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MarketScreener Homepage  >  Equities  >  Nasdaq  >  Funko, Inc.    FNKO

FUNKO, INC.

(FNKO)
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FUNKO : Management's Discussion and Analysis of Financial Condition and Results of Operations (form 10-Q)

11/05/2020 | 04:38pm EST
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 5, 2020. 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: (1)
following the consummation of the Transactions, to Funko, Inc., and, unless
otherwise stated, all of its direct and indirect subsidiaries, including FAH,
LLC and (2) prior to the completion of the Transactions, to FAH, LLC and, unless
otherwise stated, all of its subsidiaries.
•"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 any such fund or entity formed to hold shares of Class A common stock
for the Former Equity Owners).
•"Continuing Equity Owners" refers collectively to ACON, Fundamental, the Former
Profits Interests Holders, certain current and former executive officers,
employees and directors, and others, as well as each of their permitted
transferees, that own common units in FAH, LLC and who may redeem at each of
their options (subject in certain circumstances to time-based vesting
requirements) their common units for, at our election, cash or newly-issued
shares of Funko, Inc.'s Class A common stock.
•"Credit Facilities" refers to the Company's credit agreement, dated October 22,
2018 (as amended, the "Credit Agreement"), providing for a term loan facility in
the amount of $235.0 million (the "Term Loan Facility") and a revolving credit
facility of $75.0 million (the "Revolving Credit Facility").
•"FAH, LLC" refers to Funko Acquisition Holdings, L.L.C.
•"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 the consummation of the Transactions.
•"Former Profits Interests Holders" refers collectively to certain of our
directors and certain current and former executive officers and employees, in
each case, who, prior to the consummation of the Transactions, 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
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interests remaining subject to their existing time-based vesting requirements)
in connection with the Transactions.
•"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 Transactions, 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 as part
of the Transactions, defined below.
•"Transactions" refers to certain organizational transactions that we effected
in connection with our initial public offering ("IPO") in November 2017.
Overview
We are a leading pop culture consumer products company. 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 and homewares.
We were founded in 1998 as a consumer products company focused on designing and
selling nostalgic bobble head figures. In 2005, we were acquired by a small
group of investors led by Brian Mariotti, who took over day-to-day operations
and has served as our chief executive officer since that time. Under Brian's
leadership, we have significantly broadened and deepened our relationships with
content providers. Content providers trust us to create unique extensions of
their intellectual property that extend the relevance of their content with
consumers through ongoing engagement, helping to maximize the lifetime value of
their content. We strive to license every pop culture property that we believe
is relevant to consumers.
Domestically, we primarily sell our products to specialty retailers, mass-market
retailers, and e-commerce sites. Internationally, 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 small retailers in the
United States and in certain countries internationally, typically where we do
not have a direct presence. We also sell certain of our products directly to
consumers through our e-commerce business, our Funko-operated retail locations
and, to a lesser extent, at specialty licensing and comic book shows,
conventions and exhibitions in cities throughout the United States, including at
Comic-Con events.
COVID-19
The novel coronavirus ("COVID-19") has caused and continues to cause significant
loss of life and disruption to the global economy, including the curtailment of
activities by businesses and consumers in much of the world as governments and
others seek to limit the spread of the disease, and through business and
transportation shutdowns and restrictions on people's movement and congregation.
As a result of the pandemic, we have experienced weakened demand for our
products, which has had a negative impact on our net sales in the three and nine
months ended September 30, 2020. Many of our specialty retailer customers were
unable to sell our products in their stores for nearly all of the second quarter
and had limited in-store occupancy throughout the third quarter of 2020, due to
government-
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mandated closures. As such, many customers have deferred or significantly
reduced orders for our products and we expect these trends to continue until
such closures are significantly reduced. In addition, the pandemic has reduced
foot traffic in the stores where our products are sold that remain open, and the
global economic impact of the pandemic has temporarily reduced consumer demand
for our products as they focus on purchasing essential goods.
In Europe, as a result of the impacts of COVID-19 and key account closures
during the latter part of the first quarter through the second quarter, we made
the strategic decision to shift any new products that were initially planned to
arrive on retailer shelves in the second quarter of 2020 into the third quarter
of 2020 to preserve demand for these new items.
Given these factors, we believe that the greatest impact from the COVID-19
pandemic in fiscal 2020 occurred in the second quarter of 2020 during which we
experienced a significant net sales decline as compared to the second quarter of
2019. We expect recovery to be gradual due to the increase in infection rates
and general uncertainty in both the U.S. and international markets.
Specifically, we anticipate downward pressure on sales in Europe during the
three months ending December 31, 2020 in light of new restrictions and closures
recently put into place in certain regions in Europe, most notably in the United
Kingdom. If the significant surge in COVID-19 cases continues, and is
accompanied by additional closures or a significant halt in reopenings, the
remainder of 2020 could potentially be impacted to an even greater extent than
currently expected.
In addition, in the three and nine months ended September 30, 2020, 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.
We have taken actions to protect our employees in response to the pandemic,
including closing our corporate offices and requiring our office employees to
work from home. At our distribution centers, certain practices are in effect to
safeguard workers, including but not limited to, required daily health
pre-screening, providing personal protective equipment and operating with a
staggered work schedule, and we are continuing to monitor direction from local
and national governments carefully.
As a result of the impact of COVID-19 on our financial results for the three and
nine months ended September 30, 2020, and the anticipated future impact of the
pandemic, we have implemented cost control measures and cash management actions,
including:
•Assessing workforce needs and furloughing and laying off a portion of our
employees;
•Implementing 20% salary reductions across our executive team and other members
of upper level management until the end of the second quarter of 2020;
•Executing reductions in operating expenses, planned inventory levels and
non-product development capital expenditures; and
•Proactively managing working capital, including reducing incoming inventory to
align with anticipated sales.
In addition, given the rapidly changing environment and level of uncertainty
being created by the COVID-19 pandemic and the associated impact on future
earnings, on May 5, 2020, we amended our Credit Agreement (the "Third
Amendment") in order to modify the financial covenants and provide operating
flexibility during the COVID-19 crisis. See "Liquidity and Capital Resources"
below for discussion of the Third Amendment.
As of September 30, 2020, we had $75.0 million available under the Revolving
Credit Facility.
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Key Performance Indicators
We consider the following metrics to be key performance indicators to evaluate
our business, develop financial forecasts, and make strategic decisions.
                                                                              Nine Months Ended
                              Three Months Ended September 30,                  September 30,
                                    2020                      2019           2020           2019
                                                  (amounts in thousands)
Net sales             $         191,229                    $ 223,307$ 426,028$ 581,571
Net income (loss)     $          15,597                    $  15,548$  (5,144)$  34,108
EBITDA (1)            $          31,779                    $  32,505$  35,885$  83,154
Adjusted EBITDA (1)   $          36,191                    $  40,617$  47,012$  97,327


