any such delay or cancellation may decrease the number of products we sell and harm our business.
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As a purveyor of licensed pop culture consumer products, we may not be able to design and develop products that will be popular with consumers, and we may not be able to maintain the popularity of successful products.
The interests of consumers evolve extremely quickly and can change dramatically from year to year. To be successful we must correctly anticipate both the products and the movies, TV shows, video games, music, sports and other content releases (including the related characters), that will appeal to consumers and quickly develop and introduce products that can compete successfully for consumers’ limited time, attention and spending. Evolving consumer tastes and shifting interests, coupled with an ever changing and expanding pipeline of products and content that compete for consumers’ interest and acceptance, create an environment in which some products and content can fail to achieve consumer acceptance, while others can be popular during a certain period of time but then be rapidly replaced. As a result, consumer products, particularly those based on pop culture such as ours, can have short life cycles. In addition, given the growing market for digital products and the increasingly digital nature of pop culture, there is also a risk that consumer demand for physical products may decrease over time. If we devote time and resources to developing and marketing products that consumers do not find appealing enough to buy in sufficient quantities, our sales and profits may decline, and our business performance may be damaged. Similarly, if our product offerings fail to correctly anticipate consumer interests, our sales and earnings will be adversely affected.
Additionally, our business is increasingly global and depends on interest in and acceptance of our products and our licensors’ brands by consumers in diverse markets around the world with different tastes and preferences. As such, our success depends on our ability to successfully predict and adapt to changing consumer tastes and preferences in multiple markets and geographies and to design products that can achieve popularity globally over a broad and diverse consumer audience. There is no guarantee that we will be able to successfully develop and market products with global appeal.
Consumer demand for pop culture products can and does shift rapidly and without warning. As a result, even if our product offerings are initially successful, there can be no guarantee that we will be able to maintain their popularity with consumers. Accordingly, our success will depend, in part, on our ability to continually design and introduce new products that consumers find appealing. To the extent we are unable to do so, our sales and profitability will be adversely affected. This is particularly true given the concentration of our sales under certain of our brand categories, particularly Core Collectibles. Sales of our Core Collectible branded category products accounted for approximately 73% and 76% of our sales for the nine months ended September 30, 2023 and 2022, respectively. If consumer demand for our Core Collectible branded category products were to decrease, our business, financial condition and results of operations could be adversely affected unless we were able to develop and market additional products that generated an equivalent amount of net sales at a comparable gross margin, which there is no guarantee we would be able to do.
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We may not realize the full benefit of our licenses if the properties we license have less market appeal than expected or if sales from the products that use those properties are not sufficient to satisfy the minimum guaranteed royalties.
We seek to fulfill consumer preferences and interests by designing and selling products primarily based on properties owned by third parties and licensed to us. The popularity of the properties we license can significantly affect our sales and profitability. If we produce products based on a particular movie, TV show or video game, the success of the underlying content has a critical impact on the level of consumer interest in the associated products we are offering. Although we license a wide variety of properties, sales of products tied to major movie franchises have been significant contributors to our business. In addition, the theatrical duration of movie releases has decreased over time and we expect this trend to continue with the increase of content made available on video streaming services. This may make it increasingly difficult for us to sell products based on such properties or lead our customers to reduce demand for our products to minimize their inventory risk. If the performance of one or more of such movie franchises failed to meet expectations or if there was a shift in consumer tastes away from such franchises generally, our results of operations could be adversely affected. In addition, competition in our industry for access to licensed properties can lessen our ability to secure, maintain, and renew our existing licenses on commercially reasonable terms, if at all, and to attract and retain the talented employees necessary to design, develop and market successful products based on these properties.
Our license agreements usually also require us to pay minimum royalty guarantees, which may in some cases be greater than what we are ultimately able to recoup from actual sales. When our licensing agreements require minimum royalty guarantees, we accrue a royalty liability based on the contractually required percentage, as revenues are earned. In the case that a minimum royalty guarantee is not expected to be met through sales, we will accrue up to the minimum amount required to be paid. As of September 30, 2023 and December 31, 2022, we recorded reserves of $2.4 million and $0.8 million, respectively, related to prepaid royalties we estimated would not be recovered through sales. Acquiring or renewing licenses may require the payment of minimum guaranteed royalties that we consider to be too high to be profitable, which may result in losing licenses that we currently hold when they become available for renewal, or missing business opportunities for new licenses. Additionally, we have no guarantee that any particular property we license will translate into a successful product. Products tied to a particular content release may be developed and released before demand for the underlying content is known. The underperformance of any such product may result in reduced sales and operating profit for us.