(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"), or non-GAAP financial
measures. For a reconciliation of EBITDA and Adjusted EBITDA to net income
(loss), 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, 2020 Compared to Three Months Ended September
30, 2019
The following table sets forth information comparing the components of net
income for the three months ended September 30, 2020 and 2019:
                                             Three Months Ended September 30,               Period over Period Change
                                                 2020                2019               Dollar                Percentage
                                                                (amounts in thousands, except percentages)
Net sales                                    $  191,229$ 223,307$   (32,078)                     (14.4) %
Cost of sales (exclusive of depreciation and
amortization shown separately below)            117,504            137,801              (20,297)                     (14.7) %
Selling, general, and administrative
expenses                                         41,167             52,424              (11,257)                     (21.5) %
Depreciation and amortization                    11,887             10,472                1,415                       13.5  %
Total operating expenses                        170,558            200,697              (30,139)                     (15.0) %
Income from operations                           20,671             22,610               (1,939)                      (8.6) %
Interest expense, net                             2,875              3,620                 (745)                     (20.6) %
Other expense, net                                  779                577                  202                       35.0  %
Income before income taxes                       17,017             18,413               (1,396)                      (7.6) %
Income tax expense (benefit)                      1,420              2,865               (1,445)                     (50.4) %
Net income                                       15,597             15,548                   49                        0.3  %
Less: net income attributable to
non-controlling interests                         5,801              6,909               (1,108)                     (16.0) %

Net income attributable to Funko, Inc.$ 9,796$ 8,639

        $     1,157                       13.4  %



Net Sales
Net sales were $191.2 million for the three months ended September 30, 2020, a
decrease of 14.4%, compared to $223.3 million for the three months ended
September 30, 2019. The decrease in net sales was due primarily to the continued
impacts from the COVID-19 pandemic, including reduced shipments to our specialty
retailer and distributor customers as limited in-store occupancy and social
distancing guidelines or non-essential business closures were in effect for the
three months ended September 30, 2020 compared to the three months ended
September 30, 2019. These decreases were offset slightly by growth in our net
sales to e-commerce sites and our own direct-to-consumer channels as the
COVID-19 pandemic non-essential business closures had minimal effect on those
customers.
For the three months ended September 30, 2020, the number of active properties
increased 14.0% to 715 as compared to 627 for the three months ended
September 30, 2019, and the average net sales per active property decreased
24.9% for the three months ended September 30, 2020 as compared to the three
months ended September 30, 2019 due primarily to the impacts from the COVID-19
pandemic, discussed above. An active property is a licensed property from which
we generate sales of products during a given period. While we expect to see
growth in the number of active properties and average sales per active property
over time, 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 4.3% to $140.9
million in the three months ended September 30, 2020 as compared to $147.3
million in the three months ended
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September 30, 2019, and net sales internationally decreased 33.8% to $50.3
million in the three months ended September 30, 2020 as compared to $76.0
million in the three months ended September 30, 2019, driven primarily by
decreased sales in Europe. The decreases reflect the significant impacts from
the COVID-19 pandemic as limited in-store occupancy and social distancing
guidelines or non-essential business closures impacted domestic and overseas
markets throughout the quarter. On a product category basis, net sales of
figures decreased 17.8% to $145.0 million in the three months ended
September 30, 2020 as compared to $176.5 million in the three months ended
September 30, 2019, and net sales of other products decreased 1.4% to $46.2
million in the three months ended September 30, 2020 as compared to $46.8
million in the three months ended September 30, 2019, which reflects sales
declines in nearly all product categories due to the impacts from the COVID-19
pandemic.
Cost of Sales and Gross Margin (exclusive of depreciation and amortization)
Cost of sales (exclusive of depreciation and amortization) was $117.5 million
for the three months ended September 30, 2020, a decrease of 14.7%, compared to
$137.8 million for the three months ended September 30, 2019. Cost of sales
(exclusive of depreciation and amortization) decreased primarily as a result of
lower sales, as discussed above.
Gross margin (exclusive of depreciation and amortization), calculated as net
sales less cost of sales as a percentage of net sales, was 38.6% for the three
months ended September 30, 2020, compared to 38.3% for the three months ended
September 30, 2019. The increase in gross margin (exclusive of depreciation and
amortization) for the three months ended September 30, 2020 compared to the
three months ended September 30, 2019 was driven primarily by improved product
margins and enhanced inventory management processes implemented in the second
half of 2019 partially offset by an increase in shipping and freight costs as a
percentage of net sales during the three months ended September 30, 2020 due to
higher volume of domestic shipments.
Selling, General, and Administrative Expenses
Selling, general, and administrative expenses were $41.2 million for the three
months ended September 30, 2020, a decrease of 21.5%, compared to $52.4 million
for the three months ended September 30, 2019. The decrease was driven primarily
by a $4.0 million decrease in professional fees (including legal), $2.2 million
decrease in personnel and related costs (including salary and related
taxes/benefits, commissions and equity-based compensation expense), and a $1.9
million decrease in advertising and marketing costs. Additional expenses
generally related to COVID-19 business interruptions and our remote working
environment as well as lower sales volumes. Selling, general and administrative
expenses were 21.5% and 23.5% of net sales for the three months ended
September 30, 2020 and 2019, respectively.
Depreciation and Amortization
Depreciation and amortization expense was $11.9 million for the three months
ended September 30, 2020, an increase of 13.5%, compared to $10.5 million for
the three months ended September 30, 2019, primarily driven by an increase in
depreciation on our office and warehouse facilities.
Interest Expense, Net
Interest expense, net was $2.9 million for the three months ended September 30,
2020, a decrease of 20.6%, compared to $3.6 million for the three months ended
September 30, 2019. The decrease in interest expense, net was due primarily to
lower interest rates on debt outstanding during the three months ended
September 30, 2020 as compared to the interest rates on debt outstanding during
the three months ended September 30, 2019 as a result of the second and third
amendments to the Credit Facilities entered into on September 23, 2019 and May
5, 2020, respectively.
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Other expense, net
Other expense, net was $0.8 million and $0.6 million for the three months ended
September 30, 2020 and 2019, respectively. Other expense, net for the three
months ended September 30, 2020 and 2019 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 $1.4 million and $2.9 million for the three months ended
September 30, 2020 and 2019, respectively. The decrease for the three months
ended September 30, 2020 from September 30, 2019 was primarily related to
reduced income tax expense due to a decrease in income before income taxes
partially offset by a true-up of a return to provision adjustment.
Net income
Net income was $15.6 million for the three months ended September 30, 2020,
compared to net income of $15.5 million for the three months ended September 30,
2019. The decrease in net income was primarily due to the decrease in net sales,
partially offset by a decrease in cost of sales (exclusive of depreciation and
amortization) and selling, general and administrative expenses for the three
months ended September 30, 2020 as compared to the three months ended
September 30, 2019, as discussed above.
Nine Months Ended September 30, 2020 Compared to Nine Months Ended September 30,
2019
The following table sets forth information comparing the components of net
(loss) income for the nine months ended September 30, 2020 and 2019:
                                             Nine Months Ended September 30,                Period over Period Change
                                                 2020                2019               Dollar                 Percentage
                                                                (amounts in thousands, except percentages)
Net sales                                    $  426,028$ 581,571$   (155,543)                     (26.7) %
Cost of sales (exclusive of depreciation and
amortization shown separately below)            261,103            361,455              (100,352)                     (27.8) %
Selling, general, and administrative
expenses                                        127,590            136,539                (8,949)                      (6.6) %
Depreciation and amortization                    33,947             31,127                 2,820                        9.1  %
Total operating expenses                        422,640            529,121              (106,481)                     (20.1) %
Income from operations                            3,388             52,450               (49,062)                     (93.5) %
Interest expense, net                             8,221             11,455                (3,234)                     (28.2) %
Other expense, net                                1,450                423                 1,027                      242.8  %
(Loss) income before income taxes                (6,283)            40,572               (46,855)                    (115.5) %
Income tax expense (benefit)                     (1,139)             6,464                (7,603)                    (117.6) %
Net (loss) income                                (5,144)            34,108               (39,252)                    (115.1) %
Less: net (loss) income attributable to
non-controlling interests                          (229)            18,142               (18,371)                    (101.3) %
Net (loss) income attributable to Funko,
Inc.                                         $   (4,915)$  15,966$    (20,881)                    (130.8) %