An inability to develop and introduce products in a timely and cost-effective manner may damage our business.
Our sales and profitability depend on our ability to bring products to market to meet customer demands and before consumers begin to lose interest in a given property. There is no guarantee that we will be able to manufacture, source, ship and distribute new or continuing products in a timely manner or on a cost-effective basis to meet constantly changing consumer demands. This risk is heightened by our customers’ increasingly compressed shipping schedules and the seasonality of our business. Furthermore, our license agreements typically require us to obtain the licensor’s approval of the products we develop under a particular license prior to making any sales, which can have the effect of delaying our product releases. Additionally, for products based on properties in our movie, TV show and video game categories, this risk may also be exacerbated by our need to introduce new products on a timeframe that corresponds with a particular content release. These time constraints may lead our customers to reduce their demand for these products in order to minimize their inventory risk. Moreover, unforeseen delays or difficulties in the development process, significant increases in the planned cost of development, manufacturing or distribution delays or changes in anticipated consumer demand for our products and new brands, or the related third party content, may cause the introduction date for products to be later than anticipated, may reduce or eliminate the profitability of such products or, in some situations, may cause a product or new brand introduction to be discontinued.
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If we are unable to obtain, maintain and protect our intellectual property rights, in particular trademarks and copyrights, or if our licensors are unable to maintain and protect their intellectual property rights that we use in connection with our products, our ability to compete could be negatively impacted.
Our intellectual property is a valuable asset of our business. As of September 30, 2023, we owned approximately 119 registered U.S. trademarks, 277 registered international trademarks, 29 pending U.S. trademark applications and 74 pending international trademark applications. The market for our products depends to a significant extent upon the value associated with our product design, our proprietary brands and the properties we license. Although certain of our intellectual property is registered in the United States and in several of the foreign countries in which we operate, there can be no assurances with respect to the rights associated with such intellectual property in those countries, including our ability to register, use, maintain or defend key trademarks and copyrights. We rely on a combination of trademark, trade dress, copyright and trade secret laws, as well as confidentiality procedures and contractual restrictions, to establish and protect our intellectual property or other proprietary rights. However, these laws, procedures and restrictions provide only limited and uncertain protection and any of our intellectual property rights may be challenged, invalidated, circumvented, infringed or misappropriated, including by counterfeiters and parallel importers. In addition, our intellectual property portfolio in many foreign countries is less extensive than our portfolio in the United States, and the laws of foreign countries, including many emerging markets in which our products are produced or sold, may not protect our intellectual property rights to the same extent as the laws of the United States. The costs required to protect our trademarks and copyrights may be substantial.
In addition, we may fail to apply for, or be unable to obtain, protection for certain aspects of the intellectual property used in or beneficial to our business. Further, we cannot provide assurance that our applications for trademarks, copyrights and other intellectual property rights will be granted, or, if granted, will provide meaningful protection. In addition, third parties have in the past and could in the future bring infringement, invalidity or similar claims with respect to any of our current trademarks and copyrights, or any trademarks or copyrights that we may seek to obtain in the future. Any such claims, whether or not successful, could be extremely costly to defend, divert management’s attention and resources, damage our reputation and brands, and substantially harm our business and results of operations.
In order to protect or enforce our intellectual property and other proprietary rights, or to determine the enforceability, scope or validity of the intellectual or proprietary rights of others, we may initiate litigation or other proceedings against third parties. Any lawsuits or proceedings that we initiate could be expensive, take significant time and divert management’s attention from other business concerns. Litigation and other proceedings also put our intellectual property at risk of being invalidated, or if not invalidated, may result in the scope of our intellectual property rights being narrowed. In addition, our efforts to try to protect and defend our trademarks and copyrights may be ineffective. Additionally, we may provoke third parties to assert claims against us. We may not prevail in any lawsuits or other proceedings that we initiate, and the damages or other remedies awarded, if any, may not be commercially valuable. The occurrence of any of these events may have a material adverse effect on our business, financial condition and results of operations.