                                       24
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Net Sales
Net sales were $426.0 million for the nine months ended September 30, 2020, a
decrease of 26.7%, compared to $581.6 million for the nine months ended
September 30, 2019. The decrease in net sales was due primarily to the COVID-19
pandemic which negatively impacted net sales for the majority of the nine months
ended September 30, 2020 compared to the nine months ended September 30, 2019.
During the nine months ended September 30, 2020, we experienced reduced
shipments to our customers as well as supply chain disruptions as non-essential
business closures and social distancing guidelines related to the COVID-19
pandemic were in effect for the majority of the period.
For the nine months ended September 30, 2020, the number of active properties
increased 9.2% to 805 as compared to 737 for the nine months ended September 30,
2019, and the average net sales per active property decreased 32.9% for the nine
months ended September 30, 2020 as compared to the nine months ended
September 30, 2019, primarily due to the impacts from the COVID-19 pandemic. An
active property is a licensed property from which we generate sales of products
during a given period. While we expect to see growth in the number of active
properties and average sales per active property over time, we expect that the
number of active properties and the average sales per active property will
fluctuate from year to year 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 16.2% to
$317.3 million in the nine months ended September 30, 2020 as compared to $378.9
million in the nine months ended September 30, 2019, and net sales
internationally decreased 46.4% to $108.7 million in the nine months ended
September 30, 2020 as compared to $202.7 million in the nine months ended
September 30, 2019, driven primarily by decreased sales in Europe. The decreases
reflect the significant impacts from the COVID-19 pandemic as non-essential
business closures impacted domestic and overseas markets. Our overseas markets,
especially within Europe, were impacted earlier in the period. On a product
category basis, net sales of figures decreased 29.3% to $333.7 million in the
nine months ended September 30, 2020 as compared to $472.3 million in the nine
months ended September 30, 2019, and net sales of other products decreased 15.5%
to $92.3 million in the nine months ended September 30, 2020 as compared to
$109.2 million in the nine months ended September 30, 2019, primarily due to
declines in nearly all product categories resulting from the COVID-19 pandemic.
Cost of Sales and Gross Margin (exclusive of depreciation and amortization)
Cost of sales (exclusive of depreciation and amortization) was $261.1 million
for the nine months ended September 30, 2020, a decrease of 27.8%, compared to
$361.5 million for the nine months ended September 30, 2019. Cost of sales
(exclusive of depreciation and amortization) decreased primarily as a result of
lower sales stemming from the COVID-19 pandemic, as discussed above.
Gross margin (exclusive of depreciation and amortization), calculated as net
sales less cost of sales as a percentage of net sales, was 38.7% for the nine
months ended September 30, 2020, compared to 37.8% for the nine months ended
September 30, 2019. The increase in gross margin (exclusive of depreciation and
amortization) for the nine months ended September 30, 2020 compared to the nine
months ended September 30, 2019 was driven primarily by improved product margins
and enhanced inventory management processes implemented in the second half of
2019, partially offset by increased shipping and freight costs as a percentage
of net sales during the nine months ended September 30, 2020 due to lower sales
volumes and higher volume of domestic shipments.
Selling, General, and Administrative Expenses
Selling, general, and administrative expenses were $127.6 million for the nine
months ended September 30, 2020, a decrease of 6.6%, compared to $136.5 million
for the nine months ended
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September 30, 2019. The decrease was driven primarily by a $5.2 million decrease
in personnel and related costs (including salary and related taxes/benefits,
commissions and equity-based compensation expense), a $3.2 million decrease in
advertising and marketing, and a $2.3 million decrease in warehouse and office
support. These decreases were partially offset by a $2.7 million increase in
administrative costs which primarily resulted from increases in our estimated
bad debt reserves and a $2.0 million increase in facilities and rent as a result
of full period rental expense on our Hollywood retail store. Additional expenses
generally related to COVID-19 business interruptions and our remote working
environment as well as lower sales volumes. Selling, general and administrative
expenses were 29.9% and 23.5% of net sales for the nine months ended
September 30, 2020 and 2019, respectively.
Depreciation and Amortization
Depreciation and amortization expense was $33.9 million for the nine months
ended September 30, 2020, an increase of 9.1%, compared to $31.1 million for the
nine months ended September 30, 2019, primarily driven by an increase in
depreciation on our office and warehouse facilities, including the addition of
our Hollywood retail store.
Interest Expense, Net
Interest expense, net was $8.2 million for the nine months ended September 30,
2020, a decrease of 28.2%, compared to $11.5 million for the nine months ended
September 30, 2019. The decrease in interest expense, net was due primarily to
lower interest rates on debt outstanding during the nine months ended
September 30, 2020 as compared to the interest rates on debt outstanding during
the nine months ended September 30, 2019 as a result of the second and third
amendments to the Credit Facilities entered into on September 23, 2019 and May
5, 2020, respectively.
Other expense, net
Other expense, net was $1.5 million for the nine months ended September 30,
2020, compared to other income of $0.4 million for the nine months ended
September 30, 2019. Other (income) expense, net for the nine months ended
September 30, 2020 and 2019 was primarily related to foreign currency gains and
losses relating to transactions denominated in currencies other than the US
dollar.
Income tax (benefit) expense
Income tax benefit was $1.1 million for the nine months ended September 30,
2020, compared to income tax expense of $6.5 million for the nine months ended
September 30, 2019. The decrease in income tax expense for the nine months ended
September 30, 2020 from September 30, 2019 was primarily related to reduced
income tax expense due to a decrease in income (loss) before income taxes
partially offset by income tax expense related to a true-up return to provision
adjustment.
Net (loss) income
Net loss was $5.1 million for the nine months ended September 30, 2020, compared
to net income of $34.1 million for the nine months ended September 30, 2019,
primarily due to the decrease in net sales and partially offset by the decrease
in cost of sales (exclusive of depreciation and amortization) and decrease in
selling, general and administrative expenses, for the nine months ended
September 30, 2020 as compared to the nine months ended September 30, 2019, as
discussed above.

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Non-GAAP Financial Measures
EBITDA, Adjusted EBITDA, Adjusted Net Income and Adjusted 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 income (loss), earnings (loss) per share or any other performance measure
derived in accordance with U.S. GAAP. We define EBITDA as net income (loss)
before interest expense, net, income tax expense, depreciation and amortization.
We define Adjusted EBITDA as EBITDA further adjusted for non-cash charges
related to equity-based compensation programs, acquisition transaction costs and
other expenses, customs investigation and related costs, certain severance,
relocation and related costs, foreign currency transaction gains and losses and
other unusual or one-time items. We define Adjusted Net Income as net income
(loss) attributable to Funko, Inc. adjusted for the reallocation of income
(loss) 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,
acquisition transaction costs and other expenses, customs investigation and
related costs, certain severance, relocation and related costs, foreign currency
transaction gains and losses and other unusual or one-time items, and the income
tax expense effect of these adjustments. We define Adjusted Earnings per Diluted
Share as Adjusted Net 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.
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 (loss) or other financial
statement data presented in our
                                       27
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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, acquisition
transaction costs and other expenses, customs investigation and related costs,
certain severance, relocation and related costs, foreign currency transaction
gains and losses and other unusual or one-time items. It is reasonable to expect
that 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 (loss), for the periods presented:

                                              Three Months Ended September 30,       Nine Months Ended September 30,
                                                  2020                2019               2020                2019
                                                               (In thousands, except per share data)
Net income (loss) attributable to Funko, Inc. $    9,796$   8,639$   (4,915)$  15,966
Reallocation of net income (loss)
attributable to non-controlling interests
from the assumed exchange of common units of
FAH, LLC for Class A common stock (1)              5,801              6,909                (229)            18,142
Equity-based compensation (2)                      2,456              3,715               7,494              9,830
Acquisition transaction costs and other
expenses (3)                                           -                733                   -                383
Customs investigation and related costs (4)            -              2,907                   -              3,357
Certain severance, relocation and related
costs (5)                                          1,178                180               2,184                180
Foreign currency transaction loss (6)                778                577               1,449                423

Income tax expense (7)                            (3,937)            (3,766)             (2,350)            (7,222)
Adjusted net income                           $   16,072$  19,894$    3,633$  41,059
Weighted-average shares of Class A common
stock outstanding-basic                           35,483             32,055              35,155             29,555
Equity-based compensation awards and common
units of FAH, LLC that are convertible into
Class A common stock                              16,047             20,510              15,770             22,556
Adjusted weighted-average shares of Class A
stock outstanding - diluted                       51,530             52,565              50,925             52,111
Adjusted earnings per diluted share           $     0.31$    0.38

$ 0.07$ 0.79

                                       29
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                                            Three Months Ended September 30,       Nine Months Ended September 30,
                                                2020                2019               2020                2019
                                                                    (amounts in thousands)
Net income (loss)                           $   15,597$  15,548$   (5,144)$  34,108
Interest expense, net                            2,875              3,620               8,221             11,455
Income tax expense (benefit)                     1,420              2,865              (1,139)             6,464
Depreciation and amortization                   11,887             10,472              33,947             31,127
EBITDA                                      $   31,779$  32,505$   35,885$  83,154
Adjustments:
Equity-based compensation (2)                    2,456              3,715               7,494              9,830
Acquisition transaction costs and other
expenses (3)                                         -                733                   -                383
Customs investigation and related costs (4)          -              2,907                   -              3,357
Certain severance, relocation and related
costs (5)                                        1,178                180               2,184                180
Foreign currency transaction loss (6)              778                577               1,449                423
Adjusted EBITDA                             $   36,191$  40,617$   47,012$  97,327