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In addition, most of our products bear the trademarks and other intellectual property rights of our licensors, and the value of our products is affected by the value of those rights. Our licensors’ ability to maintain and protect their trademarks and other intellectual property rights is subject to risks similar to those described above with respect to our intellectual property. We do not control the protection of the trademarks and other intellectual property rights of our licensors and cannot ensure that our licensors will be able to secure or protect their trademarks and other intellectual property rights. The loss of any of our significant owned or licensed trademarks, copyrights or other intellectual property could have a material adverse effect on our business, financial condition and results of operations. In addition, our licensors may engage in activities or otherwise be subject to negative publicity that could harm their reputation and impair the value of the intellectual property rights we license from them, which could reduce consumer demand for our products and adversely affect our business financial condition and results of operations.
Our success depends on our ability to operate our business without infringing, misappropriating or otherwise violating the trademarks, copyrights and proprietary rights of other parties.
Our commercial success depends at least in part on our ability to operate without infringing, misappropriating or otherwise violating the trademarks, copyrights and other proprietary rights of others. However, we cannot be certain that the conduct of our business does not and will not infringe, misappropriate or otherwise violate such rights. Many companies have employed intellectual property litigation as a way to gain a competitive advantage, and to the extent we gain greater visibility and market exposure as a public company, we may also face a greater risk of being the subject of such litigation. For these and other reasons, third parties may allege that our products or activities, including products we make under license, infringe, misappropriate or otherwise violate their trademark, copyright or other proprietary rights. While we typically receive intellectual property infringement indemnities from our licensors, the indemnities are often limited to third-party copyright infringement claims to the extent arising from our use of the licensed material. Defending against allegations and litigation could be expensive, take significant time, divert management’s attention from other business concerns, and delay getting our products to market. In addition, if we are found to be infringing, misappropriating or otherwise violating third-party trademark, copyright or other proprietary rights, we may need to obtain a license, which may not be available on commercially reasonable terms or at all, or may need to redesign or rebrand our products, which may not be possible. We may also be required to pay substantial damages or be subject to a court order prohibiting us and our customers from selling certain products or engaging in certain activities. Any claims of violating others’ intellectual property, even those without merit, could therefore have a material adverse effect on our business, financial condition and results of operations.
Our operating results may be adversely affected and damage to our reputation may occur due to production and sale of counterfeit versions of our products.
As we have expanded internationally, and the global popularity of our products has increased, our products are increasingly subject to efforts by third parties to produce counterfeit versions of our products. There can be no guarantee that our efforts, including our work with customs officials and law enforcement authorities, to block the manufacture of counterfeit goods, prevent their entry in end markets, and detect counterfeit products in customer networks will be successful or result in any material reduction in the availability of counterfeit goods. Any such counterfeit sales, to the extent they replace otherwise legitimate sales, could adversely affect our operating results and damage our reputation.
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Our success is critically dependent on the efforts and dedication of our officers and other employees, and the loss of one or more key employees, or our inability to attract and retain qualified personnel and maintain our corporate culture, could adversely affect our business.
Our officers and employees are at the heart of all of our efforts. It is their skill, creativity and hard work that drive our success. In particular, our success depends to a significant extent on the continued service and performance of our senior management team. We are dependent on their talents and continuing employment, and believe they are integral to our relationships with our licensors, certain of our key retail customers and to our overall selling and creative design processes. In July 2023, we announced that Brian Mariotti, our then-Chief Executive Officer, would take a six-month sabbatical and that he would be replaced by a member of our Board of Directors, Michael Lunsford, as our Interim Chief Executive Officer. In September 2023, we announced that Mr. Mariotti resigned from the Board of Directors and entered into an Advisor Agreement with the Company. These changes in our leadership could have a material adverse impact on our business, financial condition and results of operations. The loss or temporary absence of any member of our senior management team, or of any other key employees, or the inability to successfully complete planned management transitions, could impair our ability to execute our business plan and could therefore have a material adverse effect on our business, financial condition and results of operations. We do not currently maintain key man life insurance policies on any member of our senior management team or on our other key employees.