(1)Represents the reallocation of net income (loss) 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 (loss) was attributable to
non-controlling interests.
(2)Represents non-cash charges related to equity-based compensation programs,
which vary from period to period depending on the timing of awards.
(3)Represents legal, accounting, and other related costs incurred in connection
with acquisitions and other potential transactions.
(4)Represents legal, accounting and other related costs incurred in connection
with the Company's investigation of the underpayment of customs duties at
Loungefly. For the nine months ended September 30, 2019, includes the accrual of
a contingent liability of $0.5 million related to potential penalties that may
be assessed by U.S. Customs in connection with the underpayment of customs
duties at Loungefly.
(5)For the three and nine months ended September 30, 2020, represents severance,
relocation and related costs associated with the consolidation of our warehouse
facilities in the United Kingdom. The Company also incurred charges to impaired
right-of-use leased and fixed assets related to Funko Animation Studios and
charges related to the global workforce reduction implemented in response to the
COVID-19 pandemic. For the three and nine months ended September 30, 2019,
represents severance, relocation and related costs associated with the
consolidation of our warehouse facilities in the United Kingdom.
(6)Represents both unrealized and realized foreign currency losses on
transactions denominated other than in U.S. dollars, including derivative gains
and losses on foreign currency forward exchange contracts.
(7)Represents the income tax expense effect of the above adjustments. This
adjustment uses an effective tax rate of 25% for all periods presented.
                                       30
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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, 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 as a public company 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 long-term future needs beyond the next 12 months,
particularly in light of the ongoing nature of the COVID-19 pandemic and its
continuing impact on the global economy and consumer demand. In addition to the
flexibility provided by the Third Amendment (as described below), we are
currently evaluating additional options to improve our liquidity, such as the
issuance of additional unsecured and secured debt, equity securities and
equity-linked securities. There can be no assurance as to the timing of any such
issuance, which may be in the near term, and any such financing may be material
in nature and could result in significant additional borrowings or issuances of
equity or equity-linked securities. If we obtain additional capital by issuing
equity, the interests of our existing stockholders will be diluted, which may be
significant. 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, 2020 and 2019 (in thousands):
                                                                 Nine 

Months Ended September 30,

                                                                   2020                    2019
Net cash provided by operating activities                   $         60,345          $     62,986
Net cash used in investing activities                                (14,704)              (33,524)
Net cash used in financing activities                                (39,662)              (30,759)
Effect of exchange rates on cash and cash equivalents                    687                 1,303
Net increase in cash and cash equivalents                   $          