In addition, competition for qualified personnel is intense. We compete with many other potential employers in recruiting, hiring and retaining our senior management team and our many other skilled officers and other employees around the world. Our headquarters is located near Seattle and competition in the Seattle area for qualified personnel, particularly those with technology-related skills and experience, is intense due to the increasing number of technology and e-commerce companies with a large or growing presence in Seattle, some of whom have greater resources than us and may be located closer to the city of Seattle than we are. In 2022 and 2021, we also faced higher than normal recruitment and personnel costs in efforts to seek and retain qualified personnel.
Furthermore, as we continue to grow our business and hire new employees, it may become increasingly challenging to hire people who will maintain our corporate culture. We believe our corporate culture, which fosters speed, teamwork and creativity, is one of our key competitive strengths. As we continue to grow, we may be unable to identify, hire or retain enough people who will maintain our corporate culture, including those in management and other key positions. Conversely, when we furlough or lay off employees, as we did in connection with our cost-cutting reduction-in-force measures during the nine months ended September 30, 2023, there have been and may in the future be adverse consequences for our corporate culture and employee morale. No assurance can be made that our cost cutting measures, including our recent reduction in force, will not harm our corporate culture, employee morale, or have a material adverse impact on our business, financial condition and results of operations. Our corporate culture could also be adversely affected by the increasingly global distribution of our employees, as well as their increasingly diverse skill sets. If we are unable to maintain the strength of our corporate culture, our competitive ability and our business may be adversely affected.
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Our operating results may fluctuate from quarter to quarter and year to year due to the seasonality of our business, as well as due to the timing and popularity of new product releases.
The businesses of our retail customers are highly seasonal, with a majority of retail sales occurring during the period from October through December in anticipation of the holiday season. As a consequence, we have experienced moderate seasonality in our business. Approximately 53.0%, 59.0% and 64.0%, of our net sales for the years ended December 31, 2022, 2021 and 2020, respectively, were made in the third and fourth quarters, as our customers build up their inventories in anticipation of the holiday season. This seasonal pattern requires significant use of working capital, mainly to manufacture inventory during the portion of the year prior to the holiday season and requires accurate forecasting of demand for products during the holiday season in order to avoid losing potential sales of highly popular products or producing excess inventory of less popular products. In addition, as a result of the seasonal nature of our business, we would be significantly and adversely affected, in a manner disproportionate to the impact on a company with sales spread more evenly throughout the year, by unforeseen events such as a terrorist attack or economic shock that harm the retail environment or consumer buying patterns during our key selling season, or by events such as strikes or port delays that interfere with the shipment of goods during the critical months leading up to the holiday shopping season.
The timing and mix of products we sell in any given year will depend on various factors, including the timing and popularity of new releases by third-party content providers and our ability to license properties based on these releases. Sales of a certain product or group of products tied to a particular content release can dramatically increase our net sales in any given quarter or year.
Our results of operations may also fluctuate as a result of factors such as the delivery schedules set by our customers and holiday shut down schedules set by our third-party manufacturers. Additionally, the rapid growth we have experienced in recent years may have masked the full effects of seasonal factors on our business to date, and as such, these factors may have a greater effect on our results of operations in future periods.
Our use of third-party manufacturers to produce our products presents risks to our business.
We use third-party manufacturers to manufacture all of our products and have historically concentrated production with a small number of manufacturers and factories. As a result, the loss or unavailability of one of our manufacturers or one of the factories in which our products are produced, even on a temporary basis, could have a negative impact on our business, financial condition and results of operations. This risk is exacerbated by the fact that we do not have written contracts reserving capacity or providing loss contingencies with certain of our manufacturers. While we believe our external sources of manufacturing could be shifted, if necessary, to alternative sources of supply, we would require a significant period of time to make such a shift. Because we believe our products represent a significant percentage of the total capacity of each factory in which they are produced, such a shift may require us to establish relationships with new manufacturers, which we may not be able to do on a timely basis, on similar terms, or at all. We may also be required to seek out additional manufacturers in response to increased demand for our products, as our current manufacturers may not have the capacity to increase production. If we were prevented from or delayed in obtaining a material portion of the products produced by our manufacturers, or if we were required to shift manufacturers (assuming we would be able to do so), our sales and profitability could be significantly reduced.
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In addition, while we require that our products supplied by third-party manufacturers be produced in compliance with all applicable laws and regulations, and we have the right to monitor compliance by our third-party manufacturers with our manufacturing requirements and to oversee the quality control process at our manufacturers’ factories, there is risk that one or more of our third-party manufacturers will not comply with our requirements, and that we will not promptly discover such non-compliance. For example, the Consumer Product Safety Improvement Act of 2008 (the "CPSIA") limits the amounts of lead and phthalates that are permissible in certain products and requires that our products be tested to ensure that they do not contain these substances in amounts that exceed permissible levels. In the past, products manufactured by certain of our third-party manufacturers have tested positive for phthalates. Though the amount was not in excess of the amount permissible under the CPSIA, we cannot guarantee that products made by our third-party manufacturers will not in the future contain phthalates in excess of permissible amounts, or will not otherwise violate the CPSIA, other consumer or product safety requirements, or labor or other applicable requirements. Any failure of our third-party manufacturers to comply with such requirements in manufacturing products for us could result in damage to our reputation, harm our brand image and sales of our products and potentially create liability for us.
Additionally, there are increasing expectations in various jurisdictions that companies monitor the environmental and social performance of their suppliers, including compliance with a variety of labor practices, as well as consider a wider range of potential environmental and social matters, including the end of life considerations for products. Compliance can be costly, require us to establish or augment programs to diligence or monitor our suppliers, or, in the case of legislation such as the Uyghur Forced Labor Prevention Act, to design supply chains to avoid certain regions altogether. Failure to comply with such regulations can result in fines, reputational damage, import ineligibility for our products, or otherwise adversely impact our business. Monitoring compliance by independent manufacturers is complicated by the fact that expectations of ethical business practices continually evolve, may be substantially more demanding than applicable legal requirements and are driven in part by legal developments and by diverse groups active in publicizing and organizing public responses to perceived ethical shortcomings. Accordingly, we cannot predict how such expectations might develop in the future and cannot be certain that our manufacturing requirements, even if complied with, would satisfy all parties who are active in monitoring and publicizing perceived shortcomings in labor and other business practices worldwide.
Additionally, the third-party manufacturers that produce most of our products are located in Vietnam, China and Mexico. As a result, we are subject to various risks resulting from our international operations. See “Our substantial sales and manufacturing operations outside the United States subject us to risks associated with international operations.”
We are subject to a series of risks related to climate change.
There are inherent climate-related risks wherever business is conducted. Various meteorological phenomena and extreme weather events (including, but not limited to, storms, flooding, drought, wildfire, and extreme temperatures) may disrupt our operations or those of our suppliers, requiring us to incur additional operating or capital expenditures, or otherwise adversely impact our business, financial condition, or results of operations. Climate change may impact the frequency and/or intensity of such events. While we may take various actions to mitigate our business risks associated with climate change, this may require us to incur substantial costs and may not be successful, due to, among other things, the uncertainty associated with the longer-term projections associated with managing climate risks.
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Additionally, regulatory, market, and other changes to respond to climate change may adversely impact our business, financial condition, or results of operations. Developing products that satisfy the market’s evolving expectations for product composition may require us to incur significant costs. Reporting expectations are also increasing, with a variety of stakeholders seeking increased information on climate related risks. For example, several regulators, such as the SEC and the State of California, have adopted, or are considering adopting, rules that would require companies to provide significantly expanded climate-related disclosures in their periodic reporting and other disclosures, which may require us to incur significant additional costs to comply, including the implementation of significant additional internal controls processes and procedures regarding matters that have not been subject to such controls in the past, and impose increased oversight obligations on our management and board of directors. All of these risks may also impact our suppliers or business partners, which may indirectly impact our business, financial condition, or results of operations.
Increased attention to, and evolving expectations for, sustainability and environmental, social, and governance (“ESG”) initiatives could increase our costs, harm our reputation, or otherwise adversely impact our business.