6,666 $ 6



Operating Activities. Net cash provided by operating activities was $60.3
million for the nine months ended September 30, 2020, compared to $63.0 million
for the nine months ended September 30, 2019. Changes in net cash provided by
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 provided by 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 for the nine months ended September 30, 2020 compared to the nine
months ended September 30, 2019 was primarily due to the decrease in net income,
excluding non-cash adjustments, of $34.6 million, driven primarily by a decrease
in net sales due to the impact of the COVID-19 pandemic, partially offset by a
decrease in interest expense, net and a decrease in cost of sales (exclusive of
                                       31
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depreciation and amortization) and selling, general and administrative expenses.
Partially offsetting the decrease in net income was an increase related to
changes in working capital that increased net cash provided by operating
activities by $32.0 million and was primarily due to decreases in accounts
receivable, net of $33.2 million and prepaid expenses and other assets of $13.6
million, partially offset by a decrease in accounts payable of $25.9 million and
an increase in accrued expenses and other liabilities of $12.2 million.
Investing Activities. Our net cash used in investing activities primarily
consists of acquisitions, net of cash, and purchases of property and equipment.
For the nine months ended September 30, 2020, net cash used in investing
activities was $14.7 million and was primarily related to purchases of tooling
and molds used in production our product lines.
For the nine months ended September 30, 2019, net cash used in investing
activities was $33.5 million and was primarily comprised of $27.2 million for
purchases of property and equipment primarily relating to tooling and molds and
initial cash consideration, net of cash acquired of $6.4 million for the
Forrest-Pruzan acquisition.
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 Continuing Equity Owners and proceeds from the exercise of
equity-based options. We anticipate minimal future financing activity related to
contributions from the Continuing Equity Owners.
For the nine months ended September 30, 2020, net cash used in financing
activities was $39.7 million, primarily related to payments on the Term Loan
Facility of $8.8 million, distributions to the Continuing Equity Owners of $3.5
million, and net repayments on the Revolving Credit Facility of $26.8 million.
For the nine months ended September 30, 2019, net cash used in financing
activities was $30.8 million, primarily related to distributions to the
Continuing Equity Owners of $22.9 million, payments on the Term Loan Facility of
$8.8 million, and net payments on the Revolving Credit Facility of $0.8 million
partially offset by proceeds from the exercise of equity-based options of $2.2
million.
Credit Facilities
On October 22, 2018 (the "Closing Date"), Funko Acquisition Holdings, L.L.C.,
Funko Holdings LLC, Funko, LLC and Loungefly, LLC (each, a "Borrower" and
collectively, the "Borrowers"), entered into a new Credit Agreement by and among
each Borrower, certain financial institutions party thereto and PNC Bank,
National Association, as administrative agent and collateral agent, providing
for a Term Loan Facility in the amount of $235.0 million and a Revolving Credit
Facility of $50.0 million. Proceeds from the Credit Facilities were primarily
used to repay our prior senior secured credit facilities.
On February 11, 2019, the Company amended its Credit Agreement to increase the
Revolving Credit Facility to $75.0 million, reflecting the incremental capacity
of $25.0 million contemplated under the Credit Facilities prior to such
amendment.
On September 23, 2019, the Company entered into a second amendment to the Credit
Agreement (the "Second Amendment"). The Second Amendment extended the maturity
date of the Term Loan Facility and Revolving Credit Facility under the Credit
Agreement to September 23, 2024, reduced the interest margin applicable to all
loans under the Credit Agreement by 0.75% and reduced certain fees incurred
under the Credit Agreement. The Second Amendment also allows the Company to
request that the Term Loan Facility be increased by an additional $25.0 million.
On May 5, 2020, the Company entered into the Third Amendment, which amended and
modified the Credit Agreement, to, among other things, (i) waive the financial
covenants under the Credit Agreement
                                       32
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for the fiscal quarters ending June 30, 2020 and September 30, 2020 (the "Waiver
Period"), (ii) add a requirement to maintain a minimum liquidity of at least $30
million until the Leverage Ratio (as defined in the Credit Agreement) is less
than 2.50 to 1.00 for a period of four consecutive fiscal quarters, (iii) hold
the incurrence ratios for certain restricted payments, investments and
dispositions at the levels applicable prior to the effectiveness of the Third
Amendment, (iv) increase the interest and fees payable under the Credit
Agreement from the date of Third Amendment through (but excluding) the first
date on which the Company receives cumulative net cash proceeds of at least $50
million from certain issuances of permitted equity or convertible subordinated
debt and (v) allow that any calculation of Consolidated EBITDA (as defined in
the Credit Agreement) that includes the fiscal quarter ended December 31, 2019
may include non-cash expenses for inventory write-downs incurred by the Company
during such quarter. For the four consecutive fiscal quarter period ended June
30, 2020, we were able to demonstrate a leverage ratio of less than 2.50 to 1:00
and were therefore no longer subject to the minimum liquidity requirement.
The Third Amendment adjusted the required leverage levels for the Leverage Ratio
to provide the Company with additional flexibility following the Waiver Period.
The Credit Facilities are secured by substantially all assets of the Borrowers
and any of their existing or future material domestic subsidiaries, subject to
customary exceptions. We are a holding company with no material assets, and we
do not conduct any business operations of our own. We have no independent means
of generating revenue or cash flow, and our ability to pay dividends in the
future, if any, is dependent upon the financial results and cash flows of FAH,
LLC and its subsidiaries and distributions we receive from FAH, LLC. Under the
terms of the Credit Facilities, our operating subsidiaries are currently limited
in their ability to pay cash dividends to the Company, subject to certain
customary exceptions, including:
•the ability to pay, so long as there is no current or ongoing event of default,
amounts required to be paid under the Tax Receivable Agreement, certain expenses
associated with being a public company and reimbursement of expenses required by
the FAH LLC Agreement or the Registration Rights Agreement; and
•other than during the period commencing on (and including) the Third Amendment
closing date and ending on (and including) September 30, 2020, the ability to
make other distributions of up to $25.0 million during any period of four fiscal
quarters in order to pay dividends to the common unit holders of FAH, LLC
(including the Company) as long as the funds received by the Company are used to
pay dividends to the Company's stockholders, the Leverage Ratio (as defined in
the Credit Agreement) is not greater than a ratio that is 0.50:1.00 less than