Companies across industries are facing increasing scrutiny from a variety of stakeholders related to their ESG and sustainability practices. Expectations regarding voluntary ESG initiatives and disclosures may result in increased costs (including but not limited to increased costs related to compliance, stakeholder engagement, contracting and insurance), changes in demand for certain products, enhanced compliance or disclosure obligations, or other adverse impacts to our business, financial condition, or results of operations.
Our operations, including our corporate headquarters, primary distribution facilities and third-party manufacturers, are concentrated in certain geographic regions, which makes us susceptible to adverse conditions in those regions.
Our corporate headquarters are currently located in Everett, Washington and our primary distribution warehouse is located in Buckeye, Arizona. We also have additional warehouse facilities and/or offices located in Coventry, England; London, England; Burbank, California; and San Diego, California. In addition, the factories that produce most of our products are located in Vietnam, China and Mexico. As a result, our business may be more susceptible to adverse conditions in these regions than the operations of more geographically diverse competitors. Such conditions could include, among others, adverse economic and labor conditions, as well as demographic trends. Furthermore, Buckeye is the location from which most of the products we sell are received, stored and shipped to our customers. We depend heavily on ocean container delivery to receive products from our third-party manufacturers located in Asia and contracted third-party delivery service providers to deliver our products to our distribution facilities. Any disruption to or failures in these delivery services, at our headquarters or at our warehouse facilities, whether as a result of extreme or severe weather conditions, natural disasters, labor unrest or otherwise, affecting western Washington or Arizona in particular, or the West Coast in general, or in other areas in which we operate, could significantly disrupt our operations, damage or destroy our equipment and inventory and cause us to incur additional expenses, any of which could have a material adverse effect on our business, financial condition and results of operations.
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For example, in 2020, 2021 and early 2022, certain of our suppliers and the manufacturers of certain of our products were adversely impacted by COVID-19. As a result, we faced delays or difficulty sourcing products, which negatively affected our business and financial results. In response, we shifted a greater amount of our production from China to Vietnam. Although we possess insurance for damage to our property and the disruption of our business, this insurance, and in particular earthquake insurance, which is subject to various limitations and requires large deductibles or co-payments, may not be sufficient to cover all of our potential losses, and may be cancelled by us in the future or otherwise cease to be available to us on reasonable terms or at all. Similarly, natural disasters and other adverse events or conditions affecting east or southeast Asia, where most of our products are produced, could halt or disrupt the production of our products, impair the movement of finished products out of those regions, damage or destroy the molds and tooling necessary to make our products and otherwise cause us to incur additional costs and expenses, any of which could also have a material adverse effect on our business, financial condition and results of operations.
Our substantial sales and manufacturing operations outside the United States subject us to risks associated with international operations.
We operate facilities and sell products in numerous countries outside the United States. Sales to our international customers comprised approximately 31% and 27% of our sales for the nine months ended September 30, 2023 and 2022, respectively. We expect sales to our international customers to account for an increasing portion of our sales in future fiscal years. Over time, we expect our international sales and operations to continue to grow both in dollars and as a percentage of our overall business as a result of a key business strategy to expand our presence in emerging and underserved international markets. Additionally, as discussed above, we use third-party manufacturers located in Vietnam, China and Mexico to produce most of our products. These international sales and manufacturing operations, including operations in emerging markets, are subject to risks that may significantly harm our sales, increase our costs or otherwise damage our business, including:
•currency conversion risks and currency fluctuations;
•limitations on the repatriation of earnings;
•potential challenges to our transfer pricing determinations and other aspects of our cross-border transactions, which can materially increase our taxes and other costs of doing business;
•political instability, civil unrest, war and economic instability, such as the current situation with Ukraine and Russia or Israel and Hamas and any impacts on surrounding regions;
•greater difficulty enforcing intellectual property rights and weaker laws protecting such rights;
•complications in complying with different laws and regulations in varying jurisdictions, including the U.S. Foreign Corrupt Practices Act (“FCPA”), the U.K. Bribery Act of 2010, similar anti-bribery and anti-corruption laws and local and international environmental, labor, health and safety laws, and in dealing with changes in governmental policies and the evolution of laws and regulations and related enforcement;
•difficulties understanding the retail climate, consumer trends, local customs and competitive conditions in foreign markets which may be quite different from the United States;
•changes in international labor costs and other costs of doing business internationally;