the Leverage Ratio under the Pro Forma Financial Covenant Requirement (as
defined in the Credit Agreement) for the applicable fiscal quarter and there is
remaining Availability (as defined in the Credit Agreement) under the Credit
Facilities of at least $25.0 million.
We expect these limitations to continue in the future under the terms of the
Credit Agreement and that they may continue under the terms of any future credit
agreement or any future debt or preferred equity securities of ours or of our
subsidiaries.
The Borrowers and any of their existing or future material domestic
subsidiaries, subject to customary exceptions, guarantee repayment of the Credit
Facilities. The Term Loan Facility matures on September 23, 2024 (the "Maturity
Date"). The Term Loan Facility amortizes in quarterly installments in aggregate
amounts equal to 5.00% of the original principal amount of the Term Loan
Facility ("Original Principal Amount") in the first and second years of the Term
Loan Facility, 10.00% of the Original Principal Amount in the third and fourth
years of the Term Loan Facility and 12.50% of the Original Principal Amount in
the fifth and sixth year of the Term Loan Facility, with any outstanding balance
due and payable on the Maturity Date. The Revolving Credit Facility terminates
on the Maturity Date and loans thereunder may be
                                       33
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borrowed, repaid, and reborrowed up to such date. As of September 30, 2020, we
had no outstanding borrowings under the Revolving Credit Facility.
As amended, loans under the Credit Facilities, at the Borrowers' option, bear
interest at either the Euro-Rate (as defined in the Credit Agreement) or, in the
case of swing loans, the Swing Rate (as defined in the Credit Agreement), plus
3.00% or the Base Rate (as defined in the Credit Agreement) plus 2.00%, with
0.25% step-downs based on the achievement of certain leverage ratios following
the Closing Date. The Euro-Rate is subject to a 1.00% floor and for loans based
on the Euro-Rate, interest payments are due at the end of each applicable
interest period.
The Credit Agreement governing the Credit Facilities 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;
•alter the business conducted by us and our subsidiaries;
•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 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.
In addition, the Credit Agreement requires FAH, LLC and its subsidiaries to
comply on a quarterly basis with a maximum Leverage Ratio and a minimum fixed
charge coverage ratio (in each case, measured on a trailing four-quarter basis),
except as described above in connection with the Waiver Period. The maximum
Leverage Ratio and the minimum fixed charge coverage ratio for the fiscal
quarter ending December 31, 2020 are 4.25:1.00 and 1.25:1.00, respectively.
As of September 30, 2020 and December 31, 2019, we were in compliance with all
covenants in our Credit Agreement, as amended. In accordance with the Third
Amendment, the financial covenants under the Credit Agreement were waived during
the Waiver Period. 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 caused by the
COVID-19 global pandemic worsen and the Company's earnings and operating cash
flows do not start to recover as currently estimated by management, this could
impact our ability to maintain compliance with our amended financial covenants
and require the Company to seek additional amendments to our Credit Agreement.
The Credit Agreement also contains certain customary representations and
warranties and affirmative covenants, and certain reporting obligations. In
addition, the lenders under the Credit Facilities will be permitted to
accelerate all outstanding borrowings and other obligations, terminate
outstanding
                                       34
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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
judgments and changes of control. The 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, 2020, we had $208.1 million of indebtedness outstanding
under our Credit Facilities, consisting of $208.1 million outstanding under our
Term Loan Facility (net of unamortized discount of $3.4 million) and no
outstanding borrowings under our Revolving Credit Facility, leaving
$75.0 million available under our Revolving Credit Facility.
Form S-3 Registration Statement
On April 20, 2019, we filed a preliminary shelf registration statement on Form
S-3 (as amended on May 13, 2019 and August 30, 2019, the "Form S-3") with the
SEC. The Form S-3 was declared effective by the SEC on September 16, 2019. 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 27,884,185
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, 2020, we had $31.9 million of cash and cash equivalents and
$100.2 million of working capital, compared with $25.2 million of cash and cash
equivalents and $101.6 million of working capital as of December 31, 2019.
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 our line of credit.
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 4, Debt.
In addition, as described above, on April 20, 2019, we filed a preliminary shelf
registration statement on Form S-3 with the SEC, which was declared effective by
the SEC on September 16, 2019. 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.
We cannot assure you that our cash provided by operating activities or cash
available under our Credit Facilities will be sufficient to meet our long-term
future needs beyond the next 12 months, particularly in light of the ongoing
nature of the COVID-19 pandemic and its continuing impact on the global economy
and consumer demand. We are currently evaluating additional options to improve
our liquidity, such as the issuance of additional unsecured and secured debt,
equity securities and equity-linked securities. However, the disruption and
volatility in the global capital markets caused by COVID-19 could impact our
                                       35
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ability to access the capital markets and could therefore have a material
adverse effect on our future liquidity.
Uses
Additional future liquidity needs may include public company costs, 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. The
Continuing Equity Owners may exercise their redemption right for as long as
their common units remain outstanding. Although the actual timing and amount of
any payments that may be made under the Tax Receivable Agreement will vary, we
expect that the payments we will be required to make to the Continuing Equity
Owners will be significant. Any payments made by us to the Continuing Equity
Owners 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.
Contractual Obligations
There were no material changes in our commitments during the nine months ended
September 30, 2020 under contractual obligations from those disclosed in our
Annual Report on Form 10-K for the year ended December 31, 2019 outside the
course of normal business.
Off-Balance Sheet Arrangements
As of September 30, 2020, we did not have any off-balance sheet arrangements.
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.
                                       36

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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, equity-based compensation and income taxes.
Changes to these policies and estimates could have a material adverse effect on
our results of operations and financial condition.
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, 2019 except as
disclosed in Note 2, Significant Accounting Policies.

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